Investing for Retirement: Employee's Choice

How you invest your retirement savings can be just as important as how much you save Whether investing through a company registered provident fund (PVD) or through tax exempted vehicles such as Retirement Mutual Funds (RMF) and Long Term Equity Funds (LTF), the question remains: in what, specifically, should you invest? . There are literally hundreds of investment options vying for your retirement savings ranging from low-risk investments such as government bonds to higher risk ones such as stocks, mutual funds, life insurance policies etc. However, many of these can be easily dismissed as totally inappropriate for your retirement savings.

Investment Basics

The two most fundamental elements that you will need to consider about any possible investment are its potential for risk and its probable long-term return . There are ultra-low-risk investment options available such as government bonds and bank deposits, which currently enjoy full guarantee from the government, and on the surface, these can have some appeal. After all, why take chances with “your last lump sum”? But almost inevitably, low-risk investments also are low-return investments. Therefore, if you want your investments to earn significantly more than the rate of inflation, then you essentially are required to put your money in investments that have the potential to lose money. Admittedly, many people simply don't like the idea of sacrificing the safety net of government bonds for the return potential of stocks, even when they know it's probably the right thing to do. But the amount of volatility that you should take and, thus, the type of investments that you should make for retirement depends largely on three factors:

1.Your Age. The chief investment vehicle available to retirement savers, particularly those that are still young, is stocks and equity mutual funds. Other types of investments might have a place in your retirement portfolio as well, but chances are equity should dominate. After all, volatile investments such as stocks might not be as risky as you think, especially those of you that have many more years before retirement. It's true enough that over a one-year period, there is a fair chance that you will lose some money investing in equity. Even over 5-year spans, substantial stock market losses have occurred. But if your portfolio is sufficiently diversified through equity index funds both on shore and offshore, it has been proven that over a long period of time, stocks will outperform bonds and the probability of losing money will be greatly diminished.

2.Your Saving Targets. By using retirement calculators, which are now widely available on the internet ( ) you can figure out for yourself how much you will need for a comfortable retirement and the sum Baht 10 mm. is not an unrealistic target for someone in his or her 30s with Baht 30,000 monthly salary. Realistically speaking, your retirement investments will need to earn 8-10% per year in order to achieve that target and you won't be getting that kind of returns from government bonds nor bank deposits. The only realistic choice is equity.

3.Your Risk Tolerance. There are people with cast iron stomachs that could watch their retirement savings decline in value by 30 or 40% and not panic. But for most of us, such a substantial decline in the value of our retirement savings would be a gut wrenching experience. However, there are two ways to deal with this problem:

Option 1 is to pull back slightly on the potential volatility of your portfolio by reducing the exposure to equity but this will definitely mean lower returns in the long run and you may not reach your retirement savings target.

Option 2 , which in my opinion is a better way to go, is to diversify , which is a dependable way to decrease your investments' risk without necessarily reducing their potential for some long term returns. Simply put, diversification means spreading your investments among a variety of asset classes. Since different investments often react in different ways to the same market condition, this can reduce the chances that your entire portfolio will take a nosedive at any given moment.

In the real world, there are times when virtually every stock will go up or down together, although to different degrees. In fact, there are even times when both stocks and bonds head in the same direction. And it's not always obvious how a stock will react to a given market condition, or is it possible to predict what conditions might prevail in the future. Therefore, investors will be better off if they spread their investments around a bit.

Employee's Choice: The Portfolio That's Right for Your Retirement

What's the right balance between stocks and bonds? To some extent, your personal risk tolerance and your retirement savings target play a role, but the most significant factor is your age. The further you are from retirement the less concern you should be about stock market volatility. As you get closer to retirement, it generally makes sense to become increasingly cautious. Opinions vary on the best formula, but the old rule of thumb used to be subtract your age from 100, and invest that percentage in stocks. That worked well enough when people lived to 70, but today there's a good chance we will live into our 90s, therefore, we have to be a bit more aggressive and the following is a good start:

  • Aggressive Plan: 125-Current Age= % to Invest in Stocks
  • Average Plan: 115-Current Age= % to Invest in Stocks
  • Conservative Plan: 105-Current Age= % to Invest in Stocks

For example, a 40-year-old planning for retirement might invest as much as 85% of his retirement savings in stocks or equity mutual funds if he considered himself a risk-tolerant investor, or as little as 65% if he wanted to play it a bit safer. In either case, the remainder would be invested in bonds or bond mutual funds.

The decision between stocks and bonds is only the first asset allocation decision process. The next step is to divide the stock component in the portfolio between the many different types of stocks that are available. The same principle also applies to bonds, which can be summarized as follows:

  • Foreign and domestic stocks . 40% domestic (SET Listed) stocks and 60% foreign equity is perhaps the most recommended allocation.
  • Large Cap and Small Cap Stocks. Index funds are often used to achieve optimum diversification because they are cheap and easy to execute. Medium and small capitalization stocks, on the other hand, tend to be more volatile and have greater long-term earnings potential, so they might make up a small portion in the portfolio.
  • Bonds of different maturities. Bond funds of different credit risks and maturities are often used to make up the remainder of the retirement savings portfolio.

The abovementioned asset allocation guidelines can be readily applied to Retirement Mutual Funds (RMF) and to a lesser extent Long-Term Equity Funds (LTF). Currently, there are several RMFs and LTFs covering pretty much all of the major asset classes to choose from. However, for many of us who are employees, the bulk of our retirement savings are tied up in the form of registered provident funds and more often than not, investment choices are not available and worse of all they are not readily “portable” when changing jobs. The good news is that the SEC is trying to promote the concept of “Employee's Choice” where provident fund members can determine their own asset allocation decisions. Already, one or two asset management companies have already taken the initiatives to launch the concept. Therefore, when ever possible, always insist on employee's choice because one size does not fit all and at the end of the day, it's your own retirement funds that matters not your co-workers.

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