Wealth Accumulation

Because a retirement plan may span several decades, many people believe that retirement planning is difficult and unrealistic. Actually, retirement planning is not as difficult as you may think. If you set your goals for an ideal retirement systematically, have a clear, step-by-step execution plan, and review and modify the plans periodically, you can realize your ideal retirement.

Some people have spent their whole life working in big cities and look forward to returning to nature and the countryside after retirement; others have spent their whole life busily working for the family and making a living and hope to live a carefree life or spend retirement for themselves through continued education to realize the dreams they had when they were young. No matter what kind of person you are, you must have an image of the ideal retirement in mind, and the first step in retirement planning is transforming that image into a concrete financial goal.

HSBC recommends that you first determine an expected standard of living (or level of expenses) after retirement and compare it with the standard of living before retirement to find out if it is going to be higher, lower or the same as the standard before retirement. For example, if you plan to go golfing twice a week and take many trips overseas after retirement, your level of expenses after retirement may be higher than before retirement, whereas if you plan a simple life after retirement doing volunteer work, the level of expenses after retirement may be the same or lower than before retirement. With an image of life after retirement, it is easy to translate it into numbers, and with the help of income replacement rates and other simple figures, we can make a simple estimate as to the funds required after retirement.

The next example shows how to translate your ideal retirement lifestyle into concrete financial figures through the setting of parameters.

Example:

We take the example of white-collar Mr. Zhao who wishes to take two more overseas trips per year and go golfing two more times per month after retirement. In addition to maintaining the standard of living before retirement, his total expenses will increase with the increase in entertainment expenses after retirement. In this case the income replacement rate is a good transformation parameter. We suggest Mr. Zhao to pick a higher income replacement rate of 80% and an appropriate salary growth rate to estimate his salary and monthly expenses before retirement. He can then turn his ideal retirement lifestyle into concrete financial figures to be used in setting financial goals for retirement planning.

Please refer to the following table for details:

*The affects of return on asset on the appreciation of total assets are taken into account.
*For the detailed calculation formula, please consult an HSBC financial consultant.

After setting a retirement goal, you must understand what the sources for your retirement funds are. By clarifying these sources of funds and examining your current financial condition, you can estimate the assets you will have by retirement and the difference between the funds you need for retirement. As long as you have a systematic plan to fill that gap, reaching your ideal retirement goal is not a dream.

Understand the main sources of retirement funds

There are three main sources of retirement funds: 1. Old-age citizen's welfare allowance from the Bureau of Labor Insurance 2. Employer contributed pension 3. Personal savings and investments; In Switzerland, where its comprehensive pension system is world renowned, the first two sources of retirement funds constitute 60% of the income replacement rate. Thus, the Swiss can fill the 10% gap easily with savings. On the other hand, after the new pension system is introduced in Taiwan, the income replacement rate of welfare allowance and employer contribution is rather low. Take the average domestic monthly salary of NTD32,000, the old-age welfare allowance available at retirement is about 1.4 million. Dividing that by a rough estimate of the remaining life expectancy of 25 years, the amount comes down to only 4,600 per month. In other words, the labor insurance allowance has an income replacement rate of only 14%. In terms of employer contributed pension, under the new pension system, the employer must contribute 6% of the employees salary into his/her retirement pension account. Assuming an employee works from 25 to 60 years of age with a salary growth of 2%, and the ROI of the pension is 2%, the employer contributed pension will have an income replacement rate of 13%. Therefore, even before taking the effects of inflation into account, the combined income replacement rate of old-age allowance and pension amount to only 27%. To reach the level of income replacement, conventionally considered appropriate, of 70%, the gap that must be filled by oneself is a whopping 43%. This figure illustrates precisely how important personal savings and investments are for retirement planning in Taiwan.

Examine your personal assets, Determining the gap to fill for retirement

Before determining how much to save per month for retirement, you must first examine how many financial assets (eg. cash, equities, mutual funds) you currently own and the value of real estate invested; then, by estimating a reasonable expected return (e.g. the 2-yr NTD time-deposit rate), estimate the value of your assets at the time of retirement. This plus the amount of old-age allowance and pension will constitute your assets at the time of retirement. Finally, subtract the value of your retirement assets from the estimated funds required for retirement and you now have determined the gap you must fill.

Example:

Continuing with Mr. Zhao's example, to find out the gap he needs to fill for retirement, see the calculations in following table：

After determining the gap to fill, the next step is to assess your risk tolerance and develop an appropriate investment strategy using the asset allocation and investment instrument most suited for your needs.

Importance of Asset Allocation

In recent years, the concept of “asset allocation” is becoming prevalent in personal wealth management. According to a study published by Brinson, Singer and Beebower in the Financial Analyst Journal in 1991, the most important factor affecting long-term returns is “asset allocation”; the degree of influence is 91.5% whereas factors normally considered important such as stock choice and timing have a mere 6.4% effect on long-term returns However, asset allocation is more than selecting different investment instruments. True asset allocation examines the characteristics of assets and the correlation between different assets, and raise long-term returns by adjusting the investment position of different assets.

Instruments for retirement planning

Since retirement planning focuses on “preserving capital", it has a lower risk tolerance than conventional investments. The next table lists investment instruments commonly used for retirement planning and their respective strengths and weaknesses to help you select the appropriate instruments for your retirement planning.

To conclude from the above, investment-type insurance is an excellent investment instrument for retirement planning as it satisfies both the need for wealth accumulation and protection, and effectively diversifies risk through appropriate asset allocation. However if you already have enough life insurance coverage, mutual funds can also be an appropriate choice for the accumulation of wealth.

The last step in retirement planning is to periodically review your wealth accumulation progress. As one's financial condition, investment capacity and investment environment can all change over time, continuously tracking and reviewing one's retirement plan, then making appropriate adjustments, is extremely important. Without periodical review and adjustments, it may be hard to successfully reach your retirement goals over the long-term; in other words, periodical reviews can ensure the appropriateness of the retirement plan. Also, we must re-examine our original retirement plan whenever the following significant changes take place:

• Family Structure
  Events such as marriage, divorce, remarriage and childbirth all affect expenditures of the family.
• Financial Need
  Taking overseas trips, continued education, medical expenses and losses due to natural disasters can all affect the financial gap to fill for retirement.
• Income
  Don't forget to calculate the effects to your retirement plans when changing jobs or when getting a promotion or demotion.
• Asset Value
  When there is a change in the value of assets, you must reassess whether an adjustment needs to be made to the current investment plan.
• Retirement Goal
  There may be a change of retirement goals in terms of retirement timing and lifestyle due to changes in health.

Finally, inflation is also a variable that needs to be watched closely; if inflation is higher than previously expected, it means that the rise in prices is higher than expected, and more retirement funds must be prepared as the real purchasing power decreases (see table below). Thus, adjustments must be made to the contents and asset allocation of the original retirement planning when there is a change in the rate of inflation.

Amount of required retirement funds change under different rates of inflation

Assume：Investment Return= 5% annually