Rajen Devadason, a licensed financial planner with Manulife Investment Management Bhd, says falling interest rates are not exclusive to Malaysia but a recurring phenomenon around the world. “It is natural for retirees to want to safeguard their retirement nest eggs keeping their precious money super safe in banks. Unfortunately, with falling interest rates, FD rates are also dropping. As a result, the amount of interest earned retirees shrinks.
“For most conservative, relatively unsophisticated retirees, who rely wholly on FDs to generate their retirement income, that passive income stream falls steadily. This leaves them with no choice but to dip into their capital to fund their retirement.
“In the long run, this will result in impoverished elderly people who have fully depleted their retirement nest eggs. The outcome is grim and, for many people, inevitable. It is a demographic time bomb.”
It is crucial to note that people who focus on increasing their savings in FDs often overlook their “real returns”, says Joyce Chuah, a licensed financial planner and CEO of Success Concepts Sdn Bhd. The real rate of return is calculated subtracting the inflation rate from the nominal interest rate.
“FDs should only act as a cushion in retirement income. If people were to depend 100% on their FDs, decisions like the OPR cut would be unavoidable. These people would have to downgrade their lifestyle choices because they would not be able to control factors such as the OPR,” says Chuah.
“I understand that they would want their capital protected. But FDs are not altogether protected against inflation, for example. It is just protection of capital in absolute terms.”
Neoh points out that in the attempt to preserve their wealth, many tend to be highly averse to risks. “If you want to substitute your FDs with something of a similar nature and compensate for what these lack, look at fairly safe investments such as bonds and bond funds, which can be substitutes to a certain extent.”
While bond investors are subject to credit risk, liquidity risk and interest-rate risk, bonds with good credit ratings reduce these pertinent risks, he adds. “The good thing about bonds is that if you buy a bond that is highly rated such as AA or AAA, the likelihood of capital loss is quite low if you hold it to maturity.”
Retirees can also leverage bond funds as these are often structured in such a way that the terms emphasise capital preservation and returns, says Neoh. “The returns of a bond fund is typically 1% to 2% above FD rates.”
However, he stresses that retirees need to understand their financial goals before making such investments as not all bond funds carry the same risks. “Some are purely bond funds while others could have small exposure to equities or some kind of derivative.
“While bond funds in general may be a suitable alternative, pay attention to the funds’ investment universe. If there is an equities element to the fund, it cuts both ways — it could give you slightly better returns, but it could also have potential depreciation of principal risk.”
For those willing to take on more risks, there are the options of having a dividend-focused investment portfolio, which could include defensive stocks or bonds, and real estate investment trusts (REITS). “The nature of REITs is that they actually distribute the bulk of their income to investors,” says Neoh.
Alternatively, EPF members could voluntarily increase their contributions to the provident fund. Malaysians are allowed to deposit a maximum of RM60,000 a year, says Neoh. Last year, EPF declared a dividend rate of 6.15% for conventional savings and 5.9% for shariah savings for the year 2018.
Devadason says prudent retirement planning involves gradually reducing one’s reliance on active income over time and replacing it with a growing stream of passive income. “Without getting too esoteric, there are four primary forms of passive income, which most regular people focus on nurturing and growing over their working career. These are interest from bank savings and money market funds, dividends from high-quality income stocks, distributions from unit trusts and direct rental income from bricks-and-mortar properties or indirect rental inflows from REITs and REIT funds.”
To preserve their wealth, people need to change their approach to investments, says Chuah. “It is important to have a portfolio that consists of core, cushion and complementary investments — one that gives you better returns than the inflation rate, one that could include FDs but also supplemented with dividend-yielding stocks and bonds.
“Retirees have to learn to look at their portfolios differently and remember that keeping their money in FDs 100% is not without risks, even if there is no change to the OPR. The inflation rate in Malaysia is already 3% to 4%. So, they are already losing money without really knowing it. If they want to preserve their wealth, they need to think like investors.”
First published in Personal Wealth, The Edge Malaysia Weekly, on February 3, 2020 – February 09, 2020.