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Difficulty: Easy
1) When you become a parent, your risk appetite naturally changes
2) Which investment options are suitable for parents?
3) Characteristics of investment options
4) Are long-term stock holdings a good alternative to endowments?
5) Consider endowment plans, especially if your child is starting university in <10 years
Disclaimer: This article is meant for information purposes only! Such information does not constitute financial or investment advice and is solely the opinions expressed by The InvestQuest, as we start planning for children in the future. All information and opinions are made on a best efforts basis at the time of publication but should not be relied upon for making any financial or investment decisions. Do your own homework!
1) When you become a parent, your risk appetite naturally changes
Prior to becoming a parent, young individuals might have a bigger appetite for risk, in hopes of higher returns to grow their wealth. This is especially the case if their parents and siblings are not dependent on them for financial support.
But upon becoming a parent, these individuals may make certain financial priorities non-negotiable, especially those concerning their offspring. For instance, you might want to commit to supporting your child through university – no matter what. For these non-negotiable expenses, volatile instruments like stocks might not be suitable.
At the same time, to store your wealth *entirely* in cash is NOT optimal. Cash doesn’t earn you a return. In fact, its value decreases as time passes with positive inflation.
2) Which investment options are suitable for parents?
Instead of just cash, it’s better to store your wealth across different investment instruments to match specific types of expenses. Here are specific investment instruments that are suitable for the various expenses, in our opinion.
We matched investment options with expenses according to 1) when one would need the money and 2) how much risk we believe most parents can tolerate when it comes to meeting that expense.
With regard to when the money is needed, we generally matched “liquid” instruments with fairly urgent expenses. By “liquid”, we mean that those instruments are easy to buy and sell and can be done so quickly.
With regard to risk tolerance, we believe that these expenses are non-negotiable to most parents: 1) monthly expenses, 2) emergency/medical expenses, and 3) university fees. If you’ve set aside money for those purposes, you probably really don’t want the value of that money to go down. As such, the instruments we suggested for those expenses have low to negligible risk of principal loss.
On the other hand, most people can withstand some degree of risk when it comes to 1) their retirement savings and 2) excess money that they have on hand, in hopes of better returns.
3) Characteristics of investment options
Here are the main investment options available for Singapore investors.
Disclaimer: Do note that the risk, return and liquidity profiles of the various investment options are made on a best efforts basis, at the time of publication. Please do your own due diligence before making any purchases.
Below we show the yields of commonly held SGD investment options. We have colour-coded bond vehicles in green, mixed-asset vehicles in yellow and stock vehicles in orange.
You shouldn’t pick investment options based on yield alone. As we highlighted below, only the Singapore Savings Bond and Singapore Endowments are/are often principal protected. The other investment options may lose their principal value (i.e. you may end up with less than what you put in).
Note 1: Bond ETF yields = ETF’s yield to maturity minus total expense ratio.
Note 2: Endowments may offer guaranteed & non-guaranteed returns, depending on policy.
Note 3: Investors typically invest in stocks for the prospect of “capital gains” (increases in stock prices). That is not reflected in its dividend yield.
4) Are long-term stock holdings as a good alternative to endowments?
As we wanted to compare investing in the Straits Times Index over a long period vs. endowments with long maturities, we plotted the rolling 10-year and 5-year total returns for the Straits Times Index (see charts). “Total” returns means dividends are included.
If you’re not familiar with rolling returns, think of the first data point on the below chart (Jun 2010 on x-axis) as referring to a 10-year period that ended on Jun 2010. The data point reads 6.3%. This means that for that 10-year period, the annualized return is 6.3%. The next data point refers to the 10-year period that ended slightly after Jun 2010, etc.
For the first chart, we looked at 10-year periods with data from Jun 2000 till now. For that time frame, Straits Times Index posted annualized returns of 7.4% on average. The lowest annualized return recorded was 1.9%. Notwithstanding that this is historical (not future) performance, these results suggest investing in a stock index over the long term can potentially be an attractive alternative to endowment options which currently offer a 1.8%-4.75% yield.
If you can deal with greater risk for your child’s future university expenses, holding stocks in a broad-based index over the long term appears to be one potential alternative to endowments for meeting university expenses. We emphasize “greater risk” – it is still possible to lose money even over the long-term with stocks.
Hence, for the second chart, we looked at 5-year periods with data from Jun 2000 till now, which is more in line with the average investment holding period for Singapore investors. Here, the Straits Times Index has posted much more volatile annualized returns – as low as -2.8% for the five-year period ending 31 Mar 2020. In this case, endowment plans may be particularly relevant.
While we have looked at 5-year and 10-year horizons, note that Singaporeans generally have a shorter holding period for their investments. According to a survey published by Schroders in their Global Investor Study 2019, Singapore respondents answered that their average holding period for investments was 2.7 years.
5) Consider endowment plans, esp. if your child is starting uni in <10 years
As such, endowment plans appear to be particularly relevant (versus stocks) if your child is starting university in <10 years. As shown above, the shorter the holding period for stocks, the more volatile the annualized returns. In fact, for the STI’s 5-year rolling returns, there was a 30% chance of getting less than an annualized total return of 4% per annum for the period we looked at.
In addition, endowment plans generally offer a small degree of terminal illness or death coverage. If the holder meets an unfortunate event, the endowment plans will typically pay out a death or terminal illness benefit as part of the insurance coverage. For instance, the total payout may be 105% of premiums paid to that date.
With regard to stocks, we also note that it’s an extraordinary time in history considering the 1) huge economic impact of Covid-19 versus 2) the massive monetary and fiscal stimulus worldwide. People disagree on how stocks are going to behave in the next decade.
Ultimately, choosing an investment option that suits your preferences doesn’t have to be an either-or decision. For university fees, you can choose to buy an endowment, to hold stocks long-term, or to do a combination of both, depending on your risk tolerance.
To compare endowment plans, we like PolicyPal’s platform. To get recommendations on endowment coverage for your life stage and demographic, take a look at this link.
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