***Not making money to maintain his retirement lifestyle.

2008/08/09

YAP MING HUI: Hedging against inflation


IT was an anxious Jimmy that came to see me about a year after he retired. He had sold his factory to a US company.

At our first meeting, I asked him how his retirement life was. He said: "Everything is fantastic. I get to travel a lot and play golf."

However, there was a problem.

"I need to break my fixed deposit every now and then to maintain my lifestyle."

Jimmy has about RM10 million but most of his investments in property, unit trusts and shares were not making money to maintain his retirement lifestyle.

He has about RM4 million in fixed deposit. But the interest income from fixed deposit barely covers the impact of inflation.

If he were to spend the interest income, he will risk having the principal depleted over the years due to inflation.

What is the problem?

Jimmy's problem is a typical case of "asset rich, income poor" -- people who are good at creating wealth from their business or profession but weak at generating income from the created wealth. They are rich in assets which are not generating good investment income.

Jimmy's total wealth is RM10 million. His RM4 million generates four per cent of interest.

However, four per cent of interest is not enough to cover the four per cent of inflation provision. As a result, there is no net income for Jimmy from his fixed deposit asset.

His RM3 million of properties generates a RM50,000 income per annum. This can be considered a net income for him because inflation will be hedged by the capital appreciation of at least four per cent per annum.

His RM1 million of shares give him a total return of nine per cent. After the provision of four per cent inflation, his actual income is RM50,000.

His RM2 million unit trust investment didn't make him any money at all.

Therefore, the total actual income after inflation is RM100,000. Due to the fact that Jimmy needs RM400,000 to maintain his lifestyle, he is short of RM300,000 of annual income.

Solution

- Review the performance of each investment asset classes

Jimmy needs to review the performance of all his investments. He will need to get rid of poorly performing investments. He will need to look at each unit trust fund and property to decide if he should sell or keep them.

- Move fixed deposit into higher return investment

Jimmy's fixed deposit will be eroded by inflation if he continues to leave that much of his wealth under fixed deposit.

After calculating and providing for his short-term cash flow needs, the balance of his fixed deposit should be in other investments that are able to generate higher return to hedge against inflation.

- Diversify retirement income

Just because one investment asset gives you good income and a hedge against inflation, it doesn't mean that you must put all or the majority of your wealth into it.

Some people have been successful in property investing. They managed to generate good capital appreciation and rental income. However, rental income is not necessarily sustainable in the long run and is normally subject to a lot of changes.

Therefore, the best practice is still to diversify your retirement income so that it is not badly affected by any one source.

One should consider also share dividends and capital gains, unit trust gains, bond investment gains and retirement income products.

Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia

http://www.nst.com.my/Current_News/NST/Sunday/Focus/2315138/Article/index_html