So I introduced you guys to the cutest girl in the entire world the other day in this article. No, it's not a debate.
And well, I also recommended a savings plan for her future education purposes.
You guys know I love investments.
I really do. Everyday, I have a renewed appreciation for investments.
I mean you lend someone money and then you get paid for your good deed. And you get to see them do cool things with that money.
And then the rest of the world all basically chips in to reward you too. It’s pretty damn awesome.
You would think that I would invest everything (I basically do, between 80% - 90% of my income every month).
Even a really good savings plan might yield about 4.4% annualized in 20 years. I could easily do 7%, or way more if I advocated for higher risk (20 years is not a small-time horizon).
So why didn’t I do that for my niece?
1) Guaranteed
Guaranteed has always been a magical word for people, especially as you increase in age.
Even if you’re a pretty investment savvy person who manages risk well, it still stacks up.
One of the worst things that any parent can experience is to sell below their capital to pay for their kid’s education.
After years of delayed gratification, self-sacrifice for your child – compared to taking an expensive, high interest education loan – the least that could happen is to have that illiquid money have a higher yield than what you put in.
You can guarantee this with a perpetual savings plan. It is guaranteed that you will get more than you put in, regardless of what year you need to utilize this money.
This isn’t the case for investments.
2) Meets the Timing Better
It further elaborates on above, but this is a pretty notable example.
Let’s look at something like the SNP500.
While the 57.57% 1 year loss is staggering, losses in the short term are common for any all equity fund, even one with a certain degree of diversification. What should be really jarring for investors - especially parents, is the 10 to 20 year returns. Some of this can be mitigated using Dollar Cost Averaging, but the lump sum result is extremely clear.
The second worst scenario might not be as bad, but you have to remember that we're looking at strict index results. So you haven't accounted for:
1) Withholding Tax
2) Forex Risk
3) Any platform fee
4) Any fund management fee
5) If you're using the ETF and try to time the market or compromise it for short term needs - you really only have to screw it up ONCE over the 20 year period.
Comparatively, you can leave it in a perpetual savings plan - where:
1) You will never sell low, especially when you're paying across 4 years by semester.
2) There is a complete guarantee that you will meet the purpose which you set out to achieve - which is that there is more money returned from what you put in to pay for your kid's education.
3) Your result has only one variable - the participating fund performance and subsequent bonus payout. There are no additional costs unlike the above.
The above is just an example - it is entirely possible to have a higher yield than that.
3) Other benefits
Naturally, when it comes to plans offered by insurance companies, they are bound to offer other benefits.
a) Death benefits.
b) Total and permanent waivers
c) Critical illness waivers also tend to be available.
Some are built in and some of them require a small additional premium, which is a small price to pay in the scheme of things. Unlike the dictionary definition of a waiver, a waiver offered by an insurance company means that they are obligated to pay for your plan upon claim.
So if you’re committed to 15 years of $10,000 and you claim on the first year, that’s $140,000 going towards your plan that the company forks out, for a premium cheaper price than even Term Insurance.
4) Superior to its Fixed Counterparts
Well you might be convinced by this point – but you might have overlooked my repeated emphasis on the word ‘perpetual’. What exactly is a perpetual savings plan compared to my ‘usual’ endowment plans?
If you’ve ever purchased a ‘fixed’ endowment – it basically has fixed terms for:
i) How long you pay
ii) When you collect your benefit
Someone is going to look into it at some point so I’ll do it for them - you might notice that if you assume the same duration: (e.g. 20 years), that a fixed counterpart might outperform it’s perpetual one.
But even if it did, it wouldn’t address the education need as effectively.
Let’s look at my niece now.
If a ‘fixed’ endowment had been purchased for her, you couldn’t do a 25 year one. It would likely be too long.
You’d do a 20 year one and assume that the money will kick in a good two years before university starts.
That two years? It’s an opportunity cost that a perpetual endowment doesn’t experience.
Furthermore - assuming she goes to Polytechnic and Normal Academic, she finishes her 4 year degree by age 24 instead of 22. That two years becomes four.
You could leave it in Singapore Savings Bonds or something, but it wouldn’t be anywhere close to the return that the 20th year + of a perpetual endowment is generating.
Potential Downsides
Since it's only a 5 minute read and I have time, I thought I'd take on some of the potential downsides for this particular strategy.
1) If you're a risk taker, this is not your cup of tea. It is very likely you will achieve higher returns, especially if you add a little diversification into your portfolio.
2) If you are a savvy investor who knows how to compartmentalize and not leave your investment completely liquid like a clown, this is not for you too.
3) If you are insisting about matching education inflation, which is considerably higher than core inflation (closer to 5, 6 % in Singapore), this won't work out for you.
It will give you significant peace of mind, but you would likely still have to top it up if you don't start earlier or diversify your funds.
Summary
I am not saying that you shouldn’t use an investment strategy for your child’s education.
As an investment specialist (and it’s my FULL-TIME JOB) I wouldn’t doubt that the probability is still hugely in my favor.
I could probably beat a savings plan return, triple or quadruple it, and meet the purpose very comfortably. In the last few months, all of my younger/aggressive clients from January/February have been doing well over 22%.
But the risks I take on as a single young person in his 20s, are easier to take on and so I can beat the market regularly.
Much like how our risk profile lowers as we get older, planning for a child requires you to take on another level of risk.
And I understand that not everyone is prepared for that.
Especially a young pair of parents who are already juggling investing for their retirement, caring for their aging parents and a ton of liabilities - that you only just started on a few years ago.
A good consultant will present multiple options to you and help you work your way up to your goals, even if he's personally way more inclined to invest everything.
Now you have a good alternative.
Money Maverick
Credit to Hariz Arthur Malfoy (and Dimension Funds) for providing information about the SNP500 when I so desperately needed it and also showing the maximum drawdowns, etc.
Thanks to all the people who helped me to polish this article - it is not easy to get work done in camp!
Money Maverick