Key investment principles
One key factor which has a big influence on your retirement planning is asset allocation of your MPF account and other retirement savings products, and you have full control of this.
While asset allocation may sound complicated to you, there are several simple investment principles that you should know before understanding the importance of asset allocation.
1. Compound interest
Albert Einstein once called compound interest “the greatest mathematical discovery of all time”. While we are certainly not as smart as him, we also think that compound interest may be one of the most important investment principles for retirement planning.
Assuming you have invested $10,000 today in certain investment, if that investment grows at just 3% every year, your $10,000 investment will be more than doubled in 25 years.
MPF System has achieved an annualized rate of return of 4.7%, which is higher than the average inflation rate 1.8% over the last 16 years. (December 2000 - March 2018)
What can 40 years of investment do? Assume an initial investment of $10,000 with 3% return per year
2. Long-term investment
Stock markets go up and down every day, and financial crises, geopolitical issues and natural disasters could also have an outsized impact on the short-term performance of any stock market.
However, when you still have some years to retirement, it is worth bearing in mind that while stock markets can fluctuate considerably in the short-term, over the longer-term stock markets offer good opportunity for wealth accumulation.
If you have invested $100 40 years ago ……
Source: Bloomberg, June 1978- June 2018, assumed dividend/Income reinvested
3. Dollar cost averaging
While you do not have any control over stock market fluctuations, you still have control as to how to mitigate the negative effects of stock market fluctuations.
Your control is how much and when you are investing in the stock markets. As an MPF member, you invest a fixed amount every month. By doing so, you will be buying less units when the fund price is higher (in other words the market is doing well), and you will also be buying more units when the fund price is lower (in other words the market is not doing as well).
The net effect is that you will smooth out the stock market fluctuations when you invest a fixed amount at regular intervals. This effect is called “dollar cost averaging”.
Lump Sums VS Regular Investments (June 2008 - June 2018, 10 years)
4. Stay calm
While dollar cost averaging can help smooth out the stock market fluctuations, there are times that stock markets can really fluctuate wildly. The most common reaction when this happens is to sell your investment in the stock markets, put that into safe investment like cash or money market funds, then wait for the stock markets to calm down before investing again.
This reaction may turn out to cost you considerable returns over the longer-term.
Mr. Panic: $10,000 initial investment, withdrew in panic during market turmoil and re-joined when the market returned to the last peak.
Mr. Calm: $10,000 initial investment, sticking to his investment strategy during market turmoil.
5. Understanding risk and return
Over the longer-term stock markets can offer good opportunity for wealth accumulation, dollar cost averaging can help smooth out stock market fluctuations, and staying calm during market crises may be better over the longer-term.
However, these are just general investment principles, and you are entitled to look at risk and return based on your preference. Your investment time frame until retirement is also an important factor when it comes to balancing the risk you want to take with the potential of the return for your investment.
There is no absolute best investment in MPF or in other retirement savings products, but there will be a well-structured portfolio out there that best fits your life.
Risk and Return Among Assets (Jan 2001 - June 2018)