Tuesday, December 16, 2014

My offensive and defensive strategies

I wrote about my dilemma regarding whether to pay down my HDB loans or use the excess money for investment. That was back in Nov 2013 and more than a year had since passed. Back then, I really put in an extra 24k to do partial repayment for my HDB loans, and it shaved off 2.5 yrs off my 30 yrs loan.


One year later, I still don't know if I did the right decision. The dilemma is always the same: given a sum of money, is it better to use it pay down the 2.6% mortgage loan or invest in the market to get a yield of more than 2.6%? The decision is complicated by factors such as:

1. Certainty of interest payable on money borrowed vs uncertainty of returns in the market

2. Property insurance bought in the event that either owners hit death or TPD

3. The liquidity of the money invested in the market vs doing a partial capital repayment


In the end I opted for a balanced solution, meaning that I will save a portion for investment and save a portion to make partial capital repayment for my HDB loans. This will avoid the two extreme end game scenario of being asset rich but cash poor (if I use my savings to pay off HDB loans early) and paying excessive interest by dragging the loan period to the maximum (if I invest my savings totally). Both are not ideal outcomes for me, so I would avoid both.


This year, I'm more slanted towards investing my savings in the market. Value is emerging in the stock markets, and so I would keep a larger part of my savings liquid to take opportunities. I made a proposal to my wife to see if she can part with 6k (12k in total) to make partial capital repayments. If we can keep at this rate for every year, we'll be out of debt in 14.2 yrs. This is opposed to not doing any repayments, and letting the loan drag for 24.4 yrs. 6k per person per year seems like a reasonable amount to be able to continue for the long term (at least 10 over years!), and with that we can save about 70k off the total payment for our flat.


I did a comparison by doing several amount of repayment, ranging from 6k all the way to 24k annually. The table shows the results obtained. I tried putting in half yearly too, which means say instead of putting in 24k per year in one shot, I put in 2 injections every half a year of 12k each. Interestingly, not much difference, so I dropped that plan.




24k per year (12k per person per year) is too insane. I can do it for extended period but I'm quite sure my wife would be complaining. If I save 50k per year, 12k would be roughly 25%, so it might be a tad too much. The consensus so far is 12k or 6k per person per year, roughly 10% of my savings of 50k. Like the government, I'll have to adjust this percentage on a yearly basis, seek the shareholder's vote (aka wife's consent) and roll out the plan.


This year, I seem to have a lot of bright ideas to manage my personal finance, like setting up a emergency fund of funds in CPF by doing voluntary contribution and building a base of 240k so that I can generate enough yield to cover my mortgage loan of 1k, It seems like I'm a headless chicken running around in all different directions, don't you think?


But I have my financial freedom plan! On one hand, I'll build up a capital base of 240k. Grow big enough to make my problems smaller. At the same time, I'll reduce my debts by making capital repayments. That's my 'offensive' strategy. My 'defensive' strategy is to lock up enough funds in my CPF OA by doing voluntary contribution, so that I can depend on it in the event that I cannot work for prolonged period of time. A back of the envelope calculation means I've to put 6k per year to make partial repayments (I'll make an effort to do it annually), another 6 to 12k to put into CPF OA (entirely optional, depends on circumstances), so in total about 12k to 18k out of my savings will be channelled into my strategies. And the good thing is that I reserve the rights to change my opinion anytime haha! I'll tweak to my heart's delight every year based on the circumstances. That will give me the leeway to evolve my financial plans together with me.


Here's the summary of the 'budget' needed to run these 'programs':

1. HDB capital repayment plan (intermediate priority)

Short summary: Pay extra $ on top of mortgage payable to reduce interest paid for flat
End point: Be debt free in 14.2 yrs
Amt needed per year: 6k
Expected project duration: 14.2 yrs

2.  Build up of capital for 1k/mth dividend plan (highest priority)

Short summary: Build up a base of 240k (shortfall 100k), invest at >5%
End point: 1k per month dividends based on 5% returns
Amt needed per year to fund: 30k to 50k
Expected project duration: 2-3 yrs

3. Emergency fund of funds (lowest priority)

Short summary: Do voluntary contribution, build up OA acct to contain 1 yr of full monthly mortgage (2k)
End point: Have >24k in OA account
Amt needed per year: 6k to 12k (depending on earnings and tax reliefs obtained)
Expected project duration: 1 to 5 yrs


That's why I need to save money!! 3 programs and I need the budget to run them! Somewhere down the line, the 3 programs will overlap and I will (likely) change my plan again. Paying off my HDB loans will require me to have less money in my emergency fund of funds, then I can use the money to build up my capital of passive income, which will lead me to have more money to pay off my housing loans and have more emergency funds etc etc.


We'll see :) I think my plan for the next 3-5 yrs are crystallising nicely. I'll just need time and effort to carry it through then.








1) Updates of goals on 8th Nov 2017 here


17 comments :

finance4uandme said...

Hi LP,

I am wondering why you did not choose to change to a bank loan, in particular, POSB's HDB loan which is capped at 2.5% for the first eight years?

Due to the nature of housing loan, ie the depreciating amortization model, a large portion of the early years' installments goes into interest. Therefore, I would look for a bank loan with the lowest interest rate and secure the low rates with lock-in period of around 3 years.

After the lock-in period, one can choose to refinance or reprice the loan, and there will not be a penalty for reducing your principal by making lump-sum payment during this window.

I understand that I am not self-employed like yourself. Therefore, the mentality is slightly different as my employer and myself contribute CPF. For my case, I took a 30-year bank loan at 1.35% interest with a lock-in period of 3 years. Compared with a HDB loan with 2.6% interest, I save around $270 on monthly installments. Over 3 years, savings is $9,720. If you include interest earned (2.5% for CPF-OA), total savings is about $10k . While this amount is small, its still additional money in my pocket. Depending the interest rate environment when I refinance or reprice, I can choose whether to pay down my loan's principal amount.

Just sharing my opinion but do note that my case makes sense when the interest rate is low. In addition, once one take a bank loan, one cannot go back to HDB loan. That's why I think the POSB HDB loan makes sense because it caps the rate at 2.5% for the first eight years.

Furthermore, some people view that CPF money is not their money and hence no need to save on the interest. I do get very angry when people say that and are not prudent when managing their CPF monies. Based on my case, I managed to save about $270 on monthly installments. If I can consistently do that over 30 years, the cumulative savings with CPF-OA interests amounts to $145k! This is additional money one can put into their CPF Retirement Account!

Apologies as it sounds a bit like I am venting my frustration. Hope you don't mind.

Cheers,
Naro

Singapore Man of Leisure said...

LP,

1) Feels good in the soul and shows you know your priorities:

"Like the government, I'll have to adjust this percentage on a yearly basis, seek the shareholder's vote (aka wife's consent) and roll out the plan.

I noticed some married people make financial freedom plans based on "I" and not "We"???


2) I was going to poke - What? More planning?

That's until I saw:

"And the good thing is that I reserve the rights to change my opinion anytime haha! I'll tweak to my heart's delight every year based on the circumstances. That will give me the leeway to evolve my financial plans together with me."

Good, good. You plan like a land owner ;)

la papillion said...

Hi Naro,

May I know how much is your loan amt? For me, it's 500k and I'm pretty sure I'll never be able to pay the loan in 8 to 10 yrs. In my opinion, the POSB loan is good only if you can pay off within 10 yrs. Anything after that, the interest rate might shot up and it'll create too much uncertainty. There's enough variability in my income already, I think I can do with less with my mortgage :)

The other impt thing is that being a self employed, it's going to be hard to take a bank loan. Even for HDB loan, they would not initially lend me the amt that I wanted, citing that I'm a self employed. The rules are just different, regardless of whether I've a paper trail showing the amt of money that I have. I guess the bank are scared of unemployment risk for self employed.

I've no illusions about CPF not being my money. I have to contribute to it using cash - it's my money alright! lol!

Thanks for introducing me to the posb loan, but again, I'm going to say no for a peace of mind haha

la papillion said...

Hi SMOL,

Haha, gentle poke from you :) I don't make shared financial decisions with wife because she is not interested in such things. If she's interested in it, then I would gladly discuss the different options with her. As such, the situation now is that I'll propose, and present to her the plan, she can adjust a bit but then we'll agree or not if the plan will go ahead. This works well because she knows she is in good hands.

On other stuff, where she's clearly the expert, she'll lead the way. I'll keep quiet and let her run the show. This is team work at its best. We don't do shared decision since there's informational asymmetric between us - it'll only dilute the outcome.

My plan (call it whatever you like) is subject to changes. And I do change my mind when circumstances change. I figured that if I do not utitlise the greatest adv of being a self employed, which is being flexible and own time own target, then what's the point? Might as well be employed and let others do the leading.

I'm never ashamed or defensive about my planning or my ad-hoc basis of living my life. It's not consistent, but so what? LOL...I'm too complicated to be a grasshopper or an ant. I think I'm just a butterfly - and I'm metamorphosing into something free and light and beautiful ;)

finance4uandme said...

Hi LP,

My loan is $428k. I can understand the mentality difference when you're self-employed while I am an employee. Less volatility is good for you.

Depending on one's appetite, bank loans offer lock-in periods for fixed rates to give one visibility over that period (usually 1 to 5 years). Even for floating rates, some banks offer 12-month SIBOR + a certain percentage without lock-in period. This means your rate is fixed for a year, which is still not too bad.

Actually, I need to correct myself. POSB HDB loan is pegged at a max of 0.1% p.a. below HDB Concessionary Loan rate for the first 8 years.

I am just presenting options that will help to reduce interest payments. I am of the opinion that additional interest saved means more money. Furthermore, banks are already earning a lot of money, why let them earn more. :)

Cheers,
Naro

Tee Chong Yen said...

Thank you for the post. I had just send this piece of idea to my wife!

Btw, can i be added to your chat community?

la papillion said...

Hi naro,

Thanks for clarifying :)

I still think the risk reward for it is not worth it for me, esp when I know I'll drag the loan beyond the fixed 8/10 yrs where the interest rate is 0.1% below HDB. For that slight gain in interest savings, I might lose a lot more when the interest environment increases after the lock in period. Nah...not going to work well for me :) Again, thanks for introducing it to me :) I certainly learnt something!

la papillion said...

Hi CY,

Haha, thanks for reading my post :)

Sure, can you send me an email? I'll work out the details from there.

Anonymous said...

Reminded me of the time I took a loan in 2002 at 2.3%p.a.Within 6 months, I paid a $7k penalty and switched to one at 1.6%p.a. Less than 6 months later, I switched again and this time, it was 0% for the first year and 1.2% for the second year. This was during the SARS period. All this was done with the same bank and even though the penalty was hefty, overall the interest saved was worth it.

Matt

Tee Chong Yen said...

la papillion,

I cant seem to find your email? I search high and low already.. Can you give me some hint where can i find them?

CY

Sillyinvestor said...

Hi LP
Was wondering why u contribute to CPF as a emergency fund until it dawn on me u are self-employed. Things employee like me took for granted.

Hmm... Why is your HDB loan so ex? You only bought it in recent years?

la papillion said...

Hi Matt,

Wow, some nifty footwork there ;) Can you share with us how much you saved in interest vs the penalty? That would give us a magnitude of your nifty footwork ;)

la papillion said...

Hi CY,

I'll put it here :)

Email: duckula06[at]yahoo[dot]com

The 06 is zero-six

la papillion said...

Hi SI,

Yea, I've to balance a lot of things on my own, so it's not a decision that I would take lightly. If I contribute too much, I will save on taxes, but I'll have less liquidity both for investment and also less buffer for expenses, which will also affect the amt I hold for emergency funds. All inter-related lol

It's a resale 5 rm in a mature estate, bo bian loh...I bought it about 3-4 yrs ago? Near the peak, but I need a place to stay and at that time, nobody can guarantee that a BTO is going to be so fast.

Oh well, luck is not on my side for property. I'll just have to make the best out of the situation.

Anonymous said...

LP,

I did not do the calculations beyond the first year. The loan quantum was $1mil for 30 years. I broke even within the first year when switching from 2.3% to 1.6% pa. It goes without saying that switching to the 0% for the first year was even better. I had another property which was put in the market for sale so I knew I was not going to hold the loan for long. I cleared the loan within 4 years after selling the other property and cashing in on capital gains on about 4 blue chip stocks.

Matt

la papillion said...

Hi Matt,

Thanks for sharing :) 4 yrs to clear the loan! Amazing...

Dhimanendu Sarkar said...
This comment has been removed by the author.