I recently had to write an email to my dad providing my opinion on how he and my mom should structure their assets for their retirement.

I will extract some excerpts for the blog because I think they are helpful to record.

Outline

I would divide my analysis into two sections:

1. Defining the objectives of the financial portfolio
2. Building a portfolio that best meets the objectives set

Note: CPF in this article refers to the retirement income scheme in Singapore equivalent to Superannuation in Australia.

1 Objectives

The core objective is to get mom and papa a pension.

The remaining money can be invested for long-term capital growth.

1.1 Core Objective: Buy a pension

I think the starting point for any retirement portfolio is to create a pension.

Specifically, a pension is a consistent stream of income that is adjusted for inflation for the duration of your life.

Almost all retirement income systems start with a pension, which can be provided by a combination of the government, employers and financial markets.

On that basis, the objective is to figure out how to get mom and papa a pension from their assets (CPF, cash, bonds etc.) that is adequate to cover their living expenses.

If in doubt, a cash buffer can also be added to ensure the adequacy of the portfolio to cover living expenses.

1.2 Remaining Objective: Long-term capital growth

Once mom and papa have secured a pension to cover their expenses, the remaining money can be invested for long-term capital growth.

The key features for long-term capital growth should be to deliver high returns over the long term with minimal fees and tax efficiency.

2 Building a portfolio

I go through the steps of building the portfolio which are:

1. Work out your living expenses
2. Account for existing assets - CPF & Bonds
3. Core Asset - Inflation-protected government bonds
4. d. Cash Buffer
5. Remainder of Portfolio - Shares ETF
6. Example Portfolio

2.1 Work out your living expenses

The first thing to do is to work out your annual expenses, ideally in SGD and AUD.

If you aren't sure, you can use your historical expenditure as a guide.

You can always adjust your estimate over time as you discover what your ideal expenditure level is like.

2.2 Account for existing assets - CPF & Bonds

The second thing to do is to work out the extent to which your existing (illiquid) assets already produce income to meet your expenditure level.

You should take a look at your:

1. CPF Life income streams; and
2. Existing portfolio of bonds

And see how much income they produce each year, and therefore how much of your expenditure needs they cover already.

Your ideal CPF Life income stream should be on the Escalating Plan.

2.3 Core Asset - Inflation-protected government bonds

The financial product you need is something that produces:

1. consistent income
2. adjusted for inflation
3. for the duration of mom and papa's life

The one product that neatly captures those properties is inflation-protected government bonds. Happily, the Australian government specifically issues Exchange-traded Treasury Indexed Bonds (eTIBs) for retirees for this exact purpose.

Based on the remaining need, I think mom and papa should buy enough eTIBs to generate Australian dollar income, with a duration sufficient to cover mom and papa's life.

For example, you can buy some eTIBs, maturing in 2035, trading on the ASX as GSIO35.

For about $1.1m, mom and papa can buy a (pre-tax) income of AUD30,000 + inflation adjustment every year from now until 2035.

At maturity in 2035, you also get ~$1.1m + inflation adjustment back.

For reference, the Reserve Bank targets inflation at 2-3%. If the RBA hits 2.5% inflation per year, 10 years of inflation adjustment is equal to 28.0%.

There are also longer-dated bonds that mature in 2040 and 2050 if you are interested.

This meets the criteria as it gives mom and papa:

1. A consistent income to spend on living expenses
2. Automatic inflation adjustment which insulates them from inflation
3. Requires minimal adjustment over the course of their lifetime

2.4 Cash Buffer

I would set aside money for a cash buffer just in case. The $Xm-$Xm would be adequate. This can be in a bank account that can be accessed in an emergency.

2.5 Remainder of Portfolio - Shares ETF

The remainder of the portfolio can be placed in a Shares Index ETF for long-term capital accumulation.

The key criteria for this ETF should be:

1. Shares
2. Globally diversified
3. Tax effective

For example, one option would be iShares MSCI All Country World Index UCITS ETF (Accumulating).

This trades on the London Stock Exchange as SSAC, which you can buy through Commonwealth, NAB Trade or any decent broker in Australia.

It meets the criteria as it invests in:

1. Shares
2. Globally diversified: across 23 developed and 24 emerging markets countries
3. Tax Effective: The accumulating funds in the UK ensure that dividends are automatically re-invested and get realised as capital gains, receiving preferential tax treatment in Australia.

General advice for a general retiree

I did also show my parents the overall shares to bonds glide path described by Vanguard here:

The key takeaway is the transition from equities to bonds.

A small criticism of the Vanguard glide path as applied to non-US investors

For a non-US investors, the glide path show is incredibly overweight domestic equities.

This carries over to the Australian version of this glide path. For example, Vanguard Australia's High Growth Index Fund (ETF) has an allocation of 36% of the portfolio to Australian Equities. This is insanely high.

Australian equities counts for ~1.8% of global equity market cap, which makes this allocation have an incredibly high domestic overweighting. In comparison, the US accounts for ~59% of the global equity market cap.

If you're Australian, the correct allocation to Australian equities should be <5%, a fact that I did not realise until much later in my investing career.

Shout out to John Cochrane

My thoughts in this piece are heavily influenced by the John Cochrane speech titled "Portfolios for long-term investors". The money quote from the speech is:

I am inspired by the brilliant Campbell and Viceira (2001) article on long-term bonds. They show that inflation-indexed perpetuity is a riskless asset for a long-run investor.
...
Well, let us try to sell some indexed perpetuities. Bring along your infinitely risk-averse spouse who is not a finance professor, and let us set up your retirement portfolio. We will start, of course, with enough indexed perpetuities to keep you and your altruistically linked dynasty going at a minimum standard of living forever.

The next month, the statement comes in. Interest rates have gone up and the value of your investment has plummeted. “Hey, Mr. or Ms. brilliant finance professor,” your spouse intones, “you just lost a third of our retirement savings in your supposed risk-free asset!” Hmm. This is going to be a long conversation, as you delve into state variables, cross-derivatives of the value function, hedges for state-variable risk, dynamic multi-factor models of the term structure of interest rates, and mean-reversion of fixed-income prices.

A much better explanation is, “Honey, look, this investment pays a steady coupon forever that we can live on. That’s the point. We’re not going to buy or sell those bonds, we’re going to live off the coupons. Just tear up the statements, and stop worrying about the portfolio’s mark-to-market value. They’re meaningless for us.”