Mind the retirement gap to secure financial independence

Below is a commentary I wrote that was published by The Straits Times here .

What does it take to retire with confidence? As people live longer than ever before, it is a question of rising importance, one that pushes us to rethink how we save, invest and plan.

For Asia, this longevity spike reflects the flip side of a wildly successful development story, fuelled by long-term socioeconomic development, an enduring middle-class boom and advanced healthcare.

In the region, people aged 60 and above accounted for 13.5 per cent of the population in 2022. The Asian Development Bank expects this to nearly double by 2050.

Retiring well thus demands a hard and honest look at one’s financial reality and assessing whether sufficient funds exist to cushion the life they’re used to living as they age.

After all, cost-of-living concerns – amid rising aspirations to live longer and age better – add to the multitude of risks that could lead to depleted nest eggs. So, how can people afford their extra years?

BRIDGING THE PENSION SHORTFALL

Retirement systems provide one solution. The UBS International Pension Gap Index analysed 25 mandatory retirement systems worldwide to assess the “pension gap” – the additional private savings needed to maintain an accustomed standard of living in retirement.

Invariably, the findings show that pension gaps are often exacerbated by rising costs of living relative to median wages, extended life expectancy and low retirement age thresholds.

Indeed, mandatory retirement schemes are not a catch-all safety net. While they help cover basic needs, it is more prudent to consider them as a single component of one’s retirement strategy.

Other than a handful of cities – mostly European ones with high retirement ages – future pension benefits are insufficient to finance one’s accustomed lifestyle. A varying degree of additional savings will be required to fill the financial gap.

In Asia, Singapore stands out with a relatively low required private savings rate of 21 per cent, largely due to high mandatory Central Provident Fund contributions, which cover 37 per cent of median wages when both employee and employer components are included.

This structure puts comparatively less pressure on individuals to save and invest aggressively during their working years. In contrast, workers in cities like Tokyo, Shanghai and Hong Kong face some of the highest savings demands in the region to offset projected shortfalls.

These challenges are compounded by long life expectancies (89 years in Hong Kong and Tokyo) and, in Shanghai’s case, a particularly low retirement age of 56.

LIMITS OF RELYING ON REAL ESTATE

For many retirees in Asia, residential property serves as a crucial financial fallback, often representing a significant portion of their private savings and investments. This can be effective in markets where property value gains have consistently outpaced consumer inflation.

But monetising real estate comes with its own limitations, primarily due to the illiquidity and cyclicality of the asset class.

The UBS Global Real Estate Bubble Index highlights these challenges: Hong Kong, for example, saw real housing prices decline by a double-digit percentage over the past four quarters, returning to 2012 levels.

Although the bubble risk has eased significantly, with the market now only moderately overpriced (down from extreme pre-pandemic levels), a lasting price rebound likely depends on more housing inventory reduction over the coming years.

Closer to home, Singapore’s private housing market experienced a 7 per cent drop in real rents over the past year, while property prices rose modestly by 3 per cent.

Although a housing bubble is unlikely here, government interventions are likely to limit the potential for rapid price gains.

Meanwhile, rental yields remain in anaemic low single digits.

Moreover, holding costs have increased significantly – property taxes on investment properties have risen from 20 per cent a decade ago to 36 per cent today.

Altogether, to confidently close the pension gap in retirement, investors need to consider alternative financial instruments to boost yields.

STRATEGIES FOR RETIRING WELL

What might these alternative instruments look like? A well-diversified portfolio is a time-tested strategy that balances various core asset classes such as diversified fixed income and equities from developed and emerging markets, with alternative investments such as private markets and infrastructure.

Consequently, the optimal asset allocation should produce higher returns for one’s preferred risk tolerance.

However, generating returns that merely match inflation will not ensure a blissful retirement.

Once spending (or regular portfolio withdrawals) is considered, a portfolio must achieve returns well in excess of one’s “personal” cost-of-living increase to prevail.

To retire well, our research shows that annualised investment returns should exceed one’s personal rate of inflation – by at least 2 percentage points – for the portfolio to endure 50 years in retirement and beyond.

In sum, longer life expectancies today raise the question of financial preparedness and the risk of a pension gap, while popular sources of private savings, such as residential property, may not always be steady guarantors of yield.

For the young, start investing early to maximise compounding effects. For those further along, manage your longevity plans sooner than later, to mitigate the risk of lifestyle downgrades in retirement.

Ultimately, a diversified and balanced investment portfolio better maintains and grows its value despite withdrawals. By taking charge of your financial future today, you can pave the way for a fulfilling and secure retirement tomorrow.

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