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Friday, August 01, 2014
Trinidad & Tobago Guardian Online
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What to do with a lump sum?
Financial windfall comes in many forms. For the very lucky few, it could be winning the lottery. For many others, it is usually the result of more mundane events, an inheritance, or a decision to accept voluntary separation and early retirement programme (VSEP) as some 608 TSTT workers have done. In an interview with the Sunday Business Guardian last week, the company’s current CEO George Hill said the company’s five-year strategic plan called for a significant reduction of employee expenditure.
The National Enterprises Ltd, which is TSTT’s 51-per cent shareholder, said in a release that these employees will benefit from packages that will cost $650 million in total. Company officials were reluctant to give average dollar amounts, citing the privacy and security of workers. However, John Julien, the president of the Communications Workers Union, TSTT’s representative body gave an idea of how the formula for arriving at the packages worked.
“Security will receive three months’ salary for every year they have worked at the company, while senior staffers and managers will receive four months’ salary for every year worked. Therefore, if someone has a salary of about $10,000 a month and works for 10 years, their payment would be $300,000.” At the opposite end of the scale, Julien said top managerial staff, who earned salaries of about $100,000 per month could potentially go home with millions.
Employees who opt for the package will have access to a retraining benefit, partially sponsored by TSTT, which will allow them to re-tool for another career. They will also be given “financial counselling” to help them plan for the future. For many of the employees accepting VSEP, that future will be stripped of a regular pay check at the end of the month. With lump sum payments for workers amounting to the hundreds of thousands of dollars and even millions, the question now is: what to do with the money?
Others too who find themselves in this position wonder what should they do. Should the money be invested? What investments will provide returns that ensure current standard of living yet beat future inflation? Should the money be used to pay off debt, for example credit cards or more long-term borrowing like a mortgage?
The answer is...it depends
Speaking with several investment advisors, the Sunday BG learned that solutions were aligned to personal circumstances. Among the factors that local investment experts said should be taken into account were age at the time of accepting the package, the length of the remaining mortgage, general level of health, appetite for risk and whether the former employee intended to find another job. All of these, must be plotted against an investment horizon.
Jason Julien, general manager at First Citizens Investment Services, said the investment horizon is the length of time that someone intends to hold an investment. “If you are talking about a fixed deposit and it is fixed for three months, then the investment horizon is three months. If you are thinking about buying a bond and you want to hold that bond until maturity and that bond is ten years, then your investment horizon is ten years.”
Julien said younger employees may be better off continuing with their mortgages and investing the money, since their investment horizons were likely to be longer than the older worker. Essentially, they would have more time to realise returns on their investments. Julien said that older workers with five years and less to go to the end of their mortgage could consider paying it off.
“It may make sense for them to free themselves of that debt versus save the money. What that does now, it means that they now have an asset that is unencumbered which they can now do many different things with. One, they don't have to worry about the monthly instalments of a mortgage and two, they now have a valuable asset, which is a store of wealth.”
This opens up further options for an older worker, said Julien. Owning their home free and clear, they can now decide to sell it and get something smaller if all of their children have moved out. They can also pass on the earnings from the sale to their children. Or they can invest it. Whether younger or older, the choice to invest has to take prevailing interest rates into account.
Finance and investments adviser at KSBM Asset Management, Brent Salvary, gave some insight into the current environment, which he said features relatively low rates of interest on mortgages, historically low rates on savings, fixed deposits and bonds of all types, a rising stock market, an area-specific real estate market where some regions are seeing appreciating property values and downward trending inflation that has averaged 8 per cent for the past ten years.
He said in such a case, tolerance for risk and financial goals over time become important. “For a conservative investor who is unwilling or unable to put their funds at risk, the returns on the funds if invested would most likely be very low and generate anything south of two per cent, at least in the short to medium term. Therefore the opportunity cost of paying off their debt for this individual is low and this option may not be the most beneficial one.”
For workers who have higher risk tolerance, Salvary said that investment options existed in traded securities, real estate or establishing their own business. In this instance, he told the Sunday BG: “The opportunity cost of paying off their debt can be quite high and thus the decision may tend to lean more towards the choice of not paying off their debt but rather investing the funds to generate a higher return.”
The choice to return to work after collecting a VSEP package will also impact on the decision to invest or liquidate mortgage debt. Salvary said if the worker was dependent solely on the income from the lump sum to cover their expenses then they would have no choice but to “invest some or all of it to realise that income.”
On the other hand, an employee who plans to seek another source of income can take advantage of “dollar cost averaging” and “allow the power of compounding to work for them” said Ian Narine, general manager, Guardian Asset Management Ltd, an investment adviser and regular columnist with the Business Guardian.
In dollar-cost average, Narine explained that small amounts of the lump sum are invested over time, rather than all at once. Meanwhile, compounding is the additional return on earnings from an initial investment.
To illustrate, Narine said: “Consistently investing over time has been proven to outperform investing a lump sum at a point in time. This is because the lump sum takes on all the risk of the market at one point in time. You could be investing at the top of the stock market or when interest rates are lowest. However, with dollar-cost averaging the environment does not matter as you will be investing a smaller amount every month regardless of circumstances.”
Nick Dean, another regular contributor to the Sunday BG, said in the event that the lump sum is not enough to make investments, a reduction in monthly expenditure should be considered. “If the person is in receipt of a pension or other income the elimination of a mortgage payment will invariably improve cash flows and remove the pressure on the pension income.”
Weighting investment options
As observed by most of our experts, most regular investment instruments such as annuities, money market funds and fixed deposits do not stay ahead of inflation.
Julien described investment at this point in time as “challenging” because of a lack of marketable securities or strategic investments. However, he thought the First Citizens Bank IPO, as well as the upcoming one for Phoenix Park represented a resurgence in equities. Moreover, he saw stocks as a solution to the problem of people not having enough, profitable opportunities to invest.
“There have to be more quality companies that people can buy into. It can't be just about fixed income, there also has to be capital appreciation. For capital appreciation to occur there has to be good quality assets that have good growth potential and a good story coming to market. Thankfully, I think First Citizen fits the bill in this regard. Phoenix Park fits the bill in that regard as well.” Real estate was also another favoured investment option among the experts. Dean said:
“Real estate is by far the most superior instrument added. When the retiree dies, they leave an asset behind for future generations unlike pensions that stop or reduce when the person dies. I would always consider taking a lump sum to first direct towards some form of real estate investment, even land as this appreciates the capital sum over time.” Dean also suggested that part of the lump sum could be used to make additions to the home to generate rental income.
Asked about other tangibles like gold, Julien advised caution. He told Sunday BG that gold was a “speculator’s market,” with an element of danger.
“There is a popular investment quote that says, ‘you invest on the sound of the cannon and you retreat on the sound of horns.’ When everybody is saying to do something, that is when you shouldn't be doing it. And when everybody is retreating from something that is when you should be doing it. If everybody has an idea as the best idea, is it really the best idea? ... Now that everybody is saying gold is a good investment that is a thing to be cautious about. Why is it a good investment and why are we all saying it is a good investment?
At the time of writing, gold traded at US $1,270 per ounce. He had the same view of forex trading. Julien said if there was one lesson Clico should have taught the country, it is to ask the right questions about investments. He said before anybody got into a particular type of investment, they should understand it. He termed forex as being even “trickier” than the gold market and said would be investors should find people who understood what drove foreign exchange trading and who knew the risks.
US dollar investments were also another possibility however, Julien says interest rates on US dollars were low as well.