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MPF Decoder for the Youth
Chapter 2: Capital, Time, Rate of Return
The MPF Elf's explanations enhanced my understanding of the MPF. Now I'd like to share my conversation with the MPF Elf with my friends. It went something like this:
Max: Why do I have to start contributing to the MPF as soon as I start to work? My pay is so little. Why don't I wait until I earn more? Then I wouldn't mind contributing a bit more. Wouldn't that be better?
MPF Elf: Max, let me explain. Saving or investing involves three key factors: Capital, Time and Rate of Return. The variations in these three factors will affect the success of your saving or investing.
To put it simply, let's say your goal is to accumulate a certain amount of wealth. If your capital is small and the investment period (i.e. the length of time your money can stay invested) is short, only by getting a higher rate of return can you achieve your goal; alternatively, if the investment period is short and the rate of return cannot be increased, you would need a larger amount of capital to reach the same goal; likewise, as is the case now, your capital is small and the rate of return is hard to be increased, then you must have a longer investment period to achieve your goal.
So, when there're any changes in one of the above three factors, the other two must be changed accordingly so as to achieve your targeted amount of wealth.
Max: Oh! I see!
MPF Elf: But you have to remember, since the rate of return can be affected by a number of factors (such as market fluctuations and the risks inherent in investment), it is the most uncertain variable when compared with capital and time.
Not only that, your capital can also be affected by a number of your own personal factors (such as your income stability or cash flow requirements).
On the other hand, the investment period is relatively easy to plan for and control. If the future holds enough time, it doesn't matter if your capital is smaller in amount, or even if the rate of return goes down, your saving goal can still be achieved at a relatively relaxed pace!
Max: It seems to be making sense. But I'm still not quite sure about it.
MPF Elf: Don't worry! I'll show you a few examples to make it clearer.
First of all, say your monthly MPF contribution is $500, and your employer's contribution is $500. That makes a total contribution to your MPF account of $1,000 per month from now until you reach the age of 65. So, that's 540 contributions over a period of 45 years. Assuming that the MPF gives an annual rate of return of 6%, your account could accumulate about $2.75 million as your retirement savings by the time you're 65!
Max: Wow! That's not bad! But what if I don't start saving until I'm 40, and I'm saving the same $1,000 and the annual rate of return is still 6%. How much would I save by the time I'm 65?
MPF Elf: OK, let me see! That would be about $690,000, as you can see from this table:
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Monthly Contribution
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Age at which Contribution/Investment Commences
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Annual Rate of Return*
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Contribution/ Investment Goal at Age 65
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$1,000
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20
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6%
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$2,750,000
(Capital $540,000)
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$1,000
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40
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6%
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$690,000
(Capital $300,000)
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(* These are assumed rates of return)
Look! If you start saving and investing 20 years earlier, your capital will be just $240,000 more than that of the case if you start 20 years later. However, your total sum of capital and investment return will be $2 million more when you reach the age of 65.
Max: Whoa! That's more than $2 million in difference! What's the reason for that?
MPF Elf: Well, that's because of what we call the "compounding effect". This is what happens when you continuously "roll-over", that's to say renew, your principal investment plus the interest. But you have to remember that the "compounding effect" is not so apparent in the early stage because your capital needs time to generate interest. Then, the interest added to your capital continues to roll over and generate interest, producing the effect of compounding interest.
That's why, if you only start saving when you're 40 years old, you only have 25 years left to make contributions and invest. But if you begin when you're 20, you will have 45 years to make contributions and for investment as a whole, which accounts for the extra $2 million!
Max: Hmm. $690,000 doesn't sound like enough to retire on! OK! So if I want to accumulate retirement savings of $2.75 million, but I don't want to start saving until I'm 40 years old, how much would I have to save each month?
MPF Elf: As I've mentioned, if your total contribution/investment period is shortened by 20 years while the annual rate of return remains unchanged, your monthly contribution would need to be increased from the existing amount of $1,000 to $3,968 so as to achieve your goal.
Max: Wow! That's nearly $4,000 a month—about four times as much as I start now.
MPF Elf: That's right! But when the time comes, if you can't afford the $4,000, there's another way: bearing a higher risk in the hope of getting a bigger return. However, the rate of return is usually hard to plan for and control!
Max: How big would the return have to be?
MPF Elf: OK, if you only start saving $1,000 per month when you're 40, but have the same saving goal of $2.75 million, your annual rate of return would need to be a whopping 14.1%, as you can see from this table. And as I just said, your monthly contribution amount, investment period and annual rate of return may affect your contribution/investment goal due to a number of unforeseen factors.
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Monthly Contribution
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Age at which Contribution/ Investment Commences
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Annual Rate of Return*
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Contribution/ Investment Goal at Age 65
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$1,000
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20
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6%
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$2,750,000
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$3,968
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40
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6%
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$2,750,000
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$1,000
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40
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14.1%
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$2,750,000
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(* These are assumed rates of return)
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