Should You Convert Your Bank Savings into a Savings Plan?
From the day we first receive money as blessings on special occasions like our birthdays or during the festive seasons, we were always reminded not to spend them all but to leave some or even most of them in our saving accounts. There are many reasons why saving through bank accounts have become our all-time favourite. Not only does it give us a sense of security, knowing that our money is in safe hands, it can also be withdrawn anytime, and allows us to earn interest at the same time.
As we get older, most of us have opened new accounts for salary crediting or better saving purposes as more interest can be earned as compared to our junior account. We’ve always known the importance of having higher interest rates – it will help to grow our money faster, and eventually, help us achieve our goals. We used to be able to enjoy a reasonable interest in the high-interest bank account. But things have changed drastically since the start of 2020.
What Caused The Drop In Interest Rates? (What is happening right now?)
The COVID-19 pandemic definitely came as a surprise to us. The global economy was on a 10-year long bull run before this, and suddenly we find ourselves in potentially one of the worst economic crises. Till date, most local banks would have slashed their rates more than once to stay afloat as evident from this article from The Straits Times.
As a part of the government monetary policy, low-interest rate helps to support businesses to take up loans for the funding of operations for business continuity & expansion. In return, business activities can be stimulated to boost our country’s economy. Though this may sound great for businesses and investors, we, unfortunately, cannot say the same for individual savers. If you find yourself a victim of this, you are definitely not alone.
Saving money in a bank has always been seen as a good thing. However, if you were to ask anyone sensible now, they will tell you otherwise. Saving money in a bank used to be good because we get reasonably rewarded for keeping our money in the bank – we get good interest rates and even cash rebates! But in a time like this, keeping too much money in the bank could be the least favourable option here.
How Long Will This Low-Interest Rate Environment Last?
As of September 2020, according to The New York Times, the US Federal Reserve’s latest economic forecast announced that interest rates in the country will most likely remain near zero for at least the next three years. While the rationale behind it is complicated, here is a simple explanation of it: As the pandemic-induced recession continues to threaten the economy in the near term, job losses are expected to rise while companies continue defaulting. The recovery process will not happen overnight, thus it is a part of the government’s strategies to keep interest rates low so that “cheap” money can be funded to the market and business entities for a prolonged period, in order to fuel the demand for goods and services, which in return, can stimulate employment and boost the economy.
As a financial planner, the impact of earning a low interest over the long run is something that we are concerned about as we made a promise to build a meaningful portfolio for our clients. For risk-takers who are willing to accept short term fluctuations and uncertainties in exchange for a higher return of their capital, investment in the stock market will offer the best opportunity for them. And for those who are more towards risk-aversion and prefer certainties over high returns, a participating endowment plan, or commonly known as insurance saving plan, could be the best fit in your portfolio.
Our Money Must Now Work Even Harder Than Before
In today’s environment, you have to explore beyond the traditional methods to grow your savings. Back when interest rates were high, you got rewarded with reasonable interest, cash rebates, or even occasional free gifts, for putting your money with them. But ever since the pandemic, you would have realised that it has become harder to achieve similar growth with the same input. More importantly, low-interest rates may also take away the effectiveness of compounding in a savings account. When we are still young, we enjoy having a longer time horizon when accumulating wealth with the positive effects of compounding. It is a way of accumulating wealth with the least amount of effort and risk, yet it rewards us a great lump sum of money. However, given our current circumstances, what will there be left to compound in a savings account if interest rates continue to fall?
To help you understand better on how the low-interest rate environment can affect our savings over the years, I have prepared this table to illustrate the value of our money at different time-frames under the compounding effect of 1% and 3% annual rate of returns.
Click above image to enlarge. For illustration only.
Assuming that we have $10,000 savings today, and choose to grow the money at 3% annually using other promising methods instead of keeping it in a bank savings account over the next 20 years for the mere 1% bank interest. As shown in the table, you are going to make 10% more at the end of year 5, and 58.59% more by the end of year 20, simply by doing nothing! This is the wonder of compounded interest if we use it effectively to act in our favour!
How should you plan for your savings? – 3 Tiers of Savings concept
We believe that all savings are different because of each of their purposes and the required return. Therefore, when it comes to savings allocation, we will break it down into 3 tiers for the ease of planning. For the purpose of this article, we have categorised Tier 1 as the money that you will need in the next 1-5 years. Tier 2 is for the money you will need in the next 5 – 10 years and Tier 3 is for the money you will need in the next 10 years or more. They are categorized this way to cater for short-term needs, medium-term needs and long-term needs.
Click above image to enlarge.
Tier 1 savings are meant for immediate needs (daily expenses, emergencies etc) or short-term goals (car/housing down-payment, wedding expenses etc). A Low return rate is acceptable for tier 1 savings in exchange for predictability and liquidity. Some common instruments are our bank savings account, low-risk bond funds, or even the fixed deposits (only when the loss of liquidity is justifiable, usually with higher interest return).
Tier 2 savings are meant for medium-term life goals in the next 5 to 10 years. It can be used for the same purposes as mentioned previously in tier 1, but with a longer duration to save. Another typical example of tier 2 savings could be for our career switching backup funds or even the start-up capital for new business. Higher return with a certain level of predictability could be the key focus for tier 2 savings, thus a combination of investment in a balanced fund with insurance endowment plans could well serve the purposes.
Tier 3 savings are for long term goals far in the future (>10 years). They can be things like our own retirement funds, children’s education fund, a second property or could even be a form of inheritance. The extended time horizon allows us to go for instruments with higher returns to enjoy the wonder of compounded interest. A combination of investment in an equity fund with insurance endowment plans of various features could help to capture the upside of investment while enjoying downside protection.
Should you convert your savings into endowment plans?
After all these discussions on different types of savings, let’s now come back to the fundamental question of this article: Should you be converting your savings into endowment plans?
Often, without the right knowledge, people choose to keep all their savings in the banks or fixed deposits which may not be effective especially for longer-term goals. For instance, instead of investing or setting up an endowment plan that gives us better returns over the long run, saving up with purely Tier 1 instruments will give us too much liquidity to be useful, and cost us more for not working hard enough with our money. Therefore, choosing the right instrument that aligns with your time horizon and goals paves way for an easier route to save up eventually.
Here are a few reasons why you should consider adding endowment plans into your portfolio:
A. Potentially higher returns than a standard bank account
Many endowment plans offer guaranteed basic returns that are comparable to a standard savings account, not to mention that there also additional non-guaranteed return portion which allows policyholders to directly benefit from the performance of the insurer’s investment portfolio. For those who may yet to have specific goals that you are saving up for, an endowment plan with infinite maturity date is a perfect fit for you as it allows you to save as you go. Should you require some funds down the road, a portion of the portfolio will be made available for withdrawal after a certain period.
B. A forced discipline can be a great help to you
To save money regularly can be boring and challenging, especially when the time span is long, as we need to deal with more distractions along the way. Having a savings plan ensures that you diligently save up for goals first and prioritize it over upgrading to a new phone or going for that holiday. This doesn’t mean that we should place our enjoyment last, however, by saving first, we have greater peace of mind when it comes to our lifestyle enjoyments!
C. You are saving for a longer term with a clear intention
For instance, you may be saving for your dream home, future business start-up, your child’s education, or even for early retirement! A goal without a plan will bring you nowhere. Thus, dedicating yourself into one endowment plan that can specifically help you achieve that goal means one step closer from hitting it.
D. Protection against unforeseen circumstances
Saving money in the bank will not guarantee you the realization of your goals if something were to happen to you along the way. However, by diversifying into endowment plans, our goals will be safeguarded as we have the right to call for the premium waiver option, should critical illness or disability occur to us. The policy premium will then be fully paid off by the insurer, keeping the policy alive until the maturity date where you will then be able to receive the full maturity amount.
In such a low-interest rate environment, we can certainly still enjoy higher returns instead of keeping our monies in the bank. Traditional ways of savings are not as effective as they used to be. By diversifying between different instruments and creating our 3-tiered portfolio, we may have a better opportunity to see our savings increase at a faster pace.
While we are worried about the impact and changes that the current environment brings, it is always a good time to look for growth solutions as well. You may refer to our Guide to Saving Plans which will explain further on the different types of endowment plans & their features. Above that, this guide will also help you understand which solution will suit you best. You can download the guide here.
Article by Sabrina Tan & Moo Hau Eng
The writers are financial adviser representatives representing GEN Financial Advisory Pte Ltd.