Saving my ILP - Part 5

This is a continuation from Part 1, Part 2, Part 3, and Part 4.

When it came to reducing the insurance components of my Investment Linked Policy (ILP), I learnt that I had to still pay for the minimum death benefit of $170,000. The premium is $126 at 34 years old, increasing to $14,600 at 85 years old. Over 50 years, the total premium is $164,000, which is close to the death benefit. This more or less is a rough gauge how ILPs calculate the premiums. However, if I live beyond 85 years old, the premium for the next 10 years will grow at an exponential rate. I would have to pay $16,000 at 86 years old and $33,000 at 95 years old. The total premium over that 10 twilight years is about $240,000!

Initially my calculations were against a $80,000 death benefit. After revising the death benefit to $170,000, which is double, the benefits were not that far off, probably because there is still sufficient runway to benefit from effects of compounding.

$80,000 death benefit: breakevens at 3% annual return over 60 years

$170,000 death benefit: breakevens at 4% annual return over 60 years

I went ahead to submit my application to remove the Critical Illness and Early Critical Illness insurance components. The $170,000 death benefit includes Terminal Illness and Total and Permanent Disability (TPD). I also removed the riders for female illness, medical reimbursement, and accident. 

However, in view of the high up front cost of an ILP, I decided to retain the crisis waiver rider, which cost 10% of the premium paid or $269.90/year. I estimate that I will need to keep it for another 15 years (or when the cash value exceeds the premiums paid, whichever happens earlier) where all ILP premium payments will be waived for life in the event of Critical Illness. If I were to terminate the ILP now, I will lose about 8k. Most of the agent's commissions are paid from the first 3 years' premium. As I am in the 4th year, the additional loss I incur is marginal. If I terminate the ILP next year or any other year, I will probably lose about 10k. Going back to the calculations, the ILP will break even at year 18 assuming a return of 3% or 4%. Difference is slight because the compounding effect can only be seen after 30 years. As such to mitigate any losses from early termination of the ILP plan, I must have enough money to sustain it. For now, I will treat the  $269.90/year as a "Critical Illness term plan" that pays out $2,699/year for life as a benefit. It is expensive and I will definitely terminate it when I have secured my passive income flow.

What I had learnt: I bought it with the intention to diversify my investment portfolio. This product was created with the US tax system in mind where the capital gains from investments and estates of dead persons are taxed. The rich people bought such ILP plans to avoid tax legitimately. Insurance payouts are not taxed. This plan works around the insurance policy requirement where 1% of the value must be used to buy insurance. In Singapore, there is no estate or capital gain tax. As such, there is no need to buy an ILP to avoid tax. I do not mind buying a whole life plan, like this ILP I bought, but I think that it is not necessary if I can manage my cash flow well. I will still prefer the ILP over fixed term whole life plans where you pay a fixed amount for 10 or 15 years, and it pays out a fixed death benefit upon death. The ability to allocate 1% to insurance and 99% to investment makes it a really powerful investment vehicle to force one to save, provided one has life's runway to accumulate and benefit from effects of compounding.

Stock Review: Dairy Farm International Holdings

The share price for Dairy Farm had been falling over the past few year. In fact, it has fallen by 50% from its peak in 2013. However, at the current price of US$6, it is still much higher than its price more than 10 years ago.

Historical stock prices for Dairy Farm

Historical USD/SGD exchange rates for the past 5 years

Assuming that at its peak of US$13, and an exchange rate of 1 USD=1.2 SGD, it briefly translated to S$15.60 to buy a unit of share.

Assuming a present day exchange rate of 1 USD = 1.4 SGD, it briefly translates to S$8.40 to buy a unit of share now. This simple calculation exercise shows that the exchange rate fluctuations are independent of the share price movements.

Dairy Farm has a Scottish beginning. The current management belongs to the 5th generation of the Keswick family that also manages the other conglomerates Jardine Cycle & Carriage, Jardine Matheson Holdings, Jardine Strategic Holdings.

Cash flow has been positive every year until Dairy Farm decided to plonk US$925M in a mega investment (20% stake) in Yonghui Superstores in Aug 2014. According to the bloomberg article's research, Yonghui is the 5th largest hypermarket with a 4.6% market share. The two largest chains have 14% market share each. A year later, in Aug 2015, Dairy Farm plonked another US$210M into Yonghui's rights issue.

There are many ways to enter a China market. They could have started small by launching their own international brand (difficult route), or they could have bought smaller stakes with a fraction of their free cash flow (easier route) which has been their typical investment appetite. Taking up a huge loan to finance a huge investment certainly seems a little desperate.

Based on the historical price charts, assuming that Dairy Farm bought shares at an average of of RMB7, dividend yield is estimated at 1.7% (assuming 12 cents dividend). Yonghui's share price peaked at RMB 16.96 this year.

For me, it is really a stretch to realise the gains of a US$1.135B investment at a 1.7% yield. Just for the sake of cost-benefit-analysis, I will assume that the investment is fully financed by a loan. Bank fixed-term loans rates are at an average of 2.7% which actually makes this investment seem like a -1% yield investment (-US$11.35M/year). There has to be some other benefits to this investment that I am not seeing.

At a price of US$5.81 (4 Dec), Dairy Farm has a never-seen-before attractive 5.5% yield. It is tempting, but the thought of Yonghui always eating into cash flow is worrying. There are currency exchange risks as well if we would like to buy a stake in Dairy Farm. Events that will cause Dairy Farm's prices to continue to slide:

• USD appreciating against the RMB and SGD. Continual appreciation of the USD may potentially reduce Yonghui's yield rate.
• Rising loan interest rates.
• Losing market share to digital commerce platforms and the only solution is to reduce profit margin.
• Lack of creative strategies to regain market share. (Of course they will not disclose their internal strategies, but I certainly have not seen any differences in the way the Dairy Farm-managed shops operate in Singapore.)

The writer does not own shares in the companies mentioned.

Looking back and taking stock

As we are approaching the end of another year, I think about the roller coaster rides and ask myself whether I could have done better.

I had been probably waiting for a correction like what happened in the later half of the year for four years. It was a case of increasing opportunity cost as the wait lengthened. At a certain point, I actually decided to stop waiting and bought some shares for income. After buying in Dec 2014, the market rallied and peaked in April before the sharp correction came in August. I regretted a little, but learnt an important lesson -- always be consistent in a strategy. If the strategy is to wait, then wait. If the strategy is to stay invested, then stay invested. I wavered and switched strategy while waiting and got a little burnt.

I used to time-the-market. I told myself that as long as I sit out and wait, one day I will catch the boat (the market crash/major corrections). My patience paid off and I caught the boat a few times, and I thought that it was the way to make money. I missed a few other boats too. What I realised this year is that time-in-market is a much much better way to make money. What I did was to continuously buy on every 5% dip or when a share price reaches a new low, but I stucked to just one strategy. I spent lots of money though because sometimes it feels like catching a falling knife.

Fortunately, because I had been waiting for two to three years, I had the warchest to spend. Unfortunately, I feel a little broke now. Some companies' prices were still higher than they were three years ago even after the market correction. It is really hard to time-the-market. Who will know the oil price will drop so much? What will think that the China market will crash by itself without impacting the rest of the world that much? Who will know that European Central Bank (ECB) will actually have negative interest rates? It is a crazy world.

After going on a spending spree, I have 20 different share counters in my portfolio now. Before that, I only had 4. My overall portfolio market value is negative though, -12%, but I am getting about 6% yield for it. The yield rates range from 1% to 10%. I decided to build my own "index fund" with a wide-range of businesses, but only selecting those I like. I cherry-picked the companies that I like and belong to the Straits Times Index (STI).

I still feel the need to have sufficient warchest to buy more if the market crashes anytime soon. After factoring in the additional income from half a year's work and the dividends collected from the new shares, I probably still have some buffer to buy a few more shares if they are really worth it.

Warchest allocation ratio based on a fixed sum.

Snapshot of portfolio distribution from CDP in Nov

Overall, I am quite satisfied that I had the guts to buy when market sentiment is bad. This gut feel is always backed by my own stock reviews (detailed analysis of the financial reports) and knowing that my warchest is sufficient, i.e. if the market crashes 40% tomorrow, I still have the money to buy even more.