THIS formula applies to your financial life: TI = AI + PI. The terms, respectively, stand for total income (TI), active income (AI) and passive income (PI). Now, consider these illustrative examples, John, Jane and Joshua.
John is 25, earns an after-tax-and-deductions net monthly salary of RM2,500. He has no savings and investments. So far.
Jane is 45, earns a net salary of RM10,000 a month. She has RM100,000 in bank savings, RM200,000 in EPF, and RM250,000 in a diversified savings and investment portfolio.
Joshua is 70 and fully retired. He has RM50,000 in bank savings, RM500,000 in retained EPF savings, and RM1 million in a diversified portfolio.
Using TI = AI + PI, here's what their monthly income profiles look like:
JOHN'S AI=RM2,500, while his PI=0 as he hasn't yet set aside any savings to transform into capital. Therefore, for him, TI = AI + PI = RM(2,500 + 0) = RM2,500.
JANE'S AI=RM10,000, while her PI from her bank fixed deposit interest and cash distributions from her portfolio of income-focused unit trust funds averages RM1,300 a month. As she's 45 years old, she isn't yet able to access the monthly dividend payout from EPF some retirees choose to receive after they cross 55 and 60. Her TI=RM11,300.
JOSHUA'S AI=RM0, since he's fully retired. As a retiree, he has four options on how to survive economically: To live off his children's allowances, his pool of low-yield savings, the PI from his yield-generating savings and investments, and borrowings.
Our Joshua is a widower with one married daughter with three children of her own. Joshua's daughter and son-in-law live on a tight budget, but still give Joshua and his son-in-law's widowed mother RM500 each.
She lives with them while Joshua resides 3km away in his own paid-off home. Joshua drives to visit them and his lovely grandchildren twice a week. He tries not to deplete his savings by dipping into capital for two reasons:
1. Longevity risk — he is healthy and believes he should live past 90 based on his family history; and
2. Distribution goals — he plans to leave as much as possible to his daughter and grandchildren after he dies.
Joshua now earns about RM100 a month in interest from his bank savings, about RM2,000 in monthly payouts from his healthy EPF balance, and about RM3,400 in average monthly cash distribution payouts from his well-diversified portfolio.
The RM500 Joshua's daughter and son-in-law give him each month comes from their joint after-tax income. It's given, with filial love, out of their two salaries (or AI). When that money flows to Joshua, it is part of his PI total of RM6,000 a month [=RM(500 + 100 + 2,000 + 3,400)].
LESSONS TO LEARN
If for a moment we stop thinking of John, Jane and Joshua as our three different imaginary characters in my macro illustration, and place ourselves along their personal ageing timeline from 25 to 45 to 70, we can extract these lessons:
1. When we're young like John, we probably just make ends meet. So, we need to budget fastidiously and work diligently to enhance our earnings through promotions and advancing seniority;
2. As we earn more over time, we should see our EPF balance balloon through compounding while our bank savings and portfolio balances also rise; and
3. As we age further with official retirement looming, we should do all we can to work for as long as possible beyond our official retirement age — currently 60 in Malaysia, which is low by international benchmarks — to boost the different capital balances in our EPF, bank, and portfolio accounts.
If we don't die early, ageing is a certainty. To prepare while we're economically active, like John and Jane, so we are well-positioned for our senior decades — as Joshua is — we should lay multiple passive income pipelines instead of assuming a mono-pipeline is sufficient.
SPEND LESS AND INVEST
Tomorrow is uncertain, but we can be sure — God willing — that we'll grow older and need ever more money to survive. So, a multi-pipeline system for most older folks should include at least four smaller PI pipelines:
1. Filial allowances (for those with working children and grandchildren);
2. Interest from cash savings in bank fixed deposits;
3. Regular dividends from EPF's useful option of monthly payouts; and
4. Regular cash receipts from a diversified portfolio of investments that flow into bank accounts as cash distributions from unit trusts, dividends from income-focused stocks, and rental from investment real estate.
The minority of working adults in Malaysia, who are pensionable civil servants, have a useful fifth pipeline, which is probably their largest source of retirement income. Most of them, though, are unlikely to have sufficient money in EPF to establish a viable third (see above) pipeline.
To succeed like Jane and Joshua, we should spend less than we earn and save and invest the difference for a long, long time.
Fact: Malaysia will continue facing a retirement funding crisis. But you don't need to be a part of it.
© 2023 Rajen Devadason
Rajen Devadason, CFP, is a securities commission-licensed Financial Planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, or via rajen@RajenDevadason.com. You may also follow him on X@Rajen Devadason and on YouTube (Rajen Devadason).