Got your first pay cheque? Start saving

This is the first of a three-part series on how to better manage your finances. This week, we look at young adults and offer tips on how to maximise use of Central Provident Fund savings.

Entering the working world and bringing home your own pay cheque can be a liberating yet daunting experience.

Young working professionals should take care to manage their finances well, or they may come to regret their lack of prudence in their twilight years.

Managing your finances

The fine art of managing your personal finances is governed by a simple rule: Save more than you spend.

But most people know all too well that this is easier said than done.

Young people face an onslaught of distractions tempting them to reach for the cash in their wallets - or worse, use money borrowed on plastic.

Credit cards may be convenient, but they also tend to encourage people to spend beyond their means and run up hefty debts.

Spiralling debt can mean falling behind on your repayments - and this can harm your credit repayment record, which could well lower your chances of getting a loan.

And even if you manage to get a loan, the interest rate may be higher.

So a black mark on your credit record may compromise your later ability to finance important purchases such as a house or medical expenses when you are older.

Mr Sean Cheng, financial consultant at Providend, urged young working professionals to start the golden habit of saving as soon as possible.

"You should set aside at least 10 per cent of your monthly income into a separate bank account when you first start," he said.

Later, aim to save 20 per cent or even more of your monthly income, he advised.

COVER YOURSELF FIRST

It is only by first setting aside emergency funds and getting the necessary insurance coverage to protect ourselves that we can even think about investing.

Financial blogger Sing Heng

Ms Evelyn Lim, 35, developed a healthy saving habit early in her working life.

The assistant corporate communications manager recalled setting aside at least 40 per cent of her monthly income of $1,500 when she started working at age 20.

"It wasn't that difficult. I tended to park my savings aside as soon as I got my pay," she said, adding that the proportion of income saved should increase as your income grows over the years.

Putting aside an adequate level of savings involves knowing your monthly incomings and outgoings like the back of your hand.

Plan your weekly budget and stick to it.

Mr Cheng advised that a simple step such as downloading an online app will not only allow you to keep track of, and review, your spending habits, but also "act as a psychological deterrent to overspending".

Telecommunications engineer and financial blogger Sing Heng, 27, sets monthly and annual savings goals. One goal was to save $100,000 in five years - and he is now close to meeting the target.

"By setting a target of, say, $100,000 in five years, we know we need to save $20,000 every year," he said.

"This way, we have a plan to work towards."

Young working professionals can also consider creating additional sources of income to supplement their basic salary.

For Mr Heng, the passive income earned from his blog and stocks helped to cover his expenses, enabling him to save more than half of his net salary.

These savings will go a long way towards building up a sufficient emergency cash fund.

Mr Aw Choon Hui, deputy chief executive officer of GYC Financial Advisory, said that this fund should be enough to cover at least six to 12 months of one's average monthly expenses.

"Set this money aside in savings or a fixed deposit that you can access in a hurry," he added.  

Central Provident Fund

The savings calculator and the CPF contribution calculator provided by the CPF board helps members to better manage their finances.

The regular employer and employee contributions to your various CPF accounts will help to boost your savings over time.

The CPF contribution and allocation rates depend on factors such as your age group and your salary.

For instance, those aged 35 and below and earning at least $750 a month have an employer contribution rate of 17 per cent of salary.

The employee contribution rate is 20 per cent of the person's salary.

Buying your first home

Many young working professionals will have their eye on purchasing their own property at some stage. Unlike relatively minor purchases such as a laptop, this is a significant step for young professionals, requiring careful consideration.

Their decision can very easily be coloured by a desire to attain that "dream home", prompting buyers to splurge on an expensive piece of property.

And while they may be able to afford the initial downpayment, problems may kick in later with monthly instalments and loan repayments - especially if, as expected, interest rates increase.

Borrowers will be walking a tightrope, managing their daily expenses, mortgage and other loan instalments, while setting aside sufficient funds for regular savings.

All this means you should carry out careful planning before buying a home rather than purchasing a piece of property on a whim.

For instance, Ms Lim spent five years planning for the purchase of her first property, an executive condominium, that came with a downpayment of $100,000. During that period, she was more cautious with her spending and left her bonuses untouched.

It is important to live within your means.

Mr Cheng said HDB flats might be a better option for young people with limited funds, owing to the lower costs and the subsidies available.

Home hunters should factor in the renovation and home fixture costs of perhaps $20,000 or even more, depending on their preferences, said Financial Planning Association of Singapore (FPAS) honorary secretary William Cai.

Interest rates are another thing to watch out for. While mortgage repayments may look deceptively affordable, Mr Aw warned that this can change overnight.  

He suggested that home buyers build in some buffer so that when mortgage repayments get revised upwards, they can still afford the higher monthly repayments.

To estimate a sensible housing budget, buyers can check with various financial consultants or use the "Our First Home" calculator provided by the CPF board.

Of course, even prudent home buyers will usually need to apply for a housing loan. Eligibility will be based on the Total Debt Servicing Ratio - a computation of a buyer's total monthly debt obligations as a percentage of his total monthly income.

The total monthly repayment for property loans and other debt obligations should not exceed 60 per cent of the monthly income. The monthly housing loan payment should ideally not exceed 30 per cent of the gross monthly income as well.

Use of CPF savings

Under the Public Housing Scheme and Private Properties Scheme, people can use their CPF Ordinary Account (OA) savings to buy an HDB flat or private property. Still, it is not recommended to use too much of your CPF savings to fund housing instalments.

CPF limits may apply to the amount of OA savings you can use. These limits include the valuation limit and the withdrawal limit, which depend on the type of property and housing loan.

Instead, you can use part cash and part CPF payment for housing loan instalments.

For instance, assuming a couple have a monthly repayment of $1,500 over a 25-year loan period, they could consider paying their monthly instalments using CPF ($1,000) and cash ($500).

By doing so, they earn an additional $58,000 interest by keeping the $500 every month in their CPF accounts during the loan period.

When deciding what proportion of CPF to allocate to housing instalments, keep in mind the other items being serviced with your savings. To use CPF for home loans, you have to be insured under the Home Protection Scheme or a mortgage insurance policy.

Balancing the need for funds to pay off your mortgage while setting aside regular savings for retirement can be a tricky affair.

To keep things simple, financial consultant Mr Cheng recommended that when you get your pay cheque, you should first save at least 10 per cent of your income for retirement, before paying the bank and fulfilling other financial obligations, such as your mortgage payments.

"Most people spend before saving, but they should save before spending - that way they can ensure that they will have enough for their future," he said, adding that keeping track of opportunities to refinance the property at a lower rate will offer scope for reducing the interest rate applicable to the loan, depending on market conditions.

Growing your family

Another milestone for young couples would be establishing a family while also shouldering the growing responsibility of providing for their elderly parents.

Adequate and comprehensive insurance policies are key here, as insurance coverage will rise as couples start a new family, experts say.

The most basic types of insurance would be hospitalisation and critical illness insurance.

Mr Cai said that while it is not uncommon for people to hold three to five policies, many young and old working professionals are insufficiently covered.

"This tells me that their insurance needs have not been properly established," he said.

"Remember that a wise person always insures what they cannot afford to lose, one of which is your future income," Mr Aw said.

Central Provident Fund

Couples should consider the various integrated MediShield plans available for each existing and new member of the family.

Purchasing a plan as soon as your children are born will ensure they are covered immediately. Buying a policy for your parents will also help avoid the heavy financial burden of a large medical bill as they grow older.

"A suitable integrated Shield plan, especially one that covers co-insurance and deductibles, would generally be sufficient to cover hospitalisation costs in Singapore," Mr Cheng said.

Planning for retirement

Retirement can often seem a dim and distant prospect in the minds of most young professionals, but you should not be caught off guard through complacency.

It is only by squirrelling away regular amounts of cash that you will then be able to accumulate a decent nest egg to ensure you can comfortably enjoy your retirement.

With an eye on that nest egg, you should remember that your savings need not sit untouched in your CPF accounts.

If there are unused savings in your Ordinary Account (OA), you have the option of transferring these funds to your Special Account to earn higher interest.

CPF OA savings earn interest of up to 3.5 per cent a year, while savings in the Special Account (SA) and Retirement Account earn up to 5 per cent interest a year.

If you are using your OA savings for your housing repayment, be sure to set aside sufficient funds in the OA before the transfer, as the OA-SA transfer is irreversible.

Take for example someone who is 30 years old this year with $70,000 in his OA and $25,000 in his SA. If he transfers $20,000 from the OA to the SA, he can earn an additional $2,361 in interest by the time he is 35.

Any transfer of savings from the OA to the SA is irreversible. You can transfer only an amount up to the prevailing Minimum Sum in your SA.

For members turning 55 between July 1 last year and June 30 this year, the Minimum Sum will be $155,000. The Minimum Sum of the next cohort will be $161,000.

Another option to grow your retirement nest egg is to boost your savings through investments. This can be risky but, when done properly, it can be rewarding.

Mr Cheng said that the earlier one starts investing, the better, as this will "allow the magic of compounding to work for them".

And while investing has its risks, so does doing nothing, for inflation will continue to decrease the value of your savings, said Mr Aw.

But it is important to do your research into the various types of investment instruments available.

Weigh the risk involved to make sure it suits your willingness to take risks. Using a trusted financial adviser and investment manager will also be beneficial.

According to Mr Aw, ideally a person should set aside 15 to 25 per cent of his monthly income to invest in a basket of global funds.

Avoid buying stocks directly unless you enjoy spending significant amounts of time studying and monitoring your stock portfolio, he said.

Another option for investing is the CPF Investment Scheme.

This allows members to direct their CPF savings into investment products such as the Singapore Government Bonds, approved unit trusts and bonds guaranteed by the Singapore Government.

Mr Cheng advised: "As a general rule of thumb, individuals should invest in well-diversified investment portfolios made up of ETFs or mutual funds, and invest regularly for the long term."

For more conservative investors, Mr Cai recommends introducing a 20 to 30 per cent mix of bonds into your investment portfolio as one way to enjoy more limited volatility.

Those new to investing should spend some time studying the historical risk of different portfolio mixes of equities and bonds, before selecting one that suits their temperament, he said.

"The study of historical drawdowns over a period of more than 30 years helps investors get a sense of how their portfolio can behave."

Plans such as the Regular Savings Plan (RSP) are also an option for young investors keen on low-cost, long-term investment that is not governed by market fluctuations.

Such plans direct regular investments into pre-determined investments on a monthly basis, and do not require significant capital outlay.

Ms Sharon Tan, senior vice-president of the consumer banking group DBS Bank Singapore, noted that this might be a good option for young working professionals.

"With young adults increasingly buying their first investment at a younger age, many may not have the ability or luxury of investing a large initial lump sum," she said.

But accumulating a sizeable amount of savings should remain the top priority for any young working professional.

"It will form the bedrock of any financial plan we implement," Mr Heng said.

"It is only by first setting aside emergency funds and getting the necessary insurance coverage to protect ourselves that we can even think about investing."

hsteph@sph.com.sg

Read Part 2 of the three-part series here: Pay less tax and build up nest egg with SRS

Read Part 3 of the three-part series here: Cut down risk as retirement nears