Baby Steps to Financial Peace

Most Singaporeans will probably not have heard of Dave Ramsey before. But anyway, Dave Ramsey is America's trusted voice on money matters. He also has something written on 7 Baby Steps to Financial Peace. The 7 steps are simple enough to follow and are listed as follows:

1. $1000 for emergency fund
2. Pay off all debts less the house
3. 3 to 6 months of expenses in savings
4. Invest 15% of household income for retirement
5. College funds for children
6. Pay off home loan early
7. Build wealth and Give

The steps seem simple enough to follow and should be a useful guide for most people. 

I guess not many people take financial planning seriously.

Take this comment by sigdiamond2000 on financial stability for example. It is extremely hilarious. 

Two Ideas That Will Change Your View About Investing Forever

One day, when I was taking a shower (now readers know where all my inspiration comes from!!), I reflected on my years of working, investing, conversations with friends/family/colleague and tried to distill what were the two most important ideas or messages that I should tell anyone who was getting started on investing/retirement planning/personal finance.

You see, in Asia or in Singapore, personal finance is still pretty much a taboo topic.  It isn't the best lunch conversation topic (unless one is talking about the latest stock picks and how who and who made a million bucks from some investment).  But people in general tend not to reveal their own investments, savings, etc, etc. Money is almost like a taboo topic that is not discussed.

I have heard and read about so many ideas but I think these are the two most revolutionary ideas that will perhaps change the perception or philosophy of investors:

Idea #1 - Investing is for Income

I don't really recall when this idea struck me or came into my head.  It might have been a book I read or when I was just thinking about retirement planning in general.  But the key idea to investing is not to "earn a million dollars" or to "buy a big house", etc.  Well, those are the material things that people want and I guess it is easier for people to relate to some kind of physical possession or numerical value to determine that they have reached financial freedom.  However, this is probably misguided.

For most people, becoming a millionaire seems to be the ultimate goal.  However, if you dig deeper and ask them why they want to be a millionaire, it is probably due to the pre-conceived idea that with a million dollars, they no longer have to work and can retire in peace.  That probably explains why many people buy the lottery. The idea of having a big house is also related to the very simplistic idea that "if I own a big house, I must be rich, just like people on TV/movies.  If that is the case, I no longer need to work".  While these physical possessions gives many people a financial goal to strive for, at the end of the day, if you drill down deeper, you know that reaching these arbitrarily set goals probably does not put one in a better stead to achieve financial freedom.

At the end of the day, it boils down to cashflow.  Give a big spender a million dollars and let him retire at age 30.  It is possible that the million dollars can be spent even before his lifetime and he will have to return to work.  And that probably explains why many lottery ticket winners end up becoming bankrupt or broke again.  So the idea is cashflow.  And the idea is that all that you are investing for is not for a big house or for a million dollars, but it is for the sole purpose of income.  It is the common Chinese saying : " qian sheng qian" or "using money to grow more money".

When one invests, the million dollar goal (or two million dollar goal) is actually so that you can start drawing down on that sum of money during your retirement years.  That is how most financial planners will actually work out how much you need for your retirement.  They take the age you intend to retire, and the expected life expectancy, and calculate your monthly expenditure to indicate what is the $X dollar value that you need in retirement funds.  But so many people forget that the $X dollar value is meant to provide them with income when they stop working and stop drawing an income.

So at the end of the day, all investing is for the sake of income.  Nothing more and nothing less.  That is the sole goal of investing.  You are basically trying to build up a stockpile of cash that you can tap upon when you are not drawing any money.  If you have $10million dollars invested in an instrument that gives you a 10% per annum yield, you will have $1million in income to spend every year.  That is as simple as it gets.  If you put that $10million in a bank with 0% interest, what you draw down on that bank account every month is basically income while the original value of your bank account just gets depleted month after month.

This idea is "revolutionary" because not many people I know of think or speak of investing in that sort of way.  They always speak of investing as some sort of arbitrary goal or just about making more money from the stock market.  If you realise that investing is about income, you will realise that building up that income is just one side of the story.  What you as an individual will also need to manage is your monthly expenditure so that it does not exceed your monthly income.  And isn't that all there is to personal finance.  No wonder we hear the frequent maxim: "Spend less than you earn".  Because even when you retire, you also need to spend less that you get in income.

Once this idea is firmly implanted in your head, it will then help you better strategise how you want to go about building up that income stream for your retirement years.  For some people, it could be just a bank account.  For others, it might be bonds or dividend yielding stocks/REITs or businesses or even rental income from property.

Here is where the 2nd idea then comes in a little much easier....

Idea #2 - If You Intend to Work for the Rest of Your Life, You Don't Really Need to Invest

I know that this idea will probably draw a lot of flak from some readers who will still think that it is important to invest.  What I am alluding to is the hypothetical situation of a person who has no intention to retire and whose life expectancy is say at age 80.  Effectively, a financial planner who does his calculation will realise that there is no investment product he can offer this person especially if the person is willing to live within his means.


If one is able to work till death and still draw an income, then you literally will not have the need to set up a retirement fund.  However, there is of course all the unexpected events that life can throw at us.  Illness, retrenchment, disabilities, etc, etc can all potentially strike us even if we intend to work for life.  So at the end of the day, one will still need to prepare for such unforeseen scenarios either through investing/savings/insurance.


I don't intend to retire, but I still invest.  And the reason I invest is just in case there comes a day when I am forced to retire.

Surrendering Insurance Policies?

I read the news article a few weeks back about insurance agents/financial planner shifting around the various companies in Singapore with handsome buyout clauses and stuff. These insurance agents get paid lots of money just to jump ship from one insurance company to another company.

While that might be a concern to most people, it is important to note that if your insurance agent has switched companies, he or she is not supposed to induce you to lapse or surrender your existing insurance policies and buy a new policy from them. This unethical agents are just out to earn extra commission as they no longer earn the trailer commissions that they would have earned if they had stayed with the same company. When they join a new insurance company, they start from ground zero all again and have to start building up their client base all over again. The fastest and easiest way that they go about doing this is to ask their previous clients to take up new policies with them, often citing the benefits of doing so.

Some of them might even suggest that they can continue to "take care" of you. That is not the case as the insurance policy contract that one purchases and owns is an agreement between the insurance company and you. The insurance agent is just a distributor and does not own the clients in a legal sense. When your insurance agent leaves the industry or leaves the company, the insurance company will get another insurance agent to "service" you. If all else fails, just call the customer service hotline. That is the usual way I find out information and it is much faster than going through your insurance agent.

In the insurance industry, this malpractice of replacing old policies with new policies has led to agents being caught and fired. Many have also been disillusioned by the unethical conduct and have left the industry or lamblasted the industry. However, the practice is still very widespread. I have met with many insurance agents before and all of them have at certain points in time asked me to surrender one of my existing policy to buy a "better and newer" policy from them. This happens even when I have met IFAs.

This point has been elaborated by Mr Tan KL before at his blog. In most cases, surrendering your insurance policy does not make sense. This is especially so if you are asked to buy a similar insurance policy to replace the policy that you have surrendered or lapsed.

From a monetary point of view, it is very difficult to justify surrendering a policy for another policy. Always remember to get a 2nd or 3rd opinion when in doubt so that you can make a more informed decision. Better still, ask people like me who are not in the industry and you will probably get a more informed and independent opinion. Of course, you will have to buy me coffee =) .........Just kidding..

Generate Income from Your Property

A few days ago, I wrote about HDB's Lease Buyback Scheme. I was just exploring the various options that might be available to people for generating income from their biggest asset: Their Homes or HDB flats.

I have been thinking about it for some days and I do feel that the Lease Buyback Scheme ought to be further improved if possible. For one, they should perhaps extend it to all Singaporeans to make it easier for older Singaporeans to liquidate the tail-end lease of their HDB flats. After all, not many people are ready for retirement in Singapore.

Renting Out

Another way that people can generate income from their property or HDB flat will be to rent out the entire flat or rent out certain rooms.

A person is allowed to rent out the entire flat after living in it for a certain number of years. (5 years if subsidised and 3 years if unsubsidised). Approval is required from HDB to rent out the flat. A higher property tax of 10% will be chargeable if you rent out your entire flat.

Alternatively, one can also rent out one or more rooms in your property or HDB flat with no change to the property tax payable.

Generating income from your property during your retirement years is fairly easy. However, one should realise that there are also certain risks and downsides involved:

1. Bad tenants (illegal immigrants, overstayers, people who don't pay rent, tenants who spoil your property).

2. Conflicts when living with tenants.

3. Lack of privacy.

Can You Trust Your Financial Planner?

Below is the first article that I contributed to CPF's IM$avvy. It discusses the current state of the financial planning industry in Singapore. I hope readers find this useful.

Being too trusting of others can sometimes work against us in financial planning. Too often, we are not skeptical enough when it comes to financial advice offered by others. Can you trust your financial planner? Is he really providing independent and unbiased advice or is he just trying to close a sale?

Advisory Business or Sales Business?

When the Financial Advisers Act was first introduced in Singapore, many thought that the financial planning industry would come up with a new breed of financial advisors who were independent and unbiased. While the fee based or fee-only model of financial advice is slowly taking off, most people in Singapore are still unwilling to pay a financial planner for the time and energy he takes to craft a financial plan. As long as the market is not ready, financial planners will continue to be compensated based on commissions.

A thin line separates the financial advisory business and the sales business. A sales person is one who derives his income from commissions. On the other hand, the financial advisory business is supposed to provide independent and unbiased advice to clients. It is important to realize that potential conflict of interests arise when financial planners earn commissions from the sale of financial products.

If your financial planner is earning a commission from you, can you trust that he will make the best financial decision for you? If a financial planner is selling you a product that you know very little about, how can you trust that the product is suitable for you?

Financial Products and Imperfect Information

I just read a book and it talked about a wallet auction.

Imagine that I pull out my wallet from my pocket and placed it on the desk in front of me. How much will you offer for the money in it? Whatever the case, any buyer of my wallet will be certainly worse off as I will only accept offers that they should not be making. I know what I am selling but the buyer does not know exactly what he or she is buying. It all boils down to information asymmetry or imperfect information.

The same theory applies to financial products. Imperfect information exists and the buyer has to overcome his lack of knowledge of the situation or of the seller. Market economies often deal with this problem through the mechanisms of advertising and reputation. As a consumer of financial products, your perception of a certain company’s reputation might influence you to purchase the product or invest in certain instruments. Or perhaps you have seen some advertisements that offer yields and gains that are too tempting to resist. Or perhaps, your friend had recommended a “reputable” financial planner that you can trust.

The reason why buyers rely on reputation and advertising is that they are not willing to spend the time to overcome the information asymmetry that exists. For example, a doctor gives me a prescription for a certain ailment. I trust his recommendation because of his reputation and credentials even though I am clueless about the medication that he has just offered me. In this case, it is unwise of me to spend 5-6 years of my time going to medical school just to breach the information asymmetry that exists between him and me.

But are financial products so complicated that we cannot take some of our own time and effort to breach this information asymmetry? Can you still trust that your financial planners will give you the best recommendations when there is a potential conflict of interests?

Trust Yourself: Financial Education

One simple way to overcome this information asymmetry would be for the consumer to become educated in financial matters such that they are better able to understand their own financial situation and make better financial decisions. This would help them better understand the financial products that they wish to purchase. For the beginner, the CPF IMSavvy website has a comprehensive list of articles that should serve as a good foundation for anyone interested in becoming more financially literate.

Are you willing to invest the time and energy to learn more about financial planning? Or do you still trust that a financial planner will do the best job for you?

Why Financial Knowledge is Not Enough

For most people, financial knowledge is actually easily acquired through the internet, books, friends or various other sources. Financial knowledge is simply the simple know-hows of basic financial planning. Yet, it is perhaps surprising that even when many people do possess this knowledge, not many actually act upon it. In a certain sense, having financial knowledge is not enough to guarantee financial success.

Financial knowledge is not enough by itself. It is akin to knowing about healthy living and eating but still being overweight and living a very unhealthy lifestyle. When I am choosing what to eat for lunch or dinner, I know what are the healthy food choices. I know that I ought to stay away from fizzy drinks. I know that I ought to exercise alot more. Yet even when I am armed with all this knowledge, I do not act upon it. I continue to eat unhealthy food and skip my planned exercise sessions. What results (love handles, tummy, failing IPPT) is not due to my lack of knowledge about healthy living.

The same case applies to most people when it comes to financial knowledge. They might know the need to save and invest their money. They know the importance of planning for their retirement. They know the importance of insurance. The problem is not really a lack of knowledge. The problem is that they fail to act upon it. I know of people who are well-versed in terms of financial knowledge but whose financial health itself are in a "mess".

In Bloom;s Taxonomy of Learning, it has been identified that people need to acquire Knowledge (K), Skills (S) and Attitude (A). As such, we can see that knowledge is just part of the entire learning process. Having knowledge alone does not mean you will succeed. It is an interplay between the K, the S and the A.

Financial Knowledge is not enough. We need to act upon that knowledge. We need to work on our attitudes that are so ingrained within us.

All About Expenditure

This post is a continuation of my previous 2 postings:

1. Financial Planning - Simplified to 4 Variables

2. All About Income

The 2nd posting (All About Income) has also been published at CPF's IM$avvy site.

As the title of this posting suggests, I will now try to give my thoughts on expenditure and how it affects your financial plan. In the first posting, I gave a simplified model that I have always used when I think about financial planning. It basically involves just 4 simple variables of income, expenditure, savings and returns on savings/investments.

The amount a person saves is largely dependent on his income and expenditure. While a person with high income and high expenditure might have low savings, a person with low income and low expenditure might actually have higher savings in absolute dollars and cents!

Take for example a person who earns $1000 per month and spends $950 per month. His savings rate is only $50 per month. On the other hand, a person who earns only $500 per month but spends $400 per month saves $100 per month. That is twice the amount of the supposedly "richer" person.

Expenditure - What Works and What Doesn't

I applaud people who are able to stick by their budgets when it comes to spending money. For me, it is close to impossible. I find it difficult to stick to any sort of budget and also find it too time consuming to calculate every single cent or dollar that I spend.

So how do I control my expenditure? The answer is I don't!

Budgeting doesn't work for me. What works for me is first determining how much I want to save. Experts call this the "Pay Yourself First" technique. After determining how much you want to save each month, you simply set aside that money (be it in a savings plan or separate bank account) whenever you receive your salary.

In this manner, whenever your salary arrives, the amount that you want to save is immediately deducted and goes into a saving plan or another savings account. All that is left in your bank account is the money that you have to spend. Hooray!

Isn't that a better way to view expenditure compared to boring budgeting? (Pardon me if you still use the budgeting method).

So by paying yourself first, you literally get to spend all the remaining money. Of course, the onus is on you to set aside the correct amount of savings that you will like to achieve each month. How much you should save depends on a wide variety of factors and it is too simplistic to give a general rule of thumb.

Current Expenditure versus Future Expenditure

I just coined the two terms above to differentiate between one's current versus future expenditure.

Current expenditure is the monthly expenses one needs to survive each month.

Future expenditure is the expected future expenses that one expects to incur.

As you can see, it is actually quite easy to forecast or predict current expenditure but really difficult to predict future expenditure.

For current expenditure, what you can do is simply add up all the money that flows out of your pocket each month. This would include things like food, grocery, loans, bills, etc, etc. Add all this together and it should give you a rough gauge of your current expenditure.

Future expenditure is a little more tricky especially if you are trying to predict expenditure many years down the road. A simple case of future expenditure could be the case of motor insurance. One usually pays motor or car insurance in one lump sum each year. This might vary from year to year (depending on whether you get into accidents and stuff). If you do not cater enough money for this future expenditure, you might be surprised to see a big drop in your bank account whenever the motor insurance is due.

A more complex case of future expenditure would be your monthly expenditure during your retirement years. As some of us are probably still very far from retirement, it might be difficult for us to gauge how much we might really need. Sometimes, unexpected events like illnesses can occur and might increase our future expenditure. On the whole, experts believe that people need roughly 50 to 60 percent of their last drawn salary during their retirement years. Again, that is hard to predict for the younger folks who just started working as we have no idea what our last drawn salary will be when we retire!

Anyway, to make things really simple, what I do is just make sure that my monthly current expenditure remains roughly the same each year. In this way, I am better able to predict my future expenditure and thus determine the savings rate that I hope to achieve. Savings and expenditure are actually closely linked. If you are not saving much, it is most probably because you are spending too much.

If you can't remember a word that you have just read, just remember this simple message:

Pay Yourself First and Spend the REST!

All About Income

In my previous posting, I talked about simplifying financial planning to just 4 variables : Income, Expenditure, Savings and Returns.

Today, I thought that I would just explore a little more on Income.

Earned Income and Passive Income

Many people are only familiar with earned income which is the salary they draw from their day jobs. Others supplement their income by holding part-time jobs (e.g. tuition). Since most people are familiar with earned income, I thought that it might be timely to highlight another source of income which is passive income.

Passive income is simply money that flows into your pocket without you having to work for it. This can be obtained through dividends, annuity payments (CPF Life), or royalties (e.g. from books you have written).

Discovering that one can rely on multiple streams of income instead of a single source of income can be a relief especially in times of job loss or change of jobs. By not relying solely on a single source of income, you sort of diversify your "risks".

Of course, conventional wisdom still holds that you can actually just rely solely on your salary if you are really good at your work and the marketplace values your work highly. This include highly paid atheletes, musicians, directors, etc.

So whether you should rely solely on a salary or on multiple streams of income is a choice you have to make based on your own personal situation.

Protecting Your Income

We all take our salary for granted at times.

It is important to realise that there are certain events in life that might render one jobless. This might include unfortunate events like death, disability, illnesses, accidents or just hospitalisation.

It is thus important to realise the need to hedge against these risk by protecting any loss of future income that might be earned by you. Today, insurance companies are willing to bear this risk for you. You can thus protect yourself and your family from any loss of income by buying insurance.

Protecting your income can also be through simple steps like going for personal upgrading and development courses to ensure that your remain employable.

RETIREMENT INCOME

Perhaps the most worrying trend is that Singaporeans do not plan actively for their retirement.

During retirement, most people will not be earning a salary as they stop working totally. Without an income, they either have to rely on their savings or passive income to support their lifestyle during their retirement years.

CPF Life is an example of relying on one's savings to ensure a stream of income is present for one during retirement. The reason why CPF Life was initiated was to ensure that Singaporeans have enough savings to last them through their retirement years.

If one relies solely on their earned income, it is necessary that they realise this fact which I have illustrated below. Take Mr ABC who plans to retire at age 60 and who has an expected life expectancy of 80 years.

Mr ABC's projected income flow:

Age: 25 - 35 Annual Salary: $50,000
Age : 35 -45 Annual Salary: $80,000
Age : 45 - 60 Annual Salary : $120,000
Age : 60 -80 Annual Salary : $0

For a good twenty years (age 60 to 80), Mr ABC will not be drawing an income. He will need to rely on his savings over the past 35 years of his working life (age 25 to 60) to support 20 years of retirment.

If he is fortunate enough to live till age 95, he will have to depend on 35 years of savings to support 35 years of retirement!

Adding up his total income over 35 years, he can expect to draw a neat sum of $3.1 million dollars over his entire working life. Without taking returns on investment and inflation into account, if Mr ABC saves only 10% of his income, it would leave him with $310,000 to spend over the "worst case" scenario of 35 years in retirement.

That works out to around $8,900 per year or $740 per month.

Can he survive on that amount?

Financial Planning - Simplified to 4 Variables

Before I begin today's post, I would like to highlight that my first posting at CPF's IM$avvy site should be up by tonight. Do check it out over at the CPF $avvy Blog Corner under the month of May Archives. The title of that post is "Can You Trust Your Financial Planner?"

Financial planning can be too confusing at times. There are lots of terms that people throw around to make it seem complex.

I was thinking about it for sometime and decided that there are perhaps only 4 variables or factors that will ultimately determine whether one is financially secure.

The 4 Factors

1. Income

Income determines how much money flows INTO your pockets each month or every year. Income involves both active income (from one's salary) and passive income (from dividends, etc).

2. Expenditure

Expenditure is the amount one spends every month. It is the amount of money that flows out of your pockets to buy food, transportation costs, movie tickets, housing installments, etc.

3. Savings/Investments

Savings/Investments should be the difference between Income and Expenditure. Ideally, it should work out as:

SAVINGS = INCOME - EXPENDITURE

From the simple equation above, I guess you can see that the only way to increase your savings/investments is to either increase your income and/or decrease your expenditure.

Another thing to note is that saving money is actually quite meaningless unless you know what you are saving for. Are you saving for retirement or saving up for a holiday? In either case, you need to know that there will come a day when you are going to spend your savings. The timeframe is important so that you know whether you should keep your savings liquid or you can afford to keep them in not so liquid instruments. The end goal of savings should not be just for the hidden pleasure of seeing your bank account grow fat.

4. Savings/Investment returns

This last factor determines the rate of return your savings or investment is giving you. If you are getting a 0% rate of return, the amount of money you save will be the amount of money you have at the end of the day. On the other hand, if you have chosen to invest it and the investment gives you 10% returns annually, the amount of money that you have at the end of the day will be much more than the absolute amount you have actually saved.

Conclusion

In this posting, I have simplified financial planning into 4 simple variables that you need to take note off.

Determine what is your monthly income, expenditure, savings and the rate of return you are getting on your savings. To improve your financial situation, you just need to tweak any of these 4 variables.

I shall cover this in my next posting.

Remove Commissions for Financial Planners

I read with interest the news in Channel News Asia regarding Australia coming up with certain regulations to do away with the commission based model of compensation for financial planners.

This is indeed something interesting that Singapore should consider exploring.

In today's financial planning industry, Singaporeans are limited to the banks, insurance companies and independent financial advisory (IFAs) firms. While a new breed of financial planners are still emerging that charge clients based on a fee based model, the public as a whole seem unprepared to pay for financial advice.

As such, a large majority of financial planners are still paid based on commissions. They are considered financial planners but they have sales targets and objectives to meet. In fact, insurance companies recognise their "best" financial planners as those who are able to achieve the most sales for the company. Just look through those advertisements in newspapers featuring the top financial planners and you will notice that they are called : "TOP PRODUCING FINANCIAL PLANNERS" , etc.

This basically means that these are the people in the industry who managed to make the most money for the company and themselves, not for their clients!

I have nothing against financial planners being paid a commission. The issue I have is the potential conflict of interests that arises when it comes to recommendations to the clients. Because a financial planners is compensated based on commissions, his or her judgement could be skewed to favor products that pay higher commissions. Sometimes, it could even mean recommending products to clients that are unsuitable based on their risk profile. This is worrying.

Considering that most Singaporeans are not saving enough for retirement, any bad financial planning advice will only be more detrimental to their overall financial health.

Singaporeans ought to debate more openly about this issue and demand for more professional financial planners to serve its entire population. It is time that Singaporeans as a whole consider the option of moving the financial planning industry towards one which pays its financial planners based on a fee. This is similar to seeing a doctor or a lawyer. When one needs professional and independent advice, it is best that the professional you are seeking advice from does not have to struggle with conflicts of interests.

There are limits to what regulation can do. If the market is not ready for fee-based financial planners, no amount of regulation by MAS will help. Singaporeans need to ask themselves whether they are willing to pay a fee to meet up with a professional financial planner.

Let's do away with commissions for financial planners. Let's move towards a fee-based model of compensation for all financial planners. What do you think?