Saturday, January 15, 2011

Personal Finance Part 21 – Checklist for the Financially Sound

This post started out as sort of a reminder to myself on the attributes a financially sound person (and family) should have, and went on to become a detailed checklist of what I think a married couple and investor should take note of in order to be classified as “financially sound”. Please note, however, that I am not licensed or registered to give financial advice – this is merely a list of what I feel a person should either practise or possess in order to hasten his journey to financial freedom and to avoid being shackled by debt and high expenses. If there are any points which any reader would like to comment on, add on or disagree upon, please feel free to do so (but keep it constructive, please!).

1) Knowing how to budget – I think that first and foremost, it is very important for any individual to understand the basics of budgeting. When you step into the working world, it is basically a balancing act of making sure you have enough cash to last the entire month (assuming you are a salaried employee), and how not to over-spend at any one point within the month so that you have negative cash flows. While this may sound simple, remember that all of us have multiple commitments as we age and therefore the list of expenses grows steadily longer. Not only do we have household expenses, we may also have phone bills, utility bills, conservancy charges and credit card bills; and GIRO deductions on top of those for donations and insurance. Hence, it makes sense to build up a simple budget using pen/paper or an Excel spreadsheet and to key in all future-dated expenses so as to ensure there is enough cash inflow (and at the right timing) to cover all these. I have my own personal spreadsheet which is updated daily to ensure the cash flows smoothly.

2) Understanding the importance of “paying yourself first” – This has probably been discussed to death on many personal finance websites and blogs, but it still bears repeating. One should always allocate a proportion of your salary or allowance to a separate bank account and NOT touch the money within that account. This should be done immediately once you receive your pay check, and before you even entertain thoughts of spending it. The standard is 10% of your take-home pay (after CPF), but my personal goal is about 50% to 55% (currently, I am at about 45%). Having the discipline to do so is not as common as you might think, and I do not have that many friends actually practising this as I may like to believe.

3) Appreciate the value of investing – The best way to grow one’s money is not just through fervent savings (though it will grow, albeit slowly), but to also invest the money to make the money work harder for you. Everyone has heard of the axiom – Do not work hard for your money, make your money work hard for you! This is precisely why I advocate investing as a means to not just supplement your income (through dividends), but to also allow you a chance at long-term wealth accumulation through ownership of excellent businesses. Of course, one has to be properly equipped with the essential background and knowledge on how to invest properly and prudently without taking undue high risks, otherwise instead of growing your money you will very well see it shrink faster than you can say “Hey!”. For those who feel that they are ill-equipped to handle the emotional roller-coaster which the stock markets provide, they can always choose to invest in an index fund (i.e. ETF).

4) Be aware of the importance of insurance and protection – Much as we like to believe that nothing untoward or bad will befall us, the truth is that at any given point in time, we are exposed to danger coming from a variety of sources. Even crossing a busy road using a signalized junction can be hazardous if you happen to encounter a drunk driver. My point being that we never know if disaster will befall us, just like the recent news of once in a century floods occurring in the state of Brisbane, Australia. I would bet my last dollar that those people who were affected and inundated did not have a clue that things would get so bad, and quite a few lost almost all their belongings in the deluge except for some personal items and the clothes on their backs. Therefore, I will always emphasize on the importance of being properly insured, not just on your life but also for stuff like hospitalization, critical illness and total permanent disability. Recently, I added another category to that which is disability income insurance, meaning the policy pays out a sum of money to you for the rest of your life if you cannot work in your chosen profession. All these insurance may be costly, but they provide protection for you in case of any unforeseen circumstance; and most importantly, provide you with peace of mind and a good night’s sleep.

5) Being knowledgeable about different kinds of debt – The world we live in is awash in different kinds of debt, and loans make the world go round. That’s why banks are able to exist – they serve a purpose by providing funding for start-up companies, new ventures and mega-projects which are undertaken by established companies. Hence, it is in our best interests to find out about how loans work, how interest rates work and to use this information to our advantage. Besides the normal secured loans out there, there are also other types of debt such as car loans, mortgage loans, credit card debt and bank overdrafts (i.e. line of credit). These carry different interest rates and have different conditions attached, and the individual will be much wiser if he understood how the system works so that he can exploit it to the fullest (or at the very least, avoid being exploited by the slick and glossy marketing). Too many people end up in debt for the wrong reasons, and it becomes a burden to them as it drains precious cash flows. If one is aware of how to harness leverage wisely, then one can make use of debt to their fullest advantage and become much wealthier in the process.

6) Differentiating between wants and needs – I think I had mentioned this before in one of my posts, so I shall not elaborate. I have included this because of the importance of stressing this once more, as I feel the line is becoming increasingly blurred in our society where materialism and consumerism is so prevalent.

7) Setting financial targets – Last but not least, setting financial targets is important because it helps us to work towards a goal to be attained, and to ensure we stay on track to meet these goals. In order not to waver, these targets should be explicit and deliberately difficult, such that they are achievable but much effort needs to be put in in order to achieve them. An example would be to save $X a year or to reduce your mortgage loan by $Y. If one fails at attaining the target, then one should do a thorough review on what caused the failure, and ensure that the same mistakes are not repeated.

The above are just some of the factors which I believe make one financially sound. There are probably many others which I had left out as these seven were sort of off the cuff thoughts I had which I could immediately pen down and write something about. Readers may wish to use the comments box to articulate some other ideas they may have on this topic, or to opine on what I had written.

8 comments:

Ben said...

MW

What type of insurance do you have?

Regards.

Ben

lovechoute said...

Hi MW,

Great works!

Regarding the 5th point - "Being knowledgeable about different kinds of debt", I have a question.

"If one is aware of how to harness leverage wisely, then one can make use of debt to their fullest advantage and become much wealthier in the process."

A lot of experts are saying that you should take good debt and leverage on it to get rich faster. Do you mind sharing a bit what debts you are taking currently?

You are a great investor that I admire and I believe your investment returns are higher than a lot of fund managers. Do you take some debts and invest them to get a better return?

Thanks!

JJ

Singapore Man Of Leisure said...

Hello MW,

What can I say? Another of your high quality posts.

For me personally, I have put Financial Literacy as the only checklist in my financial journey. It's my one ring to rule them all. My precious.....

You have put it very eloquently under:

"Of course, one has to be properly equipped with the essential background and knowledge on how to invest properly and prudently without taking undue high risks"

Cheers!

Temperament said...

Hi,
I believe whatever leverage a
person takes, his assets should always be more than equal to his liabilities. His cash flow should also be sound. This means he can convert his assets into cash if necessary to offset his debt due(Example: no renter for months for leverage-purchased house)
Talk is easy.
First of all how to have assets more than liabilities?
Then how to have sound cash flow?
And most important - Is being a landlord your Soul Purpose?
To tell the truth, knowing is one thing, doing it is another.
Ha! Ha!
My Soul Purpose?
It's investment in Singapore Stock Market for as long as I have my wits, and I still enjoy doing it.
Cheers!

C-130_SPOOKY said...

Hello Musicwhiz,

Like your post. I particularly like the part of setting financial for yourself. Could you share more on the benefits for doing so?

C130spooky

Musicwhiz said...

Hi all,

Thanks for the comments.

@Ben

I have 1 life insurance, 2 term plans, 1 endowment and 1 disability income. This was a change from my previous set up of 3 Life, 1 Term and 1 Endowment.

@lovechute (JJ)

I have only my mortgage debt currently, which is about S$90,000. I do not use leverage to invest even though I am reading more on how to do so safely and without undue risks.

@SMOL

Thanks, haha! Yes one Ring to rule them all! I am looking forward to "The Hobbit".

@Temperament

That's a very good point. One must always ensure he has enough assets to cover this liabilities, or else he may be in trouble if something goes wrong.

@C-130 Spooky

The benefits of having financial targets is that you can work towards it, and it provides a tangible number for you to strive towards.If a goal is too vague, people tend to get lazy and unfocused (in my opinion), so I prefer to set tough but realistically attainble targets like save $XX per year or attain $$XX in total assets by year 20XX etc.

Regards,
Musicwhiz

beginningwithf said...

Hi MW,

Regarding you saving 50% of your take home pay, isn't it difficult when you first started?

And I would disagree with you on the standard 10% - 20% savings on your take home pay. It should depend on your occupation. For example, if you are a civil servant, which is a more stable job, you can stick to saving 10% - 20% of your take home pay. However, if you are a freelancer, you would have to save more, probably in the range of 30% - 40%.

Cheers!

Musicwhiz said...

Hi beginningwithf,

Well I did not start off with 50%, I think it's more like 10-15% when I first started work. But as my salary increased, I kepy my lifestyle constant without upgrading it, so my costs remained quite constant too. As a result, I have managed to save more.

Hope this explains!

Musicwhiz