PlanningAFinancial
RoadMapForLife
By AJ Leow
MOST PEOPLE PROBABLY DEVOTE A LOT MORE TIME AND ENERGY PLANNING THEIR NEXT VACATION THAN FORMULATING A VIABLE FINANCIAL ROAD MAP FOR THEIR LIVES.
As a result, their approach towards money matters tends to be haphazard in nature, until they encounter a major milestone such as the purchase of a home or a car, or when they need to plan for a child's future education.
There is a misconception that financial planning is only for the wealthy. But the truth is that while the rich can afford to be sloppy in their finances, most people with a lot less would have less room to manoeuvre if they fail to plan properly.
Financial planning is not just about budgeting
It is really about defining the lifestyle you want and the goals you set. These goals can be owning a house, getting an MBA, getting married, having children, owning a business or retiring early.
Studies have shown that it helps to write down a list of one's lifetime goals. By writing them down and giving yourself a time frame for each goal, it makes you aware of the need to watch your spending; and provides the motivation to save and invest in order to achieve those goals.
Don't get sucked into debt
One of the first steps when you set out on your financial roadmap is to stay out of debt, say most financial planners.
For many people, one of the quickest ways to get into debt is through the misuse of credit cards. The best way to ensure you don't get into debt is to make sure you settle the monthly bill in full.
What many people do not know is that if you have a rollover balance from the previous month, any new purchase will be stuck with a two per cent interest immediately. At two per cent compounded interest, this works out to an effective rate of about 27 per cent a year. That means the $1,000 set of speakers you bought to impress your friends will actually set you back $1,270 if you choose to rollover your payments over 12 months.
Treat credit cards as a convenient alternative to carrying cash and not as a loan facility.
Also, try not to make frequent use of the cash advance facility, as there is often a hidden cost of two to three per cent for such withdrawals.
Cultivate the saving habit
Once you learn to steer clear of the debt trap, the next step is set aside some funds for a "rainy day". A good rule of thumb is to have an emergency fund equivalent to three to six times your monthly income. This would take care of the unexpected, like being laid off from work or unforeseen expenses.
Once that is done, you should create a sinking fund for your future plans, which could be a down payment for your first car or first property five to 10 years from now.
Unlike the contingency fund earlier, this portion of your savings should not be placed in a low-interest bearing savings account. Rather you should look at higher yielding accounts or financial instruments such as fixed deposits and bonds (4 per cent to 5.5 per cent on average) or investment in unit trusts (8 per cent to 12 per cent). The financial vehicles you choose will depend on the goals you have defined for yourself, and the time horizon to reach them.
Most financial planners recommend that one should set aside 10 per cent to 25 per cent of your disposable income each month for this fund. To cultivate this habit, you may want to have an automatic savings plan through Giro payments.
Such a regular savings plan may include the seeds for a retirement fund. What you are doing is simply taking advantage of something you have a lot of when you are young - which is time - and let the magic of compounding interest work in your favour. Money saved or invested at 25 will give you more than money saved at 35.
Assume that you invest $2,000 a year and stop after 10 years, but you don't withdraw the money till you are 65. At 12 per cent interest, you will end up with $1.2 million. But if you wait till 35 and invest the same sum every year for 30 years, you will end up with only $553,000 at 65.
Protection against the unexpected
If you are just starting out in your working career, you may opt for some form of term insurance, especially if you have a family or other dependants who need your support.
Such policies offer only protection against death and disability. There is no cash value (ie, no savings vehicle) and so the monthly premium is cheap. One option is to buy a convertible term plan, which allows you to convert to a whole life or endowment plan (which has savings components) later when you are earning more.
But more important is the need to have adequate health insurance since most young working adults would probably not have enough savings to cover a medical bill due to a major illness.
You should have at least one critical illness protection on top of your MediShield, which is not adequate by itself. Note that you can always shave off two to three per cent in premium costs for insurance products if you choose to pay them annually rather than monthly or quarterly.
If you and your spouse own a private property, be sure to get a mortgage insurance that will pay off any outstanding loans should one of you die or become disabled. These are usually term insurance and can be obtained at less than a few hundred dollars a year for a property worth half a million dollars.
Do note that you do not have to curtail the policy if you move to a new home. Keep the policy and top up the difference with another term protection plan if you have upgraded to a property of higher value. That way, you can still enjoy the lower premiums from the mortgage protection plan you have bought at an earlier age.
If you already have your own home, make sure you look into mortgage re-financing schemes from time to time to save on bank interest payments.
Many homeowners also don't realise the advantages of borrowing against the equity of their property.
You can apply to the bank to open an overdraft facility and use it for short-term loans like applying for a bigger block of placement shares for an IPO (initial public offer); or using it to renovate your home. That is because an overdraft has a lower interest rate than a bank renovation loan.
If you are looking to retire soon, plan to have at least two thirds of your last drawn income if you want to maintain your current standard of living during your retirement.
Besides your savings from fixed deposits, investments and insurance policies, there are also other tools that can be a source of income in your old age such as the use of reverse mortgages or annuities in order to receive a regular income when you retire.
The writer was formerly an editor of a financial planning portal.
