Friday, March 25, 2011

The 4 priorities

I believe that when we start working and start having a decent income stream, we shouldn't start investing straight away with that money. I think that certain foundation needs to be built first before we should think about growing our wealth. These following points, in my opinion, are listed in order of priority. I'll start with the first point with the greatest priority, followed by the last with the least priority:



1. Savings


This is the start of everything. Unless your family provides you with a huge sum of money to begin with, you'll have to work your way up. The savings is needed to build up a cash coffer for the many milestone events (like marriage, housing etc) that will likely occur in the near future. For those salaried worker, I think it's easy to set aside a portion of your monthly salary into another account, and then spend the remaining. This 'pay-yourself-first' strategy is reputed to be the best strategy rather than to spend and save whatever is remaining. For self employed tutors like me, I normally set aside cash as and when they come. My cash flow is not predictable, hence I work on a yearly savings target which is further broken down in monthly target. I'll continue transferring money (as it comes along) to a separate account until it hits that monthly savings target.



This brings about the next question: how much to save? I guess the answer to save as much as you can do it without feeling shortchanged in life. I think minimally, if you're earning 3k and above, you should be able to save at least 20% of your take home. If you can't hit 20%, you either have to find more ways to reduce your expenditure or to find more ways to earn more. As a guideline, I keep a savings percentage of around 60-80% of my cash intake.



2. Insurance


Insurance is to protect your savings. I'm not going to dive into the thorny whole life vs term fight here, but the first and most minimum protection should be a hospitalisation and surgery plan. Some might recommend using the cheap medisave plan and not a private shield plan. I leave it to interested parties to find out the advantages and disadvantages of each.  Personally, I have a private shield plan covering me to the the best ward available, complete with rider to cover the co-insurance / deductible portion. I think a disability income plan is the next important one to have, followed by the standard bread and butter life coverage with critical illness component. The permutations for the same coverage is infinite, so there's a lot of room for customisation according to everyone's needs and wishes.


I believe that it's good advice to think a few years ahead before you commit to any long term plan. I've heard stories of people committing to a very expensive plan but because it takes such a hefty toll on one's cashflow, the plan is surrendered often with a loss. I think if in doubt, do not buy first. Just seek professional advice.


I think unless you're super interested in the industry, insurance coverage is something that you want to have
without having too many headaches. Sort this out as soon as possible so that you can have a peace of mind.



3. Set aside money for emergencies


Life is often unpredictable and most of these events that popped up usually requires money. I think the standard recommendation is to have 6 months of your average monthly expenditure (including the cash component of housing loans) in the form of cash or cash equivalent (meaning the cash is put into assets that can be easily converted back into cash) ready for such emergencies. I think that the 6 months guideline is based on the premise that if you lose your job, you might need to look for 6 months before you can find one and starting earning the money to pay the bills. By having a buffer, you can sleep a little more soundly at night. Actually, I would put in 6 months of salary to have an even greater buffer, but that's just me.


This money is not to be used for investment purposes that is hard to liquefy when in need. I think the ideal place to put such a sum is in savings account, fixed deposit or money market funds (MMF). Personally, I had mine split into my investment of stocks and another portion in savings account and MMF. I don't mean that as an advice for everyone. I guess my job is slightly different because I am not in the mercy of just a single employer so my emergency coffer can be a little less liquid than the typical salaried worker.



4. Investment


I think everyone must be able to invest in some way or another. It's really very very hard to reach financial freedom by just working for someone because that is basically exchanging your time with money. To reach financial freedom by just savings alone isn't going to be easy and I think probably you'll run out of time. There willcome a time when you are older and less energetic and can no longer fetch such a good price for your time. This is where your passive income comes in. Ideally, the passive income should grow to such an extend that it can rival your active income. But where does the capital from your passive income comes from? Active work of course.


Everyone must dabble in some investing instruments, be it bonds, stocks or property. This is akin to taking a quick ride on a car along one's financial freedom route. If not, the slow march along the road would probably be too slow and you'll run out of time before you can reach your destination.


I think in investing, the capital idea is not to lose your capital. You may make less returns but as long as you don't lose catastrophically, you'll be alright as time would weave its compounding magic for you. This doesn't mean that because you have a lot of time on your side, you can take more risk. I think it's good advice that as long as you don't lose money, making any returns is a bonus. Remember, this is the extra boost that will propel you faster towards your destination. The main workhorse for that journey is still your active income, which will provide you with the first tranche of capital needed to grow more capital.



*This article is contributed to IM$avvy financial portal, which is managed by Central Provident Fund Board and supported by MoneySense. This site has a noble aim of promoting financial literacy to the general population.

6 comments :

Anonymous said...

LP,

You have more or less got the sequence right. The problem I see is that we have some, who are not even 30 years old, married, with a kid, still paying for the HDB apartment but already talking about FF.

Until you can finish paying for the apartment, planned for the kids education without having to borrow, then and only then can you see a glimmer of FF light. That is not to say you cannot plan for FF.

Take FF planning in perspective. Why put pressure on yourself by setting unrealistic goals of 'retiring' by 35 ? Some can but the majority won't.

Along the way, you would want a bigger apartment or buy a car or indulge in other luxuries of life. Then it is back to square one for FF.

Been there done that

la papillion said...

Hi Anonymous,

I concur with your observations too. I think to be obsessed over FF seems to be the result of the many self help books by various authors. Somehow the exposure to such ideas take root and forms the impression that everyone can do it.

That being said, who else can be idealistic if not the youth? Certainly not the jaded 40-50s.

Thanks for sharing your views :)

Anonymous said...

LP,

It is good to be able to see the idealistic side of things. Problem is, some may mistake ideal with practical.

This goes back to your post on investing at an early age. I am indifferent to the age they start investing as long as they don't think they can trade for a living or do it for FF.

Most will fall down to earth when they find, like you, that it cost an arm and a leg to own a HDB. They will fall harder now when they look at the cost of the COE.

It is still possible to achieve FF working for others but you have to be at the top of the heap. Otherwise, pick up all the skills you can and open your eyes for starting your own business or in partnership with others. When you are good in your field, others will look for you.

Li

Temperament said...

Hi LP,
"I think in investing, the capital idea is not to lose your capital."

Yes I think this is the first principle for investing. How?
The irony of investing(so is many things in life) is you must invest only with money you can afford to lose. In this way you can choose when you want to sell your shares. As long as you have done your homework on the companies you have choosened to invest, you should have no problem to choose the time to sell. Ha! Ha! NO?

You almost always post very inspirational articles. If somebody ask for a tutor, I won't hesitate to recommend you. Is it O. K.?
And yes, I hope you won't be jaded by the age of 40 or 50 or 60 or whatever. I think with your intellect you won't or shouln't be.
Ha! Ha!
i hope i am not. That's why i am learning from all of you here.
Ha! Ha! again.
Am i jaded?

la papillion said...

Hi Li,

Haha, I agree, we must all mix pragmatism with idealism. I guess idealism tempered with the pragmatism of wisdom and experience is the right way to go. The general direction is determined by our ideals but the actual path is decided by the practical side of things.


Thanks for sharing your views!

la papillion said...

Hi Temperament,

I think what you said brings to mind about performance under stress. When I was in air rifle school team, whenever I think about getting bulls eye, I'm not get it. It's only when I'm operating under the mindset that whatever results doesn't matter or my score is hopeless already, that I'll perform at my best. I think the same should go for investing, so what you mentioned about investing in money you don't need really matters a lot. I guess when you don't even need the income coming from investing, you might even do better!

Thank you so much for your encouragement...supporters like you for my blog made me realise that when I started this journey putting down my thoughts online, I would never have imagined the reaction and possible results today.

I thank you sincerely for your kind comments :) We're all learning and sharing :)