Principle #5: It May Not Happen, But It Can
When you're young, you don't think about old age or death. When you're healthy, you don't think about getting sick. When you're living a normal, quiet life, you don't think about getting into an accident. When you have a nice, cushy job, you don't think about financial catastrophes.
You'd think "It couldn't happen to me." But the thing is, it can. Of course, the probabilty of you dying when you're healthy and twenty five is small. The likelihood of you being hospitalized when you're living a healthy, active lifestyle is low.
But should you wait till you're sick, or disabled, or laid off, or dying? You can say the same thing about your properties like your house and cars.
For forget about probability first. I want you to play a game called "What if?" It's simple. Just ask yourself:
- What if I get fired from my job?
- What if my business goes belly up?
- What if my house burns down to the ground?
- What if get into a car accident?
- What if I get disabled?
- What if I get cancer?
- What if I become diabetic?
- What if I die?
Does all these sound morbid? The thing is, we avoid thinking about these things because a.) they're unlikely to happen, b.) you have too many problems to even think about these things, c.) you just don't want to think about it.
But instead of burying your head in the sand, be honest to yourself and ask these questions. You don't have to have the "right" answers. Just be honest.
Say, if you lose your job, maybe your spouse's income can sustain your expenses for six months. Or maybe, you have enough cash stashed away for three months.
If you get disabled, say you have rich parents who can and are willing to support you for life.
Or you discover you have a heart problem. Your company has a group health care plan that gives you coverage.
If you die, well, maybe there's not much financial loss since you're single and just started working.
On the other hand, say, your car gets carnapped. You only have the basic mandatory insurance. What do you do then?
Or you get sued because a customer in your restaurant got food poisoning. What do you do?
Maybe you travel a lot, but you're not insured at all. And your wife is a stay-at-home mom. What will happen to them if a plane crash happens?
So, as you ask these "what if" questions, you get a clearer picture of the possible responses to what could happen.
There are two other questions that you need to answer. And I'll discuss them in the next issue.
Principle #4: Live Within Your Means, Then Increase Your Means
Many personal finance experts emphasize managing debt and controlling costs, along with investing your savings, as the primary approach to increasing wealth.
And certainly the old adage "Live within your means" is a very fundamental principle in personal finance. As I pointed out before, it's not how much you earn, it's how much you get to keep.
However, I also subscribe to the idea that we ought to find ways all the time to increase our income, not just watch our expenses.
That is, increase your means.
To me, it includes getting a raise or increasing sales (if you own a business or work on a commission). But it's more than increasing your income from its current source. I believe in finding alternative sources of income.
Robert Allen calls it "multiple sources of income". Whatever you think of the guy, the concept has its merits. It's the same thing for companies. Those that diversify their sources of income are better able to sail through rough times during the usual business boom-and-bust cycle.
They diversify by selling various products and services, by selling to different market segments, and by acquiring other companies.
You have to start thinking the same way. If you're dependent on a single source of income, say, a salary, what would happen if you get fired? Or get a cut? It happens all the time.
If you own a restaurant, and some major crisis forces you to close down your restaurant, or stiff competition suddenly lowers your sales significantly, and your income comes solely from it, how would you cope?
Do I suggest getting another job on the side? Another business? Well, it depends on your situation.
If you're a full-time employee, consider getting a franchise that can later run on its own with minimal supervision. Or get into network marketing, or even, a part-time sales job, that you can do on weekends or evenings.
If you're a freelancer or entrepreneur, consider another business. Or, simply expand your products or services. If you're doing PR, consider handling events. If you're selling pastries, maybe start selling coffee. Whatever.
Or if you're generating substantial income, you can diversify by investing in income-producing assets. Put your money in stocks, bonds, mutual funds, rental properties, etc.
If possible, diversify without over-extending yourself or going into totally unchartered territory. That is, diversify without losing your focus.
The point is, just like with investments, you don't want to put all your income eggs in one basket. Ideally, you receive regular, predictable income, plus commissions, fees, or royalties as well as interest and capital gains. In other words, multiple streams of income.
So think about your own diversification strategy.
Philam funds hit P20 billion mark
Mutual funds in the Philippines are showing a good performance. Last year, the BPI Asset Management Group, fund manager of the Ayala Life Fixed Income mutual fund, hit P20 billion in assets under management (AUM). Now, Philam Asset Management Inc. (PAMI) hit the mark. PAMI manages five funds. Its biggest is the Philam Dollar Bond Fund with total placements of P11.4 billion. Philam Bond Fund has P7.5 billion, GSIS Mutual (Kinabukasan) Fund Inc. has P1.03 billion, Philam Fund Inc. (PFI) has P171.8 million, and the Philam Strategic Growth Fund has P24.4 million. It's targeting P36 billion in AUM this year. The entire mutual fund industry -- with 30 funds managed by less than 10 asset management firms -- is targeting around P60-billion in AUM this year.
iSilver, away!
International Exchange Bank (iBank), recently launched iFund Silver, a peso-denominated unit fixed-income investment trust fund. These funds, also known as common trust funds (CTFs), are just like mutual funds -- pooled funds from various investors that are then placed in various fixed-income instruments such as government bonds and commercial papers, or stocks, or a combination, depending on the investment objective of the fund. Investors also buy and sell at the net asset value (NAV) per unit for the day. The difference is, they buy units in the fund. In a mutual fund, which is a stand-alone company, investors buy shares in the company. Another difference is a mutual fund is regulated by the SEC and is required to submit quarterly and annual reports to the SEC and to its investors. CTFs are under the trust department of a bank, which is regulated by the Central Bank. One key difference is that CTFs are subject to the reserve requirements imposed by the BSP, so not all your money can be invested. Just by that, expect lower returns compared to similar mutual funds. iFund Silver requires a minimum initial investment amount of P100,000, with a minimum holding period of 90 days. Not bad. Mutual funds usually require a one-year holding period if you want to avoid the 1% exit fee. Would I recommend CTFs over mutual funds? Well, I see more advantages for a mutual fund. Besides, there's greater transparency. Just check out Business World for the NAV/unit and average returns, and you'll see at a glance how your mutual fund performed against competitors. For a CTF, you have to call the bank to find out (and call other banks to compare returns). But don't let this stop you from considering CTFs. There are more CTFs available in the market than mutual funds. You might want to consider them as an alternative to 90-day time deposits as they'll likely yield higher returns. So if you have short-term goals or if you're building a 6-month emergency fund, this may be a good place to park your money. Ask your bank about them.
CAP expecting equity infusion
Troubled pre-need education market leader College Assurance Plan Philippines, Inc. (CAP) announced it's expecting a $100 million equity infusion from foreign investors by month end. CAP had a P17 billion variance in its trust assets last year. It only had P8 billion in trust assets managed by trustee banks versus an actuarial reserve liability (ARL) of P25 billion. That means CAP doesn't enough money set aside to service future needs of its planholders, such that when it's time their plans mature, the company won't have enough to pay the proceeds for the tuition fees of all the plans. How did that happen? Well, CAP didn't do as good a job in projecting the growth in tuition costs, interest rates, and inflation. The other reason is the company got overexposed in poor real estate investments. The SEC has approved CAP's asset-building program. And it's to our best interest -- the pre-need industry and the general public -- that CAP recovers. Now, you know why pre-need companies now sell non-traditional educational plans. Before, they sold plans that paid the schools directly, such that you as a planholder is guaranteed your kid's tuition gets paid, no matter how much it is. There are restrictions of course as you had to make sure your child gets accepted in the school picked in the plan. Nowadays, pre-need companies will pay you the planholder directly the proceeds from the plan. The good thing is that there are practically no restrictions. It doesn't matter which school your child attends. In fact, when the plan matures, and you decide to use the proceeds for something else, you're free to do so. On the downside, you have to project the tuition costs fairly accurately, or you end up having to cough up more money when it's time to enroll. Remember, you're not guaranteed full coverage of the actual tuition, unlike before. In other words, educational plans today are just savings programs packaged as educational plans. So, are these educational plans still a good investment? Personally, I think so. Although I did a computation that showed you'll be slightly ahead with a mutual fund, there are advantages to a pre-need plan. It's forced savings. It's like paying a bill. Can you diligently set aside funds by yourself? Doubtful. If you do have that discipline, you can consider that route. It's guaranteed. That is, you'll get what you paid for. If you come up with your own savings program, the returns are not guaranteed. Plus, many educational plans have insurance attachments, such that whatever happens to you during the paying period, the proceeds will get paid. However, if you already have sufficient insurance coverage, this may not matter as much. What's my problem with educational plans? They're expensive, particularly if you're paying for grade school plans. Why? Because they attach extras like graduation gifts and insurance riders. However, you can use the lumpsum graduation gift to pay for either the entire high school or the entire college tuition costs. Whatever you decide, the CAP situation only stresses the fact that it's important which company you entrust your money to. Of course, who would have thought it can happen to CAP.
More on Treasury bonds
Consider this: P37 billion raised by the government on its first sale of retail treasury bonds. These are attractive to small investors as they're available for as little as P5,000, they have better yields than bank deposits, plus they're practically risk-free. The offering ended yesterday. You can imagine the appetite for government bonds, which raise debt yields. It was trying to raise just P10 billion on three- and five-year bonds, at a coupon rate of 11% and 11.75%, respectively, but ending up selling more than thrice its target. P37 billion has just been drained out of the system, which is now in the hands of the government for its own use. That means a less liquid market. Less cash supply means less money available for lending and therefore higher interest rates. At the secondary market, both debt papers rose 11.2289% and 12.0423% respectively. So, yes, we're looking at higher interest rates for loans, but also higher returns for fixed income investments.
Principle #3: A Little Goes A Long, Long Way
Do you think you can't save another centavo anymore? We often feel we've done everything to cut costs. That's why we always think: If only I earn more, I can save money.
Of course, we want to earn more. But don't you notice the more you earn, the more you spend? But even at our current income, we can find ways to save money.
Remember the previous exercises on coming up with your Personal Cash Flow Statement and Spending Plan? Certainly you've seen where your money goes. But look deeper.
If you track your expenses on a daily basis for a week or so, go through each expense item. Perhaps you ignore the "little" things. You know, coffee, cigarettes, dessert, movies, parking. Maybe you've lumped these under a single category such as "Daily Expenses". After all, you don't want to account for every peso that comes out of your pocket.
But the little things count a lot. A penny saved is a penny earned. And as you will learn, it will earn a lot, lot more.
David Bach, author of "The Automatic Millionaire", calls it "The Latte Factor".
If you drink latte from a fancy cafe every work day, calculate how much the "opportunity cost" is if you had invested the money in an investment such as a mutual fund.
How much does a cup of latte cost here? Say 70 pesos. That's P350 a week or P1,400 a month. You can invest as little as P1,000 in a bond fund (after the initial investment of P10,000). So if you put in P1,400 in a bond fund that returns an average of just 8% a year, and you do this diligently for 5 years (or a total investment of P84,000), you'll end up with P100,810.25 by the end of the 5th year. On year 10, it's P148,123.33. On year 15, it's P217,641.76. On year 20, it's P319,787.15.
That's almost P320,000 just for saving P1,400 a month! What if you set aside more each month? What if the fund or some other instrument averages 9% or 10%?
If you save P5,000 a month for 5 years, by the 20th year, you'll have more than a million pesos.
That's the power of compounding. When the gains from your investment (interest income, dividends, capital gains) revolve such that they too earn further gains, your money compounds. For example, for an investment that returns 10% on average per year, your P100,000 earns P10,000. That P10,000 then also earns 10%, or P1,000 in the second year, such that you now have P121,000 (i.e. P110,000 plus 10%.) And so on.
So the earlier you invest, the more you put aside, the further you hold on to the investment, and the more regular and often you save, the more powerful compounding works.
That puts your caffeine fix into perspective, right? I used to hang out at Starbucks or Figaro or some other cafe and drink brewed coffee, or a capuccino, with friends or by myself practically every afternoon. Imagine how much I could have earned if I set aside the cash for investments.
I still drink coffee, but I stopped thinking I should get my fix at Starbucks or Seattle's Best. Like today, I had coffee at Mister Donut for a third of what it would cost me at Starbucks. And most days, I don't drink at all. Sometimes, it's all in the mind. Do I flog myself if I ocassionally find myself ordering a Frapuccino? No, since it has stopped becoming an expensive and unnecessary habit.
Again, this is not about coffee-bashing. I love coffee. If a daily latte won't make much of a dent in my savings, then who really cares? But right now, it does.
And there are a myriad of things you can save on. Go through your list of expenses. Paying too much for electricity? Cell phone bills? Eating out? Shoes? CDs? Movies? You can go on and on.
All I'm saying is you can cut down a little across all these items without totally giving up on them or depriving yourself on some small luxuries. Gee, I'm not giving up going to the spa with my wife. But I don't have to do it every month. I mean, whatever.
Just cut a little across a lot. Because, as you can see, a little goes a long, long way.
10-year Treasury bonds at 12.75%
I heard 3-year T-bonds are fetching 11.4% and 5-year T-bonds at 12.14%. Not bad, right? Just to give a brief background, Treasury bills, better known as T-bills, are certificates of indebtedness issued by the government. IOUs, in other words. They're called T-bills if they're less than a year to maturity. But if they're more than one year, they're called Treasury bonds, or T-bonds. There are different kinds, such as Fixed Rate Treasury Notes or FXTN, and Retail Treasury Bonds or RTBs, which are available to retail investors like you and me. What's attractive about government bonds is that they're practically risk-free. Why? Because the government is committed to pay of its obligation. In fact, it can print money if it has to. That's why T-bills are used as a benchmark for other investments. I bought RTBs a few years ago with some four years into maturity. The rate was 14.25%. Very, very good. Between putting your money into time deposits and T-bills, you're better off with T-bills. And contrary to what most people think (including myself before), government bonds are liquid. You're not stuck with a 5-year FXTN for 5 years. You can liquidate it through the bank or securities dealer who sold it to you. Now, are T-bills or T-bonds better than mutual funds? I did some number-crunching. Say 12% fixed rate for a government bond and an 8% average return for a bond mutual fund. In the mid term, 6 or 7 years, you'll make more in government bonds. In the long run, you'll earn more in a bond fund. The disparity increases the longer you hold on to the fund. So, if you put in P100,000 in a 5-year 12% FXTN, you'll receive an interest of P12,000 a year (you'll get the interest every quarter). By year 5, you have earned P60,000 on your P100,000 investment, or 12% a year. Well, actually, you'll receive less than that, as there's a 20% withholding tax, so effectively you'll earn only 9.6%. But let's keep it simple. Now, if you placed P100,000 in a bond fund, which averages 8% a year, by year 5, you would have earned some P54,000. Not bad. The difference is it's tax free. But there's a sales load for most mutual funds, usually 1.5%-2% on your investment, although that has a minor effect on your returns. But if it were a 10-year investment, say, investing in a 10-year FXTN or in another 5-year FXTN versus holding on to the bond fund for 10 years, then you would have earned P120,000 on the FXTN but P136,000 on the bond fund, a P16,000 difference. Not much, but another 5 years and the difference balloons to P84,000! Now, if we use the 9.6% effective return, in just 3 years, you're better off with a bond fund. So why is that? Well, government bonds pay you straight interest. Bond funds compound, that is, the fund's earnings also make money. You make interest on the interest, to make it sound simple. So, the longer you hold on to your investment, the bigger the returns. That's the power of compounding. Are government bonds then not a good investment. Not exactly. If you want guaranteed income, this is a good way to go. But if you're building wealth, you're better off with a bond fund.
Putting It All Together
Now what?
Okay, we've gone through the basics of financial planning:
- setting financial goals
- calculating your net worth
- determining your cash flow
- preparing your spending plan
What's next? Well, by this time, you probably have realized you have a long way to go to meet all your financial goals. That's why we went through the exercise of prioritizing them, because for most of us, the way to achieve them is accomplish them one goal at a time.
So, start with the most immediate goal. Knowing how much cash goes in and out, find out how how you can fund that goal. Good for you if you have enough. Better yet if you can finance more than one goal at the same time.
However, if you're running a tight ship at the moment, then you have to look at several choices. Ask yourself how will you be able to achieve each of your financial goals.
Just like a business, there are various ways you should consider:
1. increase your income find a higher-paying job
- get yourself promoted
- moonlight or freelance
- get into networking
- buy a franchise
- put up a small business
2. decrease your expenses live within your means
- cut unnecessary expenses
- be a smarter buyer
3. increase your assets
- increase your portfolio income by buying paper assets
- invest in real estate for rental income
4. decrease your liabilities pay off your credit card debt
- accelerate your loan payments
- refinance your mortgage
- extend the term of your loan
As you can see, there are so many things you can do, and many of them at the same time. Of course, some are easier said than done. My suggestion: start with what's easier to do, such as cutting unnecessary expenses or paying off your credit cards, thus freeing up cash for financing your goals.
In fact, even before you think about investing, look at what you can cut. In the same way companies do cost-cutting first before thinking of investing, expanding, or adding their sources of revenues, do your own cost-cutting measures first.
You'll be amazed how much cash is actually available just by taking small steps. Because a little goes a long, long way. And that's our topic for next week -- Principle #3: A little goes a long, long way.
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