Quick 5 Step Plan for Financial Freedom

If financial freedom is your goal in life, then what steps are you taking to achieve your goal?

Let me share the five step approach in building up your plan for financial freedom.

5 Step Approach in building up your financial intelligence

Step 1: Know where you are financially in terms of net worth
How many of you actually have a personal balance sheet detailing your assets and liabilities? Knowing our assets and liabilities in clear detail is the first step in knowing how to reach our goal of financial freedom. During my army days, the first step in trying to navigate the ground to get from point A to point B on a map is to first find out where you are on the map!!! This is what we called orientating your map to the ground.

If you do not know where you are on a map in a relatively new terrain, you will find it very difficult to navigate accurately to reach your destination.

Your personal balance sheet will tell you what exactly is your net worth, where:

NET WORTH = ASSETS - LIABILITIES

Assets can be your home equity (amount that you can realisitically sell your home for, e.g. valuation), cash in bank, fixed deposits, value of shares, unit trusts (mutual funds), gold, foreign currency fixed deposits, bonds, CPF monies), guaranteed cash value of insurance policies minus your liabilities that include your outstanding credit card balances, personal credit balance, hire-purchase balances, car loans, housing loans, etc.

It is common to find yourself in a negative net-worth position. All of us who own homes cannot finance it 100% using cash and CPF and must take out some mortgage. The trick towards financial freedom is to have a plan to move ourselves from a negative net-worth to a postive net worth to whatever we have set as our target for financial freedom.

Step 2: Know where you are going in terms of expenses and savings
Your net worth only details your financial position at a point in time. What gets you moving from where you are financially to where you want to be is your income and expenditure. You either study, work, run a business or are retired. Whatever your trade, profession, business or vocation. In order to reach your financial goal, you must have a source of income and you must also spend money. The key to financial freedom is to make sure your income (almost) ALWAYS EXCEEDS YOUR EXPENSES SO THAT YOU CAN SAVE!

Some of you may complain, but I NEED TO SPEND $XX ON A, B, C. Yes, all of us have living expenses BUT YOU DETERMINE THE LEVEL OF LIFESTYLE YOU WANT. If you do not take responsibility for your spending, then you might as well stop reading my blog and just live your life as you wish. I do not wish to impose my ideas on anyone.

Let us be adults and realise we have the power to determine whether every dollar we earn is spent on expenses or is saved to be invested. It is about deciding between needs and wants. The more wants we succumb to, the longer it will take us to reach our target of financial freedom.

Back to the income and expenditure statement. Once you have noted down your income (which should include passive income from dividends, interest, capital gains) and expenditure, note down how much you can save each month. This forms the basis of your investment monies. This how you grow your investible savings to be deployed to beat the pathetic bank interest of 0.25% or even fixed deposits at 2%+.

Step 3: Determine what rate of return is needed from your monthly savings to achieve financial freedom
This is where it becomes clear. Once you have established your networth, how much savings is coming in each month, then you can start to compute how long it takes for you to reach your goal of financial freedom. A very basic calculation (with illustrative figures for returns) involves:
1) Insert figure for financial freedom, say, $750,000
2) Compound your monthly savings, say $1,000 for next 30 years at different interest rates
a) At treasury bill returns of say 2.3% = $517,774
b) At CPF special account returns of say, 4% = $694,049
c) At equities (say, 8% per annum) = $1,490,359.

It becomes obvious that the higher the returns (and usually with higher risk or volatility of returns), the faster or higher the future value you can get in 30 years' time.

Step 4: Decide which asset class to invest in based on what is your targetted return/time frame
Therefore, depending on your time frame and % return you are looking for, different types of assets will be able to meet your criteria. The question is are you ready for the amount of risk that you need to take and do you know enough about the asset classes?

Step 5: Understand the asset classes that give you the required return and take steps to invest in them
The earlier steps help you clarify why you need different asset classes. In general, a safe and steady plough everything into treasury bills approach will get barely get you to about half a million at today's treasury bill yields. But it is very safe and guaranteed. In order to reach your financial freedom target realistically in your working lifetime where you can earn income and save, you need to seriously consider other investment asset classes because by taking on some calculated risk, you can reap much higher returns and move yourself faster towards your target of financial freedom.

Investment is RISKY. Financial freedom is a journey that is FRAUGHT WITH RISKS. But to avoid taking calculated risks to seek higher returns is to accept the RISKS OF INFLATION ERODING OUR PURCHASING POWER AND TO RETIRE ASSET RICH AND CASH POOR.

You have the power in YOUR HANDS.

You decide WHAT RISKS ARE WORTH TAKING AND WHY.

You control your own financial destiny.

Be well and prosper.

Financial Planning: Big vs Small Picture

How many of us have been approached by insurance agents, financial planners, personal bankers to do financial planning?

How may of us actually realise that financial planning is basically more of an art than a science?

I will explore what financial planning is to me and why I find that we get the priorities wrong in establishing the details without critically examing the big picture in our lives.

Traditional Financial Planning
Financial planning from what I experienced from the consumer's viewpoint, entails the financial planner helping one to establish our assets, liabilities and cashflows and then projecting it against our needs in the future. The typical financial planner will come armed with his notebook to key in critical details such as age, sex, occupation, income levels, housing type, mortage loan, car loans, investments. Now going through this part of the exercise is useful as it allows one to get a snapshot of our assets/liabilities. In accounting terms, we call this having a balance sheet or a simple statement of net worth where:

Net Worth = Assets - Liabilities

Examples include -

Assets:
Investments - stocks and shares, bonds, unit trusts, fixed deposits, savings accounts etc.
Property - valuation of property (this is contentious as I will explain further)
CPF Balances - ordinary account, medisave account, special accounts

Liabilities:
Short term credit - credit card debt, personal credit line debt etc.
Medium term credit - vehicle/car loans, renovation/bridging loan etc.
Longer term credit - outstanding HDB/private housing loan (property)/commercial building loan, etc.

Most of us tend to have a net deficit position, i.e. our Net worth is negative because our outstaning housing and other loans is more than our investments and savings. Hence, we need to work for a living for the cash flows that funds the liabilities plus our living expenses.

Now the second part that the financial planner goes through is fraught with subjectivity, estimation and guesswork. Here is where he/she asks you for when do you want to retire, do you want to provide for college tuition, how many children do you want to have etc.

Financial Planning is an Art not a Science
One of the issues I have with this part is that the future is uncertain! Whatever, we plan now is just based on what we think and there are many assumptions made. For instance, when we want to retire is both a function of our choice plus whether we have earned, saved and invested and obtained sufficient targetted returns to do so. In today's globalised ever-changing world. I am of the view that these plans are mere stabs in the dark for most of us. The number of imponderables that may hit us are limitless yet we are supposed to be able to make financial decisions based on assumptions we ourselves may not believe in to provide the information that the financial planner is able to recommend products/investments that will help us achieve our objectives.

There are some areas where the financial planner can help clarify. For example, if you have no medical insurance in terms of a shield-type of plan and your employer does not provide health coverage for in-patient (i.e. hospital care) then buying a shield plan is a no-brainer. But advising on putting money aside for college education, upgrading of house etc, are just assumptions. These change all the time and that once every other year financial planner with the tool to tell you this product or that product is good smacks of lack of real understanding of one's situation. I believe each of us who are willing and able to spend some time learning about personal finance can and should do it.

How much are you willing to live on?
The key idea is how much are you willing to live on? This one single question will determine how much you are willing to save. Ideally, establish the lowest minimum you are willing to spend on living costs and the remainder goes to savings and investments. It can be potentially that simple. Of course, this is a deliberate over-simplification as one needs to consider insurance needs etc But the key idea is that our standard of living really drives our savings level. We can try for the best paying job and career but really no level is sufficient. No one can ever say, I have earned enough as human wants (and that includes our salary!) is limitless but our needs can be moderated.

Needs vs. Wants
Is a car a need or want?
Is having 1,2,3 children a need or a want?
Is staying in 3 room, 4 room, 5 room, exec flat, condominium, in districts 9, 10, 11 etc a need or a want?
Is buyng that Louis Vutton bag a need or a want?
Is buying that newer model of handphone/MP3 player/gadget a need or a want?

We have choices. No-one forces us to make the choices we do (except for conscription and taxes). :-)

7 Step Primer for Reviewing Your Financial Plans
So where do we go from here? My simple no-frills self-financial planning process:

1. Establish Net Worth ==> Where are you now?
2. Reduce liabilities (highest interest rates to lowest) ==> Compounded interest kills you
3. Spend within your means ==> Thrift = financial freedom
4. Save, save and save ==> Grow your nest-egg
5. Read, discuss and learn about personal investments ==> Be educated!
6. Invest, invest and invest ==> Take steps to grow your net worth
7. Go back to step 1 ==> It is an interative process that you own... There are no shortcuts.

I have found that this works for me though I have also gone through financial planning sessions with various big insurance companies with those software tools and fancy reports and pie-charts. So far, my best financial decisions have been step 2 and step 5.

May you grow and prosper!

P.S. I am not running down financial planners and their tools, they do serve a need in the community but I am providing an alternative view to individuals who want to see things from a different perspective. Caveat emptor, let the buyer beware!