What are the most common money management problems?

I recently had 2 conversations about money, one was with a friend with 4 kids and one millennial who just started on his financial journey. Despite them being so different in so many ways, I realized that they both have very common perceptions when it comes to managing money.

Here are my thoughts on some of the common money management problems of beginner

1. No idea what is considered safe/reasonable return

Just because the bank savings interest rate is a pittance does not mean that your investment returns have to be so also. While I don’t advocate yield chasing, being too risk adverse is not helpful too.

I advocate having goals in mind and use time and effort to understand the risk and rewards of the various investment opportunities presented in life. Not everyone will be able to land a million dollar opportunity in life, but having educated yourself you will be able to identify the most risk adjusted investments to choose in any stage of life.

2. Saving and investments out of sync with life goals

Investing <$400 a month in an index fund might be great start. But in the grander scheme of things $5,000/year is really a drop in the financial whirlpool of expenses, especially so when its inflation adjusted. In order, to have any kind of meaningful investment income you need to recognize that investment is really like an iceberg, the passive income portion is really backed up by a large portfolio of invested funds.

This means that investment and insurance amounts need to vary with needs and life goals. They are not set in stone and left to be forgotten. One needs to be engaged in your wealth building journey.

3. Underestimating future expenses

Younger Singaporeans underestimate expenses inflation later in life. While most of the spending in your 20’s is discretionary and can be cut back on, spending in your later years are likely not to be, add in the aged parents and young children and you get a combustible stickybomb most can’t shake off.

The problem of the sandwich class is real in Singapore and needs to be taken more seriously. The friend with 4 kids is considering realizing the gains from his BTO home to buy a larger but older condo, I’m not sure how doing so will help him in his wealth building journey, but he says that when you have a family “you manage”. Well, I really hope he manages to en-bloc in the future, cuz that might be his retirement sum.

Why most people end up being overinsured

Being sold an insurance plan that does not meet your needs is a common occurrence. Other than dragging down the amount available for your wealth building, overpaying for certain types of insurance might mean under coverage in other areas.

Here are some common reasons why people are over insured

1. Not being truthful – An insurance agent’s job is to ensure that you get sufficient coverage for your risk profile and they tend to do this in a hurry. Doing a needs assessment on the very first meeting without knowing someone well enough and expecting them to tell you squarely about their financial health is somewhat overly optimistic.

People are naturally egoistic or overly conservative. Can you imagine buying a income replacement insurance for someone who was not truthful about his income? Here is “the” one time where it literally pays to be honest. Expecting your insurance agents to work backwards, probe and piece your financial dots together, is akin to asking a hairdresser if you’d need a haircut.

2. Knowing who your dependents are – I would say this, if you are currently spending all of your salary on yourself – you have no dependents. If you give a small allowance to your parents whom would really be fine without you – you have no dependents.

A dependent is someone who would be unable to care for themselves financially should you not be there for them. For someone to be beholden to your income is some legit responsibility. You have to think really hard about this, otherwise you’ve just put a bulls eye over your head, where everyone is rewarded upon the insurance trigger event.

3. Not knowing a want from a need – This is a seriously wrong time to confuse wants and needs. People who base their monthly payouts on their current income in the case of disability are at real risk of overpaying for insurance. You should really be looking at your expenses plus cost of care. You are not going to be driving your car if you’re bedridden.

4. Forgetting your time horizon – Insurance agents are there to cover you through the various stages in life. Get affordable coverage for your current stage in life and review and add when you get older. Buying insurance while thinking of future children is foolhardy and a surefire way to overpay.

Conclusion

I’ve written about how important cash flow is to your financial life and wealth building journey. Over time, as your needs and circumstances change, it would be good to review and re-look your insurance plans, rather than thinking of the worst possible scenario at the outset.

Over paying for insurance early in your financial life can be a real drag on your ability to generate passive income. Don’t over insure to the point where you’ll be financially rewarded for triggering the insurance.

Lastly, insurance money is meant to supplement your wealth and ensure that your dependents downside are covered. Don’t mix insurance with investments.

Why bank savings alone not bring Financial Independence?

Typically when people start on their personal financial independence journey, they would begin with looking for the best bank interest rates. That’s great if you are looking to pay off loans or just about to start on an emergency fund. But I think it’s dangerous to just stop there.

Why interest rates should not interest you

Firstly, as a rule, i do recommend setting aside a 8-12 month emergency fund and frankly to that end, having a savings account which garners 2-3% interest per annum would not hurt either. But beware the hoops you have to jump through, high interest savings account that require a minimum spend above your typical monthly spend usually results in you being worse off overall.

Your primary job, after setting aside your emergency fund, is to find out how to exceed the interest rate on your bank savings account. This mean making your bank’s interest rate your investment hurdle rate. In other words, you should not invest in something, if it’s going to be giving less than the interest your bank is paying you to leave your money there. This relates to my post on income investing.

Banks are businesses too

I understand how people can be averse to taking on risk. Somehow as humans, we enjoy the certainty that a bank balance brings. But banks are also service providers, they do not share your interest in your money and will therefore not work harder to ensure you get paid first.

That is why keeping your money in an fixed deposit or in a checking account would mean you are effectively loaning it to the bank, to allow them to make more from money borrowed from you. Would it not therefore be better if you owned part of that bank? Especially so when they trade at a discount?

Conclusion: Focus on Yield, not interest

It’s not difficult to see how yield and interest can be confused at the beginning. While both means getting a return on your money, interest received as “loan” to a bank means you are not maximizing the yield that you could otherwise obtain on your assets.

In the long term, proper care of your finances and not turning it onto autopilot mode will mean mitigating risks and achieving far superior outcomes.

Till then, Spend Less, Save well and Invest often

Why should you take charge of your finances today?

I am sure that scrimping and saving when the entire world is spending and consuming doesn’t seem like something that is by any means sane. Most people would be laden with a heavy sense of inertia even before they started saving the first dollar. But before you start procrastinating, here are a few reasons why taking charge of your finances today makes sense.

1. Changing of habits takes time

Having the commitment to stick to your budget on your small initially salary would be one of the hardest thing to do as a fresh graduate, period. Taking your post CPF paycheck and subdividing it must rank high on the kill joy checklist.

But over time you will find small financial hacks to make the impossible happen and your financial engine really roars to life when your other income streams begin growing and your investment income slowly replaces your salary as the main source of investment capital.

2. Learning to invest takes time

If the simplest concept in investing is to be buying low and selling high (yes, this includes passive index investments), how would you know what’s high and low if you don’t take the time to look?

From experience, most people really start learning after they have made their first trade. While inevitably people do make bad investment choices from time to time, don’t be caught out missing on a good deal. Time spent researching is never wasted, even if ultimately the decision is a no buy. Like any other hobby, investing takes both practice and time.

3.Getting your loved ones onboard takes time

If you think sticking to a budget is hard, try telling your loved ones to do the same. In fact, the most common reaction towards hearing that someone is on a budget wouldn’t be too different if he/she was on a “diet”.

I know that it is incredulous to some that in this modern day and age with credit readily available that budgeting still forms the bedrock of a financially free future. The typical reaction towards budgeting is “why, when life is already so hard, do I have to do it?”. That’s understandable considering that the majority of the world have accepted and (some even take pride in) exchanging their time for money.

“As two is better than one”, getting your loved ones on board is the single most important catalyst towards fast forwarding your journey towards financial independence.

4. Learning about yourself takes time

I like to think of financial independence as a journey towards self-discovery. Just like how you won’t know how much you can stretch yourself or what really matters to you in life, biting the bullet will give you an edge over your peers by forcing you out of your comfort zone to think differently and prioritize life differently. Most importantly financial independence means learning what your real purpose in life is and having the base to stretch for your dreams when the time comes.

So don’t wait to adopt a wealthy mindset and have good habits, start today!