Whatever it is that you desire to save money for, if it’s “financial security” that you are looking for, then you need to look beyond affording that wedding, or that second-hand car.  You should also be looking at what kind of lifestyle you want to live by the time you are retired. 

It’s not that saving for a car, a house, a wedding, or education for your children are not important.  By all means, they are VERY important.  But so is saving for your retirement.  If you don’t appreciate what I mean, I dare you to find out exactly what it is that your company has set aside for your retirement (assuming you’re employed), or to find out exactly what your business is worth today and what it might be worth by the time you retire. 

Don’t be surprised that you’re probably like the great majority of employed and self-employed individuals.  After planning for your wedding, for your children’s education, for your car installment payments, and for your apartment rentals or home mortgages, you’ll find that you may not be ready for your retirement.  Oh, and did I mention that you might have to provide for your aging parents who, themselves, failed to prepare for their retirement?

It’s beginning to sound depressing that you may not even want to go through this very important step in planning for your future.  But, if you’re really serious, you CAN do something about it.  If, after you have defined your goal, you will discover that you have a problem because you don’t know how to ever achieve it, then be consoled in the old adage that says, a problem defined is a problem half solved.

As I said in an earlier post, there is good news!  You don’t have to be a genius to be financially prepared for your future, and you don’t have to be wealthy to begin with. 

The first step is to face the future squarely and define the challenge: decide what your goal is first and then make a plan.  Your goal will not happen just because you defined it.  But neither will an investment plan work, if you have no goal to begin with.  So, take the time to plan your goals.  Dream a dream, if you want to.  But do it.  Now.

For example, buying garments on wholesale and then selling them retail at a good mark-up in your local neighborhood bazaar has its risks.  You may not be able to sell everything, and at the price you hoped to get.   But maybe the possible profits that you could make are worth the risks that you’re taking. That’s entrepreneurship for you.  Or you could be buying insurance from a reputable firm, then suddenly discover one day that that insurance firm itself is going bankrupt.

No investment is perfectly predictable.  Therefore, even good investments have a certain amount of risk involved.  If no one ever took any risks, then there would be no economic progress at all.  The key is to anticipate the risks, and manage the investment so that the risks are reasonable compared to the return that you expect to make. 

It’s all a matter of risk-return tradeoffs.  The higher the risk involved, the higher should you demand the returns/profits to be; otherwise you will not make the investment.

Some suggestions

Usually, when making an investment, you are attracted by the possible returns that you could make from that investment.  Most likely, you would compute potential profits, given realistic, but favorable conditions.  You could also compute potential profits should your luck really be good (assuming the return is not fixed).  Don’t get blinded by these computations, though, but seek another person’s opinion (someone whom you consider wise and unbiased), to make sure that your assumptions make sense.  Many people have been fooled by scams and swindlers who present seemingly realistic, easy-money promises, and who take advantage of an investor’s ignorance and greed.

But you shouldn’t stop there.  Before making any investment, it would be wise to anticipate and predict a “worse case” scenario to see how much you would lose, or how low your profits would go, in case something negative happens that you didn’t expect.  With a little calculation, you can determine your break-even points, and compute your remaining profits (or losses), given those worse-case situations.   Again, it helps to seek the counsel of a third-party, someone who has no stake in the investment, and certainly not the person who’s selling you the investment, to help you assess the various downside scenarios, and give you a reality check.

Then you should weigh the pros and cons of these various situations, and the likelihood of occurrence of each of these.  If the upside is likely, but the profits are not so fantastic, compared to the losses that you might incur if the downside occurs, then you would probably decide that “it’s not worth the risk.”  On the other hand, if the upside, though not so likely, is very attractive compared to the danger of losing in a downturn, then you will decide that “it’s a good investment.”

In a future blog, we will continue this discussion on risks to see lessons from the past.

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A mutual fund is a company whose capital is invested by a professional fund manager in investment-grade instruments like stocks, bonds, and so on.  If you invest in a mutual fund, you’re buying shares of that company, and your money is included in the pool of capital that is being invested by the fund manager.  The price of buying (or selling back) your shares is based on the market value of the investments of the company at that time.

The job of a fund manager is to maximize the value of the fund while taking into account the risks involved.  Your investment will go up (or down) in value, depending on how profitable those investments are which the fund manager is making on a day to day basis.  Everyday, the value of your capital is computed based on how much money the fund manager made, or how much worth the investments are in the market at the end of the day.

Your investment in a mutual fund does not earn a fixed interest; instead you earn money when you sell back your shares at a price, or value, that is higher than when you bought those shares. 

There are risks involved in investing in mutual funds.  The value of your funds could temporarily be down from the time you purchased it, depending on capital market situations, and depending on the kind of mutual fund it is.  A bond fund (invested in the bond market) does not fluctuate in value as quickly and as dramatically as an equity fund (invested in the stock market).  On the other hand, a bond fund does not increase in value as fast as an equity fund.

You may withdraw your investment, or sell back your shares, in a mutual fund anytime you wish or need the funds.  You may, however, end up losing money when you sell at a time when the values are declining.  In the long run, say, more than two to three years, the value of a mutual fund improves at a rate much higher than if you were investing in specific individual savings or investment instruments yourself.

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Education plan. The objective of this plan is to have a sufficient amount of fund during high school, college or perhaps graduate education of your children or members of your household. The amount to be earmarked on a regular basis is dependent on some factors like  the type of school that you intend your children to go to, and the projected increases in tuition fees.

 Retirement plan. From the desired level of lifestyle that you (and your spouse) want to have, you can set up a sinking fund fior it. This can be funded by regular contribution to this fund coupled with corresponding investment activities that aim to maximize the fund’s returns.

 Estate plan. Planning your estate involves questions like: Are you going to donate real properties to your children even before you “kick the bucket” or just let them inherit these properties when you leave this world? In other words, what’s the cost-effective way of transferring wealth. This may involve making a (testamentary) will and consulting with a good tax lawyer.

 Special needs plan. These take care of other needs such as a wedding, a vacation abroad with the whole family, buying a second house, setting up a fund for charity or foundation, etc. Just like the other concerns, these need preparation and planning.

 A Financial Plan may not be as comprehensive as outlined above or it may not  be in black and white at all. I strongly suggest, however, that if you decide to have one, you might as well do it properly by incorporating the above components. A Financial plan is nothing if you will delay its implementation. A good financial planner can help you a lot not only in the implementation itself but also later on when you review and monitor your plan.

 Visit this blog again if you want to learn how the above components of a financial plan are being done.

 Now, what is a financial plan?

A financial plan is a big picture of your personal or your household’s overall financial goals together with the specific activities and strategies  crafted to implement such goals. It’s like a roadmap that guides and leads you towards your destination, financially speaking.

 What does a (comprehensive) financial plan contain?

A good financial plan should be comprehensive, and pragmatic enough to  implement. It should contain and address the following components:

 Your objectives. These involve your or your household’s  financial priorities. These answer the question: Why am I doing a financial plan?  An objective could be to quickly accumulate cash for the downpayment of your dream home, to set up an education fund that will provide the education of your children until they graduate from college, to regularly save in a fund that will become your nest egg when you retire, etc.

 Current financial condition. This is similar to a company’s financial statements where it shows the current resources that you  (or household)have which you can tap to achieve your objectives. It therefore presents your statements of assets (cash, bank deposits, investments in mutual funds, real properties, etc) and  liabilities (credit card debts, mortgage or personal loans, etc.).

 Cashflow plan. This is an enumeration and analysis of your sources of income and expenses. Income or revenues can come from salaries, rental income, professional fees, investment income. Expenses could be non-discretionary expenses like food, utilities, tuition fees, children school allowances. The other category of expenses is discretionary expenses which include expenses for recreation and entertainment, hobbies, gifts and donations.

 Tax plan. A plan the aims to minimize taxes without violating the tax rules. It involves an intelligent application of tax credits, exemptions, and other tax benefits. A good tax consultant would be very helpful in this area.

 Investment plan. It is a plan that should maximize your cashflow in order to achieve your financial objectives. It takes into account the optimization of income generated from different types of investments like, bank products, mutual funds, government securities, stocks, etc.

 Insurance plan. This involves the minimization of the financial effects of untoward events like death, illness, or damage to properties. Depending on the level of protection you want to have, a good insurance plan utilizes the right amount of life (or term) insurance  and health insurance coverage that you or any member of your household should have; non-life insurance coverage for your house and other properties.

 In Part 2, I will show you four additional components of a financial plan that you need to have.