Financial Freedom

By Andrew Massaro, CFP®, CFS
Senior Financial Planner

Are you a long-term investor? Many people think of themselves as such. After all, they say, they have been investing for a long time, and their goals are ten or more years away. 

Yet, most people – maybe you, too – may not be long-term investors at all. You see, a true long-term investor is not merely a person who has been investing for many years, or who plans to invest for many years. A true long-term investor is one who owns the same investments for many years. 

Those who buy and sell investments with any degree of regularity or frequency are actually speculators. And those who panic when markets fall, selling their investments and fleeing to bank accounts and money market funds, and who are flush with greed whenever the markets rise, racing to buy the very assets they previously sold, are market timers. 

In fact, lots of people are market timers, although most deny it. Legendary money manager Peter Lynch had such individuals in mind when he said, “Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.” 

To make a profit when investing, all one needs to do is buy low and sell high. However, during the last three years, just the opposite happened: Many people who had eagerly bought shares at the high prices of the late 1990s sold them in the early 2000s at much lower prices – a classic case of buying high and selling low. These folks, currently on the sidelines with their cash, will one day buy the shares they previously sold, at prices higher than what they had earlier sold them for. Amazingly, most of these people will always wonder why they never make any money from their investments. 

Even those who have resisted the urge to sell are acting a bit like market timers. While many of these folks are “holding on” (as they like to phrase it), they have stopped their systematic monthly investment programs or have switched from investing monthly into securities and are instead placing that cash into bank accounts. Ask them why, and they’ll tell you they’re just waiting for the market to become more attractive.

That attitude, of course, is pure folly. These folks were happy to invest monthly while prices were high, and they agree that prices will one day be high again (how else can you explain their willingness to keep the shares they already own?), but they are unwilling to invest new money at what they acknowledge are today’s temporarily low prices. 

No matter how much we advisors promote dollar cost averaging and systematic investing, no matter how much we preach the long-term mantra, too many people insist on buying only when prices are high and rising.* Anytime prices are lower, they freeze. Can you imagine a shopper acting this way? “I’ll buy that suit only when it’s expensive. I’ll wait until the sale is over before I buy it.” Silly indeed.

In the late 1990s, many people lamented that they had not invested years earlier – when prices had been much lower. We find ourselves at a similar point in history. One day, you will tell your children and grandchildren that you had the opportunity to buy shares in the early 2000s. You will either be bragging to them that you did or bemoaning the fact that you didn’t. 

* Dollar cost averaging does not assure a profit or protect against a loss in a declining market. For the strategy to be effective, you must continue to purchase shares in both up and down markets. As such, an investor needs to consider his/her financial ability to continuously invest through periods of low price levels.

On the 26th July each year, Consumer Day is celebrated to commemorate Consumer Protection Act 1999 and to actually create awareness and educate us to be responsible consumer who is aware of his/her rights as a consumer and practice them.

We should always stand up for our rights but never misuse them. These are the eight key consumer rights :

1. The rights to acquire fundamental needs.
2. The rights to acquire safety rights.
3. The rights to acquire information.
4. The rights to make a decision.
5. The rights to voice out.
6. The rights to claim for damages.
7. The rights to obtain consumer education.
8. The rights to acquire safe and healthy environment.

To find out more visit : Ministry of Domestic Trade and Consumer Affairs

Be a smart consumer and indirectly contribute towards an ethical economy.

 Happy Consumer Day !!

By Ric Edelman
From Inside Personal Finance

Do you know what the terms asset allocation, portfolio rebalancing, and diversification mean, and how to apply these concepts to your portfolio? You are not alone if you don’t. In a recent study of people who have  $100,000 or more in investments, Hartford Financial Services Group found that few investors are familiar with the term “asset allocation.” 

Of the respondents under age 24, none could explain the term. Only about 12% of those in their 20s and 30s said they knew what asset allocation means, and about 35% of those in their 40s and 50s claimed familiarity with the term. This lack of education is a big problem because asset allocation should play a crucial role in managing your investments properly. 

Asset allocation refers to spreading your assets among different asset classes, such as stocks, bonds, CDs, real estate, gold, international investments, and natural resources. Within each asset class are sectors. For example, stocks can be parsed into growth and value; bonds can be split among government and corporate, and so on. 

Therefore, educated investors know they should give equal consideration to how much money to place into an investment as well as to selecting investments that are appropriate for them. If you doubt the importance of asset allocation, consider this: Even if you buy the right investment at the right time, watching it double in value won’t do much for your finances if you had invested only 1% of your capital in that asset. 

This is why smart investors focus on percentages, not dollars. The amount of money you have fluctuates daily. But the percentage never changes: You always have 100% of your money — never more, never less. Therefore, instead of trying to decide how much money to place into a given investment, focus instead on the percentage you want there. Once you decide, for example, that you want 20% of your money in a given asset class, you know when to buy and when to sell. 

How you allocate the assets in your portfolio depends on your goals and the time it will take to achieve them. For example, two people might own identical investments, but the person who is saving for a retirement that is 30 years away will allocate money among investments very differently from the person who is planning to pay for college in five years. That’s why professional financial advisors create asset allocation models for their clients, and we’ll do so only after developing a thorough understanding of the client’s goals. If you find yourself talking with an advisor who touts investments without regard to your goals, and without regard to asset allocation, you’re really dealing with a product salesperson, not a genuine financial advisor.

When properly executed, however, asset allocation contains an inherent flaw: It becomes outdated. That’s because no two asset classes (or sectors within asset classes, or individual investments within sectors) ever perform identically in any given time period. As a result, during a given period, some investments will rise or fall in value more than others. After a period of time, some investments will comprise a larger portion of your assets than you wanted, while others will comprise less. 

That’s why asset allocators turn to portfolio rebalancing. If someone wanted, say, 65% of their assets in stocks and a review of the portfolio now reveals that stocks comprise 70% of total assets (because stocks rose faster than other asset classes), they’ll sell some of the stocks to bring the allocation back to the desired 65% level. Simultaneously, they’ll use the sale proceeds to buy more of the asset class that became underweighted (and we can guarantee that something is underweighted, since the total portfolio always equals 100%). 

Rebalancing is important because if you don’t do it, your portfolio could eventually comprise too much of one asset class and too little of another. That could be devastating to you if something bad happens to the overweighted asset class — as those who had placed all their money in tech stocks in the 1990s eventually discovered. Conversely, people who have too much of their money allocated to bank CDs could miss out on the potential profits available from other asset classes; in the worst case scenario, it could prevent them from being able to afford to retire. 

The final element is diversification. How many securities should you own in a given asset class? After all, buying a single stock would be dangerous; buying two is half as dangerous, and buying four half-again as risky. At what point is enough, enough? A recent study in the Journal of the American Association of Individual Investors shows that a properly diversified stock portfolio is one that holds shares of 400 companies; doing so, the study says, reduces diversifiable risk by 95%. 

Since ordinary consumers are highly unlikely — or unable — to own so many stocks (the security analysis, transaction expenses, paperwork, record-keeping, and tax reporting burden would be overwhelming), the approach preferred by most investors is to buy a stock mutual fund instead of individual stocks because this investment may provide the diversification an investor seeks.*

People who build and maintain portfolios based on asset allocation, portfolio rebalancing, and diversification may be likely to be successful investors. 

*Asset allocation/diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a diversified portfolio will outperform a non-diversified portfolio.

GROW YOUR MONEY

Saving up for retirement and the education of young children can be quite taxing even on successful professionals, says The Financial Planning Association of Malaysia (FPAM). 

PERSONAL retirement planning is often an intense challenge for parents with young children. Their key problem is balancing current lifestyle needs (and wants) against vital long-term future goals like retirement and children’s university education funding. 

Even those with hefty incomes face this problem. Here’s a case study involving Charles and Claire – successful professionals and the doting parents of five-year-old Cherry and three-year-old Chester. Charles and Claire enjoy a combined net monthly income of RM15,000, which is several times that of the average Malaysian household.  

Claire, who brings in a third of their total income, has been toying with the idea of quitting her job to raise Cherry and Chester full time. While Charles is supportive, he suggests they meet with a financial planner to discuss their long-term goals and to see if their tentative plan of having Claire quit her job at the end of 2007 is viable.  

They set up a series of meetings with a reputable Securities Commission-licensed financial planner. After their third meeting, they ironically find themselves both relieved and stressed! 

They’re relieved because they have a much better sense of what they need to achieve if they are to retire comfortably and to educate their children in the ambitious manner they’ve always dreamed of. 

They’re stressed because hard numbers don’t lie. They face the fundamental choices of having Claire continue to work or of dramatically scaling back their retirement and education funding plans.  

In their first meeting with the financial planner, they were asked to list all key financial goals and dreams. They came up with items ranging from the prosaic to the extraordinary, including retiring well, educating their children abroad, travelling abroad each year, buying a mansion with a swimming pool and owning a Ferrari.  

Then, when the financial planner asked them to select the essential, non-negotiable goals, Charles and Claire settled on retiring well and educating their kids abroad.  

(Wong Boon Choy, treasurer and founding member of the Financial Planning Association of Malaysia, explains, “If funds are limited, we have to face the harsh reality of revisiting goals that may have been set earlier.”) Charles and Claire initially set the education goal as their number one priority and relegated retirement to number two. 

But their financial planner explained that in the decades ahead our entrenched philosophy of Asian filial piety may give way to more Western ways of thinking. 

Also, the economic climate prevailing three or four decades from now may make it impossible for even the most caringly nurtured children to fund their parents’ retirement while paying for their own needs and saving for the next generation’s education! 

(Even financial planners who are comfortable with parents putting their children’s education ahead of their retirement advise caution. 

Alfred Sek, CEO of Standard Financial Planner explains, “A common mistake parents make is overlooking their own retirement plan while planning for their children’s education. As a financial adviser, I would not recommend they put their future retirement plans in the hands of their children.”) 

If in later decades children are unable or unwilling to provide retirement funding for aged parents who haven’t taken care of their own retirement needs, tragedy can ensue.  

Wong, an SC-licensed financial planner and CEO of unit trust management company MAAKL Mutual, says, “People usually have two choices then: To reduce their annual expenses in retirement or to delay the start of retirement by continuing to work.”  

Taking the time to run appropriate analysis will help them figure out possible future courses of action. Wong warns grimly, “Someone planning his retirement should think now, ahead of time, of the key difference between eventually being considered an ‘old man’ and an ‘elderly gentleman’ – the amount of money he possesses!”)  

So you’ll be relieved to learn Charles decides their appropriate number one financial priority should be retirement funding.  

Chart 1 shows the suggested funding path toward that goal. 

The analysis yielding that solution was based on 12 assumptions: 

1. Although they earn RM15,000 a month in net income, Charles and Claire are willing to settle for a RM4,000 (in 2007 terms) a month lifestyle throughout their long projected retirement period. 

2. Charles and Claire assume, at least at this stage of their analysis, that they will both continue working until they turn 60. As they’re both 35 now, they have 25 more years before retirement begins.  

3. They assume they will live until 2056, just before both turn 85. So, they’ll spend a projected 25 years in retirement. 

4. Between now, 2007, and the year they retire, 2032, inflation (meaning their personal average inflation rate as opposed to the official CPI rate) runs at an average of 4% a year. (By their first year of retirement, it will cost RM127,961 in future 2032 ringgit terms to afford a RM48,000 a year lifestyle in 2007.) 

5. To generate the required savings and investment growth, we will assume they utilise bank fixed deposits and unit trusts encompassing money market funds, bond funds, domestic equity funds and international equity and property funds. It seems likely if such a well-diversified, pre-retirement portfolio is regularly and intelligently rebalanced, it should yield an average compounded growth rate (CAGR) of 8%.  

6. We certainly don’t assume they will retire at the current 55 or 56 official retirement age because, with lengthening life spans, it is a certainty that conventional retirement ages will creep up by perhaps two years for every decade we move into the future. Once they stop working at 60, all active income inflow ceases. Then their ability to stomach investment risk will fall. The rational thing to do then is to restructure their portfolio to lower its inherent volatility. This should yield lower, but more stable, returns. In specific terms, both their equity and international exposure will be reduced while their fixed deposit, money market and bond weightings will rise. Their new target compounded annualised growth rate (CAGR) is assumed here to be 6%. 

7. Throughout their anticipated retirement period of 25 years, medical expenses will become increasingly important. Specific inflation affecting medical treatment tends to run higher than general inflation. So, we’ll assume their retirement inflation runs at 5% a year.  

8. Taking all those points into consideration, we find based on the software used to carry out our analysis that just over RM 2.8 million is needed to fund their joint retirement, using a capital liquidation method. (Their joint EPF savings at 55 may grow to more than RM700,000; as this amount is NOT taken into account in this analysis it can be used as a massive cash cushion to make achieving this goal and that of educating both children abroad more likely.) 

9. As we assumed earlier that Charles and Claire will earn an 8% yield on their portfolio, obviously they will require a lot less than RM2.8 million today.  

Calculating this smaller number is the mirror image of conventional compounding, which causes money to grow when we move from the present to the future. Instead, we discount that large future sum back to the present by 8% a year and discover a much smaller total theoretical sum of personal savings today is needed to reach our future goal of RM2.8 million. That currently “needed” sum is RM413,926 in 2007 ringgit. 

10. They don’t have that much. We’ll assume they have a total of RM30,000 today in savings that can be committed to initiating both their retirement funding programme and their kids’ tertiary education plan. Because their number one goal is retirement funding, we’ll further assume they choose to allocate RM20,000 of their RM30,000 available cash toward starting the retirement programme.  

(Chart 2 shows RM5,000 is set aside to begin each child’s university funding portfolio.) 

Charles and Claire also opt to take advantage of the excellent EPF Members Investment Scheme to use a portion of the money in their respective EPF Account 1 to augment their initial investment. We’ll assume a total of RM12,000 can be utilised from both Charles’ and Claire’s EPF accounts for this purpose. 

11. So, their present day shortfall for the entire retirement funding programme is RM413,926 minus RM20,000 minus RM12,000 or RM381,926. The retirement planning software used for this analysis indicates an annual investment of RM35,778 will make up for the RM381,926 initial sum shortfall. 

12. It appears as though Charles and Claire need to channel about RM3,000 a month – on average between now and when they retire – to meet their retirement funding needs. Since they currently earn a whopping RM15,000 a month, it seems they can either enjoy a RM12,000 a month lifestyle and meet their retirement savings requirement or Claire can quit her job to spend time with the children if they settle for a RM7,000 a month lifestyle, since she presently brings in RM5,000 in net income each month. Unfortunately, neither conclusion is correct. 

Remember that Charles and Claire don’t just have one important financial goal – they have two (or three, if we count each child’s education funding requirement as a separate goal).  

Chart 2 outlines the analyses for Cherry to be able to study in the UK for a three-year honours degree, and for Chester to study in the US for a four-year honours degree. 

Assumptions made in the respective education analyses include anticipated exchange rates for the pound and the US dollar. (Here we’ve assumed the ringgit will continue to track sterling at about RM7 = £1, but that the greenback will continue to weaken on the back of seemingly irreversible US trade deficits and thus average RM3 = US$1 between 2022 and 2025.) Obviously, there is no way of knowing what the true future tuition and living costs will be, but the purpose of such analyses is to provide at least a logical framework for long-term planning.  

Financial planning itself includes but goes beyond wealth accumulation initiatives. 

According to Securities Commission-licensed financial planner Rajen Devadason, “Financial planning also includes wealth protection using insurance and the power of asset diversification, and wealth distribution using wills and trusts.” 

With regard to caring for young children, Ong Eu Jin, chief operating officer and director of OSK Trustees, explains, “Education planning for couples with young children is never complete without addressing the ‘what ifs’ and the worst case scenarios.”  

Ong, who believes each adult should write a will, adds: “Parents with minor children should consider creating a testamentary trust under their will.” Such a trust comes into effect upon the demise of the testator, the person whose will it is, and can be structured to protect the goals and aspirations of loving parents who recognise the possibility of their not living long enough to see their children graduate. (We will take a closer look at this important facet of financial planning in an upcoming article.) 

Returning to our case study, it’s clear Charles and Claire’s current goal of setting aside enough money to educate their two children in the UK and the US necessitates saving and investing about RM5,400 a month.  

Once we add that sum to the RM3,000 a month Charles and Claire need to set aside for their primary goal of retiring well, we see their initially sizeable net income of RM15,000 a month doesn’t appear that large. 

Retirement funding specialist Devadason says ruefully, “I often sound like a broken record when I repeatedly urge my clients to aim to move up toward a long-term targeted savings rate of 40% to 50% of their net income. 

“Number crunching exercises like these aren’t meant to depress people but to drive home the reality of our need as a nation to consume less and to save and invest more – much more.”

By Ric Edelman
From Inside Personal Finance

Let’s turn to data provided by Dalbar, a research organization in the financial services field. For years, Dalbar has tabulated the performance of investors rather than investments. Its findings are so important that Morningstar has adapted a similar approach for its mutual fund rating system.

How can it be that a mutual fund’s investors don’t earn the returns generated by the fund itself? The answer is simple: Mutual fund performance data is based on the returns earned from January 1 through December 31, with no cash flows occurring between these dates. In other words, the data assume you invest on January 1 and that you withdraw your funds on December 31, and further assume that you don’t add any money or make any withdrawals during the year. If you follow that protocol, then your return will indeed be identical to the returns posted by the fund.

But that’s not how investors behave. As Dalbar discovered, and as Morningstar agrees, you’re far more likely to invest in a fund on a date other than January 1. You might later make an additional deposit, and perhaps withdraw some of the money at some future date. Because investment prices fluctuate, your investment results cannot possibly match those who are basing their data on January 1 and December 31 prices.

Doesn’t this mean that investors might actually earn returns that are higher than those claimed by mutual funds? Theoretically, yes: It’s possible that you’ll buy at prices that are lower than January 1’s and higher than December 31’s. But, in reality, that’s not what happens.

By studying cash flows (tracking the movement of money into and out of mutual funds), Dalbar’s and Morningstar’s data clearly show that the vast majority of people buy investments when prices are high, and they sell when prices are low.

For example, consider the returns of a fund that (according to Morningstar) averaged 15% per year for the ten years ending December 31, 2006. Morningstar says the average investor of that fund earned only 2.6% per year. In another fund that posted an 8% annual return, investors earned only 0.6%. A third, which posted a 7% average return, has an average investor return of –15%.

There’s such a large discrepancy between investment returns and investor returns because investors tend to buy funds only after they’ve risen in value. Funds attract media attention only after they do well, and fund companies place ads in magazines and newspapers only after the funds produce a great record they can tout. Investors agree that the results are terrific, and they assume that a fund that made lots of money in the past will continue to do well; so they buy. When those profits fail to materialize, they sell. Then they scratch their heads and ask, “How come I’m not making money with my investments?”

The solution: Buy and hold for years and years.