June 2021

The power of compounding interest

The effect of compounding is one of the greatest discoveries by Albert Einstein. Compounding interest is the interest calculated on the initial principal which also includes all the accumulated interest from the previous period.

Interest is what you can get when you lend the money to others and it is what you pay when you borrow money from others. When you are depositing money in the saving account in the banks, you are actually lending your money to the bank for them to borrow out. Hence, the power of compounding interest can work for you or work against you. If you are getting the interest, it is working for you. If you are paying the interest, it is working against you.

The compounding effect is magical. As a rule of thumb, a 7.2% interest means the principal will double in amount every 10 years. Imagine if you save and invest RM 24,000 lump sum at 7.2% per annum for 50 years (more extra saving in between period), it will turn into RM 768,000, 32 times the initial amount.

You might be amazed by how fast the initial amount can transform to via 50 years with only 7.2% interest. What if it is the expense and not the saving / investment? If your expense is RM 24,000 a year, it will also be translated to RM 768,000 / year after 50 years if the inflation is 7.2%. Never underestimate the power of compounding interest!

Another aspect people might not aware about the compounding effect is it needs time for the magical thing to happen. It starts really slow in the beginning years. Let’s use the above example, Year 1 amount is 24,000, Year 2 amount is 25,000+, Year 3 amount is 27,000+. It does not seem to be significant. However, in Year 40, 24,000 will turn to 387,000+, Year 45 will be 548,000+, Year 47 will be 630,000+. You can clearly see that the impact is greater after Year 40. In the nutshell, the compounding interest effect is silent and magical. If you are the one lending money to others, you will slowly and silently get the benefits from it. However, if you are borrowing money from others, you will soon find yourself paying more and more interest for the amount.

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7 income streams that you can consider building for yourself

We often hear that the rich are having more than 1 income stream. This is entirely true as it is just too dangerous to only rely on 1 single source of income. To grow our wealth at lower risk, we need to have several sources of income streams.

The first type of income stream is earned income. This is the primary income source most of us have. When we work, we get the income. When we don’t work, we don’t get the income. This type of income has a ceiling because it is based on the time we work. We have only 24 hours a day, very soon we will find ourself being not able to increase our working hour and hence limiting the earned income stream.

The second type of income is profit income. This is basically the profit we get from doing sale or business. We get profit when we sell products or services, as long as it is lower than the cost. The higher the price we sell, the more profit we get. We can also engage other people to help us to do the selling, this can help us to increase our profit income. Profit income can be increased very fast if we know how to acquire talents and have a system to help us sell.

The third type of income is the interest income. We can earn interest income by putting our money in the bank or borrowing our money to individuals or corporate. The fixed deposit interest is one of the examples of the interest income. Bond coupon is another type of interest income. The interest income is mostly fixed when we place the money with the borrower or bank. Hence, it provides better income stream stability to us.

The fourth type of income is dividend income. We get this income when we invest into stocks. Dividend is the income distribution by the companies we invest in when there are profits announced by the companies. Normally, companies which give high dividends are big, matured companies which have consistent revenues and profits. REIT, which is real estate investment trust is another vehicle which gives high dividend income. The dividend income is not necessarily stable as the dividend pay-out depends on the company performance every year.

The fifth type of income is rental income. It is generated from the real estate. When you buy a property and rent it out, you will receive the rental from the tenants. This type of income is mostly quite stable as well compared to the dividend income.

The sixth type of income is capital gain income. It is obtained when you buy an asset at a lower price and sell it at a higher price. It can be gained via real assets such as gold, properties, antiques or paper assets such as stocks, index funds, mutual funds, etc.

The seventh type of income is royalty income. You can get royalty income by designing, creating some intellectual properties such as books, franchising license, music or movies.

Out of the 7 types of income illustrated above, 3 of them are active incomes, namely the earned income, profit income and capital gain incomes. For the profit or capital incomes, if you can use a system to make it automatic, it can be considered as passive incomes. The remaining 4 of them are passive incomes, namely the interest income, dividend income, rental income and royalty income. Passive incomes mean you only need to do the work once and you shall get the income continuously without much effort later on. Passive income generation is one of the goals during the wealth creation journey because no one wants to work forever. Passive income streams will ensure we can earn money when we are sleeping.

Remember, all of us have only 24 hours a day. Let’s start to have more income streams especially passive income streams so we can let our money works for us rather than we work hard for our money. If you are not having income when you are sleeping, you will need to work forever.

If you wish to watch the video instead of reading this long post. Check out the Youtube Video here.

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Why personal financial skills are important?

Money is not everything but without money, our life will be a disaster. If you need a not-struggled life, you need to have personal financial skills. If you wish to live a healthy, happy and secured life, you need to master the financial skills, whether you like it or not. It is not a choice but a MUST.

Personal financial skills are the skills on budgeting, saving, debt and investing. Budgeting skill means the ability to allocate money for different needs and expenses. Saving skill means the ability to have positive monthly cash flow every month. Debt skill means the ability to control the debt level and not over-leveraging. Now, it also includes the ability to use debt to grow wealth. Investment skill means the ability to select and monitor the investment to meet our financial goals.

First reason why we need to have the skills is that the current world requires money for everything. We need money for our food, clothes and shelter for surviving. These are the basic living needs. There is no chance for us to say “I don’t have money, can you give me free house to stay?” With our children, our financial burden is even higher. Children education fee is increasing every year. Hence, we have no choice but need to have better ability to earn money and save money.

Second reason is personal finance is not a subject taught in school. This is the reason why many graduates are having huge student loans once they leave school. If the skill is not mastered, many will be stuck in the debt, using one debt to cover another debt. Budgeting skill is important to make sure we do know more on what we need.

Third reason is for our retirement. In general, we have only 657,000 hours in life, assuming our life span is 75 years. By the time we leave school, almost one third of time is gone. In the remaining 2/3 of our hours, do we want to spend on finding money to fund our retirement or we spend on enjoying our life? If we need early or on time retirement, we need to master our skill on saving and investment to grow our wealth so that we are able to fund our retirement even though we are not working. We need to master our skill on managing our debts so we do not need to work our life just to pay debts.

Fourth reason is for our emotional and physical health. Researches have shown that lack of money or increase of debt can increase our stress level. Stress is the number one killer to our health. If we are able to manage our personal finance better, definitely, it is very effective to maintain our health.

Fifth reason is to have more people to help you achieve what you want to achieve. If you are having better personal finance, you will have better credit score. Banks like people who have good credit score. With good credit score, it is likely to get bank loans to fund your favourite homes or businesses. The key is to be able to manage debts better, the better you manage your debts, the more money you can borrow but because of your personal finance skill, you will have more monies and not stuck in debts. I hope the above will motivate you to learn more about personal financial skill. You are the one who can control your wealth destiny, no one else!

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5 things we should do on finances Thumbnail

5 things we should do on our finances during the pandemic

The pandemic started since early 2020 does not seem to be ending too soon. Many businesses in Malaysia are now affected especially during the current lockdown. Honestly, we do not know when this will come to an end. There is nothing much we can do about it. It is better for us to get prepared rather than worrying something that we cannot control. The followings are the 5 things we should do on our finances during the pandemic.

The first thing is to visit our monthly cash flow. Cash flow is the king! Clarity is the key! Is our current monthly cash flow now positive? Predict the upcoming 6 months income and expenses. Have a feel on how the ongoing lockdown and pandemic are going to affect our cash flow. Try to find ways to cut down the expenses so that we can have more savings for the rainy days. Things are unexpected now; more cash means more security. Here is a template to key in your financial data to check your monthly cash flow.

Second, we need to have a look at our emergency fund. Make sure that we have at least 6 months’ expenses as our emergency fund to cope with any upcoming unforeseen circumstances. If you have not set up the emergency fund then you need go through your saving accounts, investment accounts to identify the emergency fund sources. Understand where we can source the emergency fund? Is it fixed deposit, is it saving account or is it in the investment account? If the emergency fund is not in the bank yet, it is time to do some switching of the investments to lower risk assets to allow for any flexible withdrawal without affecting the investment performance.

Third, look for opportunities to refinance the long-term property loan. Currently, as you know, the OPR is low. Bank Negara Malaysia has reduced the OPR 4 times in the year of 2020 from 3% to 1.75%. If the loan has been taken quite a while, the interest could be high compared to what the banks can offer now. This can potentially reduce your monthly loan instalment. It is also possible to prolong your instalment period if you are young enough, this can reduce your monthly expenses too! For example, if you bought the property in 2010 at RM 450,000 and the loan amount is RM 405,000, loan installment would be RM 2350. After paying the loan installment for 11 years, the outstanding loan amount is RM 300,000. You can choose to lower the interest only by paying lesser installment by committing to pay in another 25 years’ time, loan installment shall be reduced from RM 2350 at 4.85% to RM 1,540 at 3.15%. In addition, if you need some cash, you might be able to cash out some monies from this exercise if the property you bought has increased in price. In the last example, the property value has increased from RM 450,000 to 800,000 in the past 11 years. One can choose to refinance it up to maximum of 80% of the property value to get some cash back. 80% of RM 800,000 is RM 640,000 and the outstanding loan is RM 300,000. In this case, one can choose to cash out the difference subject to the loan approval. However, make sure you are able to make good use of the cash out!

Fourth, learn and start investing. Investing is the way to grow wealth. If you are having some excess cash, make sure you don’t just save it in the bank. Start looking into investment. Currently, the saving rate is less than 2%. OPR has been reduced 4 times in the year of 2020. It is not enough to cope with the inflation. There are many ways you can invest, i.e. stocks, unit trusts, index funds, Real Estate Investment Trusts. Make your excess money works for you and your future will thank you for doing it now.

Fifth, create a second source of income stream. During lock down period, there are many opportunities online. You can consider learning a new skill to start create another income source for yourself. Since last year, I have seen many are selling things online via YouTube channel and social medias. You can turn your passion into extra income too. Do not waste your time, start to learn a new skill to help yourself during the lockdown period when you have saved so much time on travelling to office.

Remember, we cannot control what happen to us but we are able to do something to get prepared to the pandemic.

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Does it take money to make money?

To answer the question above, we need to understand the few ways to make money. Most of the time, it does not take money to make money. The 4 ways of making money mentioned by Robert Kiyosaki are the followings:-

Being an employee: no money is required to make money. Employees trade their time for money. As long as you have time, you can earn money. There is hardly any volatility on the income as the salary is fixed when the employment contract is signed. However, the increment of the salary can be very slow.
Being a self-employed: in this category, the income earn can be higher or lower than the employee. People are choosing to be a self-employed due to the flexibility in working hours. The income they earn normally tied with how much time they spent to work and the expertise/skill of the person. This can be a part time in addition to the normal day job. This can help to increase the income easily.
Being a business owner: in this category, huge income can be earned. The level of income depends on how well the business solves the community’s problem. When people are struggling, with good business idea, great income can be generated. Business idea can also raise fund from the public, hence, you don’t actually need money to start any business if your business idea is good.
Being an investor: in this category, money is required to generate more money. An investor can grow money even better. The investors’ monies are normally channeled to the businesses on the 3^rd category above. Business owners contribute idea, investors fund the operation to get more passive income.

After understanding the above, you shall understand before you can invest, you shall have money. To get more money, you can either be an employee, be a self-employed or be a business owner. To earn more as an employee, you need to have more skill or work longer. To be a self-employed, your expertise is highly relevant to your income level. To earn more as business owner, your service/product must be able to solve a problem. The bigger problem you solve, the higher income you will get. Investors like solution to big problem and they will fund the great business ideas.

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Planning your retirement figures

When the retirement topic is raised, people always think that it is too early to plan for retirement. Most of the conversations pertaining to personal finance are normally related to how to increase income or how to reduce debts. You can see most Malaysians don’t seem to prioritize their retirement planning. It is never too early to plan. The earlier you plan, you can have more buffer for any correction on the plan. Anything can go wrong. If you fail to plan, you are planning to fail.

To start planning well for our retirement, we begin with the end in mind.

When we retire, there is no longer any active income coming in. Hence we need a huge retirement sum to fund our ongoing retirement yearly expenses. How much is the retirement sum required?

There are quite a number of information to derive the retirement sum. So, check this link out for the worksheet to help you to calculate the final retirement figure. These are the 4 elements that you need to fill up on the worksheet to get your final retirement sum.

How long we have to reach our retirement age: Let say one starts to plan for retirement at the age of 30, you key in 30 as the current age. Then what will be the desired retirement age? Let say age 60. You will key in 60 as the desired retirement age. You shall see now the number of years to retirement is calculated automatically.
Inflation rate and the investment rate of return: The published inflation rate is about 3%, however, you can use higher rate to capture for the higher retail inflation rate. The investment return is crucial. If you are saving, put in the fixed deposit rate. If you are investing, put in your investment rate of return. Once the 2 rates are entered, you will see the adjusted rate of return being calculated automatically. The adjusted rate of return is the net investment return after considering the inflation rate.

As you know, inflation is killing our wealth and the investment is growing our wealth. When having these 2 forces, we cannot use either one of it to compute the figure. We are adjusting it. If the adjusted figure is 3%, it means that our net investment return is 3% after considering the inflation, this net return will be used to fund the retirement yearly expenses since there is no more active income during the retirement period. The retirement sum is calculated using this formula: the yearly retirement expenses divide by the adjusted investment rate of return.

Monthly retirement expenses: We will key in the expected monthly retirement expenses (without inflation). Exclude any loan commitment as by the time we retire, we shall have finished paying off the loans.
Current saving / investment value: We will key in our saving / investment to calculate the gap between this figure and the retirement sum required. The next value that will be calculated automatically will be the monthly saving / investment required to fill the gap.

So, when you have the monthly figure ready, you need to ask yourself whether the monthly figure that you derive is possible to be achieved? If not, you might need to do some adjustments to your planning.

The higher the inflation, the higher retirement fund is needed.
The higher the investment rate of return, the lower the retirement fund is needed.
The longer the years to retirement, the lower the monthly investment amount.
The smaller the monthly expenses amount, the lower the monthly investment amount.

After understanding this, perhaps you know what to do. If the monthly investment amount looks big to you, you can choose to increase the investment rate of return by investing more aggressively. When you master the skill of investment, you can invest at a rate more than 6%. The other alternative will be to reduce your retirement expenses. If you can spend less, you need a smaller retirement sum. The last choice you have is postpone your retirement to a later stage. By postponing the retirement, you will have more time to prepare for the amount required, hence reducing the monthly investment amount. Hence, planning early is very important. If you start planning early, the monthly investment amount required will be much lesser than the one who starts planning 10 years later.

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Retiring well?

As statistic shows that 70% of the Malaysians outlive their retirement fund, retirement seems to be a far goal to be achieved. Most of the conversations pertaining to personal finance are normally around how to increase income or how to reduce debts. Hence, when the retirement topic is raised, people always think that it is too early to plan for retirement.

Remember that it is never too early to plan, as the earlier you plan, you can have more buffer for any correction on the plan. The following shows some aspects that you need to consider for your retirement planning.

Begin with a goal and your starting point: this starts by checking your financial situation, i.e. your monthly cash flow, your assets and liabilities. Then, set the goals, e.g. how much money you are targeting when you are retiring. Once these 2 elements are determined, you will know the gap between these 2. Then, you shall know how long you need to reach your goal based on your monthly cash flow and the return you need to achieve your goal.

Diversify your assets: when investing, we know that investment comes with risk. Hence, diversification is always required to reduce our investment risk. Diverse the assets into several sectors, geographical areas and assets classes.

Determine your retirement drawdown strategy: during retirement period, drawdown of the investment assets is required. Hence identify how the drawdown can be used, e.g. constant drawdown from equity? Rely on dividend payout? If the drawdown from investment is required, it is better to do a pre-planning to switch the money from high volatile assets to stable assets like bond 1-2 years before the cash is required. This will prevent the withdrawal during the market correction period that may not be beneficial to the owner.

Consider other elements in life, i.e. education funding, vacation planning, etc. Retirement is a holiday period. Hence, many elements can impact the financial aspects of the retirement. Consider what you will do during the retirement and budget for it when setting the target goal.

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Vaccine and vitamin for our wealth

Recently, corona virus cases are on the rise. People are buying many supplements to boost their immune system to protect their health. How about boosting wealth?

Full MCO is happening, some people are financially immune to this lock down regardless of how long it will take. These people are having multiple and consistent income sources despite lock down. However, there are some people cannot even sustain financially for a week of lock down.

What are the differences between these 2 groups of people? What the first group has done?

Do you know that statistics show that more than 53% of Malaysians are not prepared for retirement, many are still struggling financially when MCO is announced. How can you have vaccine to protect your wealth? Or even Vitamins to boost your wealth?

The number 1 reason why people cannot get the financial stability is because they do not save and invest at the same time. Some people fail to save, and so they have not had the financial stability. Some people only save but do not invest, so they could not grow their wealth.

Hence, saving is the vaccine, investment is the vitamin for wealth. How can you ensure that you can save? Well, theoretically there are 2 ways – you can either increase your income or reduce your expenses. You may have heard many people saying that do more side hustles, be more hardworking you shall have more income. You might come across many people asking you to venture into direct selling, e-commerce to earn more income. You might have more money doing these. But are you able to save? More income does not guarantee more saving. Hence, reducing expenses is the way to ensure more saving. When you have the habit to spend less, when you have more income, you will save more. So the vaccine is actually to look at your expenses, never spend more than what you can afford. If you are currently having debts, restructure your debt with lesser interest. Saving and cash flow is still the key to financial stability which gives you vaccine to protect your wealth.

Investment is the vitamin to boost your wealth. The number 1 enemy of wealth is inflation. If we only save our money in the bank at 2%, our wealth is decreasing in view of the higher inflation rate. This is why the longer we wait to invest our money, the worse our financial situation becomes. Our purchasing power is dropping without us realizing. Hence, investment is crucial to help us grow our wealth. To invest successfully, an investment plan is required, including understanding the risk tolerance, investment goal and investment yield required. The final goal of investment is to have more passive income. We want the money to work harder for us. When we are initially investing, we might only target capital gain because we want our money to grow to a certain stage so that it is sufficient to generate the passive income that we want. When we have investment income, we are better prepared for any emergency event when we are unable to work. Also, we are able to enjoy the freedom as we no longer need to worry about our job.

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