FELLOW Malaysians, it is undeniable, we are living in tough times.
Not only has the cost of living risen to an all-time high, but the weak ringgit as well as the goods and services tax (GST) have created inflationary pressure.
The recent unprecedented toll hike between 18% and 100%, may be the final straw for many Malaysians who are already struggling to cope.
Amid such a turbulent economic backdrop, what measures can one do to improve and secure his financial future?
Time and time again, I have observed how most middle-class families in Malaysia (those with a combined household income between RM15,000 to RM 30,000) end up in a net worth position that does not match up to their years of drawing from high-income salaries.
In fact, despite proactively adopting forced saving measures and subjecting their life savings to risky and stressful investment activities, many middle-class families still fall short of their retirement goals and wished that they could have accumulated more wealth
Like it or not, the above scenario is a middle-class reality. One can only imagine the severity of the situation when applied to our current economic predicament. What chance does the middle class has in such adverse situations?
Doing nothing is not an answer, nor is the short-term solution of cutting back on (household) expenses.
In this day and age, if you’re not taking active measures to grow your wealth, you are setting yourself up for a disappointing and financially burdening future.
The solution lies within the principles of money optimisation, a systematic way to grow one’s wealth and subsequently, net worth, steadily up while keeping risks to a minimum. With the right money optimisation strategy in place, the middle class has the opportunity to accumulate RM1.5mil to RM3mil more to their net worth.
The process itself is not complex, but it involves carefully thought out steps and checkpoints to ensure its effectiveness in growing money with minimum risk.
Here, I’ve outlined the five main steps of money optimisation.
Step 1: Holistic financial planning
The first step is to map out a holistic financial plan to optimise our money. Why is this step so important?
Holistic planning will help determine certain financial decisions you will need to make to reach your goals.
They include how much money to put aside for savings, adjusting your living expenses and identifying the return on investment (ROI) that you will need to target for your investments.
Many overlook this step, as they are too keen on only growing their money. While this may not necessarily be a bad thing, doing so without first identifying a saving rate may run you the risk of under-saving, and eventually preventing you from accumulating enough resources to achieve financial freedom.
A holistic financial plan also helps to narrow down investment options according to the ROI you will need to attain your goals.
It will alert you if you are taking excessive risks with your investments, or are being too cautious and underachieving in your money growth.
The key word here is “holistic”. For money optimisation to work, you cannot merely focus on a single financial goal, i.e. “a comfortable retirement” – you need to look at the big picture and take into account all the financial requirements you will need in the future.
Step 2: Cash-flow managment
Once you have set a direction for your investment strategies, the next step is to manage your cash-flow to get an accurate picture of how much you are able to invest to grow your wealth.
Managing your cash-flow is important to ensure you have holding power over your investments.
Before investing your money, set aside a cash reserve for a rainy day – six months of your expenses for those who are currently earning, and three years for those who have already retired.
With cash reserve, you can afford to wait for a badly-hit investment to rebound before cashing it in, as opposed to cashing it in when it hits an all-time low because you are in dire need for cash.
By doing this, you are safeguarding yourself against unpredictable financial crashes, because you have the resources to wait for the market to recover from a crisis.
Similarly, it is also vital to estimate when major life events will be taking place, like the funding of your children’s overseas tertiary education, and setting aside cash reserve for that purpose.
That way, you won’t run the risk of making a loss for having to force sell on an investment prematurely.
I once knew a high net-worth individual who couldn’t afford to send her children overseas for education.
Later on, it was revealed that she had put all her money into property investing, without thinking about her short-term need for cash for her children’s education.
Hence, without proper cash-flow management, you may find yourself in a tight spot for cash, or run the risk of a force sale during a time that’s below ideal.
Step 3: Holistic asset managment
When you have figured out the optimum amount to invest, the next step is to allocate your funds to appropriate investments. With so many types of investments out there, how do we choose which one to invest?
The key here is to diversify your assets. Different types of asset classes are associated with different types of risks. When you diversify your funds, you create a buffer to these risks.
The table illustrates two strategies to invest RM100,000 capital over 25 years. Each of these investment strategies have a different outcome, but which do you think will yield the most return?
At first glance, it may seem that Strategy A may be the safer way to go, as it constantly yields a positive rate of 4%.
Strategy B on the other hand, is split up into five smaller investments and is tainted with a 0% return and one complete loss of capital.
However, after 25 years, Strategy B would grow your capital to RM501,362, while Strategy A would grow your initial investment to a mere RM266,584. How did that happen?
This example highlights perfectly the concept of asset allocation. By diversifying your eggs instead of putting them all in one basket, you contain the maximum losses in each basket. On the other hand, the return for the other baskets in Strategy B is unlimited. As a result, the combined investment return is more than Strategy A.
Don’t just limit yourself to one asset class. Expand your investments to cash, foreign currencies, bond, equities, real estate investment trust and commodities.
In doing so, you’ll build a balanced portfolio of asset classes so that that no matter what happens to any asset class, your investment is well-protected.
After deciding where you’d like to allocate your assets, you then need to determine the quota for each asset class before investing, based on your personal preferences and appetite for risk.
Let me highlight an example that is closer to home. In the past couple of months, our ringgit has been at its weakest in years.
This phenomenon would affect the value of your net worth due to the currency depreciation.
If you had taken the step to diversify some money into foreign currency, however, you would have mitigated the effect on your net worth altogether.
To recap, if you overlooked this crucial step, you may run the risk of over-investing into one investment at a great opportunity cost.
Step 4: Risk-calculated investing
Choosing the right investment to put your money into can be overwhelming. There are many of products out there that promise high returns, optimum performance, and guaranteed return of investment.
Risk-calculated investing involves doing a thorough background and fact check of these different products such as the performance history, the track record of the fund manager and administrative charges.
This step will ensure that you select only superior, best of breed investments to put your money into each asset class.
Always be proactive in your research, and look for investments that are resilient. While doing this, ensure that you are clear about the policies regarding the return of your capital.
In many cases, investors focus on the ROI (profits from an investment) instead of their return of investment (the return of the initial capital should the investment fail). The loss of the latter could potentially set you a long way back!
Step 5: Active performance managment
A common mistake made by investors is to expect the investment to take care of itself once they have invested.
Therefore, review your investment portfolio regularly. Make sure that the annualised returns are always positive, and that the returns are above the current fixed deposit rate. If you find another comparable investment doing better, do not hesitate to re-allocate your funds accordingly. Park the profit in a safe vehicle when the opportunity arises.
Without active performance management, you may not have the foresight of cutting your losses on underperforming investments, and run the risk of asset depletion.
Based on your holistic financial plan, you’d also need to regularly monitor if your investments are on track towards meeting your required ROI, and if your net worth is growing correspondingly to achieve your financial goals.
Once a year, revisit your holistic financial plan. Repeat step two to five accordingly as you may need to adjust your strategies to reflect on the progress that you have made.
When done right, the five steps to money optimisation would not only lead to net worth growth but also allow you to effectively manage and minimise risk when you invest.
Overlooking any one of these steps may expose you to the risk of under-saving, executing a force sale, over-investing or under-investing, putting your money into weak investments, or the risk of asset depletion from the failure of cutting your losses.
With that said, perhaps it is now time to begin evaluating your own choice of investment strategies and processes, and plug the gaps that have caused many middle-class Malaysian not to achieve an ideal, financially free life.