Monday, 29 February 2016

BS - Liabilities

I shall now cover the other component of your Balance Sheet (BS) - Liabilities. This refers to the various types of debt you can incur - mortgage loan, car loan, student loan, credit card debt etc. The main expense that you incur from having such debt is interest expense. My opinion is that this is the singular and most destructive weapon to wealth creation I have ever seen.

Have you ever heard of the Snowball Effect? It's a term used widely on how to build an investment portfolio. This post by Dividend Mantra - Building A Snowball -  describes the analogy well and it really shows the positive power of compounding.


Now, imagine if you apply the same concept to debt. This time round, you get to see the negative power of compounding. What's going to make things worse is that certain types of debt can compound quicker than an investment portfolio. Which is why one of the first steps to Financial Independence is to always reduce the level of debt that you have i.e. decrease the amount of liabilities that you have.

What's interesting is that the type of debt causing the problem can be very different between individuals. In the end, it comes down to the personal decisions that you make and the environment you live in. For example, I read the posts by US Personal Finance bloggers regularly and you can see a recurring theme for some of them - student loans. This has grown to be such a significant issue in US and the impact on young adults has been immense. However, this is less of an issue in Singapore because the education costs are more manageable. Conversely, a car loan is often a big problem here in Singapore because cars are so expensive, whereas this is less of a problem in US. The important thing is to identify the main type of debt that is blocking your journey to Financial Independence.

For us, the credit card debt and mortgage loan are our biggest problems. Although we pay off our credit card bills in full every month and the monthly mortgage loan repayment is manageable, they continue to be the main areas of concern when it comes to our BS - Liabilities. You see, as a working couple, it's much easier to spend than to save since you find a way to convince yourself that you deserve nice things for working hard. Think overseas trips, restaurant dinners, cafe brunches etc. Yes, I agree that it also largely depends on your habits and hobbies but you are almost always going to find yourself in a position to spend than to save. It's no wonder that credit card debt continues to spiral out of control in most developed countries. That being said, how we manage our liabilities is still a work in progress and I will write more about this in the future.

Interestingly, I got asked this question by my wife about the blog over the weekend and I found myself thinking more about it than I expected.

Why am I doing it?

I guess it's a general question on why I started this personal finance & investment blog, why I post our actual investment portfolio figures, why I spend the time writing about all these topics etc. Inevitably, every blogger gets asked this question and one could write an entire post about the personal motivation behind the blog. For me, the simple reason is that I want to see if we can actually reach Financial Independence. I want to know what it feels like - the day we walk in to work and know that we can walk out at any time. The feeling of being accountable only to ourselves to figure out what we want to do with the rest of our lives. I want to document this process because it will become our library of experiences to be shared and I hope that it will benefit other people on the same journey as well.

Friday, 26 February 2016

BS - Asset Allocation

The Balance Sheet (BS) represents the assets and liabilities you have accumulated in your life and they can have a significant impact on your income and expenses. I personally prefer the BS approach to the Profit & Loss (P&L) approach when dealing with Personal Finance. Working out your own BS first is how you take stock of your life i.e. exactly where you are at with your personal finance. This then shapes your P&L since it gives purpose to your income and motivation to reduce your expenses. Hence, the BS approach - using the BS to guide the decisions you make in your P&L - and this ultimately determines your net worth.

Once we worked out all of our assets and their percentage proportion, we use an asset allocation strategy to guide our investment decisions and manage our portfolios. Justin from Root of Good, a US Personal Finance & Investment blogger, has written 2 great posts here and here on asset allocation. It's especially useful for us when managing the ETF portfolio!

We have actually extended this strategy to all of our assets. For us, our definition of an asset is any item of economic value that yields income. As such, we don't consider the apartment we live in as an asset since we don't derive any rental income from it. That being said, we do consider the mortgage as a liability since we will incur principal and interest payments.

Generally, we try to allocate target percentages to all of our assets and that's how the 40% of monthly savings gets allocated. These target percentages can change over time as you enter different phases of your life and very much reflects the priorities and economic environment at that time.

This is our current target asset allocation:

Target Emergency Cash Funds - 10%

This refers to cash holdings that we have as a buffer in the event of job loss, medical emergency etc. It provides us with stability when the economy deteriorates and the investment portfolio takes a beating. The current environment is a good example of why having emergency funds is important since you are in a better position to manage potential unemployment and the resulting loss of salary income without having to liquidate the investment portfolio. Ideally, this should cover about 6 to 12 months of your entire monthly expense.

Target Spending Cash Funds - 5%

We hold a portion of our cash holdings as spending money. This is for big-ticket items like travel (flights, hotel etc), special occasion celebrations, renovation and last minute emergencies (fines, repairs etc).

Target Investment Cash Funds - 5%

These cash holdings are for taking advantage of dips and falls in the share markets. There is a Warchest component to this, which usually refers to cash held for investment in times of severe economic duress and bear markets. The Global Financial Crisis of 2007-2008 is a good example of when a Warchest would have been useful. We generally expend some of these funds every month to consistently grow our investment portfolio. The amount we use up can vary widely depending on the share market performance in that month (usually more in bad months and less in good months).

Target Share Portfolio - 25%

You can refer to our current share portfolio here but this is the higher return & volatility equity component of our assets. The aim for the dividend yield on the share portfolio is 5%.

Target ETF Portfolio - 25%

You can refer to our current ETF portfolio here but this is the lower return & volatility component of our assets. The aim for the dividend yield on the ETF portfolio is 3%.

Target Bond/Wholesale Life Insurance Portfolio - 10%

This is the bond component of our assets and tends to grow more slowly than the equity component. We think of it as a stabiliser for our investment portfolio to reduce the impact of the wild swings we can see in the equity component at times The aim for the interest yield on the Bond/Wholesale Life Insurance Portfolio is 2%.

Target Retirement Funds - 20%

Our CPF (Singapore) and Superannuation (Australia) constitutes this portion of our assets. They also act as a bond component of our assets but we can only access the funds upon retirement. Since the contributions to CPF are mandatory, the balances should grow as long as we are employed. Given that it is possible to make voluntary contributions to CPF, use the CPF-OA for housing, use the CPF-MA for medical costs, there is a level of control over the amounts in your CPF. In any case, the aim is to grow this component in tandem with the rest of our assets. The conventional wisdom is that you should not only rely on these retirement funds as an income source when you are retired but should have other assets and income sources. However, it is still important to grow these retirement funds over time especially when you can only take the long-term approach to this.

There you have it - our target asset allocation. At the end of every month, we allocate the 40% savings to the assets that are below the target over the next month to get the percentages more aligned. For example, from early Jan to mid Feb 2016, we used up quite a bit of our investment cash funds to purchase shares and ETFs. Hence, a significant portion of our 40% savings for Feb 2016 will go into topping up the investment cash funds. The key is to increase your entire asset base by consistently pushing as much savings into it as possible.

We try to grow our assets in proportion because it facilitates the transition between different phases of our lives. Our needs and wants can change over time and we try to reflect that in our target asset allocation. We use it as a guide to prioritise our focus on various aspects of our lives and it has helped to get us to where we are. 

P&L - Expenses

There are broadly 2 types of expenses you can incur in your own Profit & Loss (P&L) statement.

Fixed Expenses

This refers to expenses that are not easily changed although it is possible to reduce them. For example - mortgage, maintenance, rent, insurance, utilities, tax etc. If you lose your job or want to start saving much more of your income, putting in the effort & time to cull your fixed expenses can be worth it. Since fixed expenses typically represent the biggest chunk of your budget, the savings can be quite substantial.

For us, our main fixed expenses are mortgage, maintenance, utilities, mobile, broadband, cable TV, whole life insurance and tax.

Variable Expenses

This refers to your daily spending decisions such as dining out, shopping etc. While most variable expenses represent discretionary spending, some variable expenses represent necessities. For example, groceries and vehicle expenditure can vary from month to month.

For us, our main variable expenses are dining at restaurants, personal care appointments, shopping, groceries, public transport and petrol.

Budgeting

This is essentially the relationship between your income and expenses. There are many ways to approach budgeting but we generally apply percentages to our fixed and variable expenses. We track our fixed expenses and try to ensure that they do not exceed 40% of our monthly income. We do not track our variable expenses in detail but try to ensure that they do not exceed 20% of our monthly income. We usually work this out at the end of each month so it acts as a guide for the next month on which areas we need to cut back on. Basically, this approach means that we save at least 40% of our monthly income. How we allocate this 40% to our emergency funds, cash for investment, cash for big-ticket spending and general savings depends on our asset allocation strategy.

Thursday, 25 February 2016

P&L - Income

In my previous post, I did mention that the first thing you should do is to get your personal finance situation in order first before focusing on investments. This is an important process since it actually determines your risk appetite and the nature of your investments. I was debating between writing about income & expenses or assets & liabilities but decided to go with the P&L aspect since it's probably more relevant on a personal level.

Profit & Loss (P&L)

I find that the accounting approach to your own personal finance situation is a good way to manage this aspect of your life. Think of it as a monthly P&L statement that eventually forms your annual P&L statement. There are 2 main components of a P&L statement - Income and Expenses.

Income

There are broadly 2 types of income you can receive.

Active income refers to income for which services have been performed. For employees like us, this is likely to be your salary, bonus, allowance etc. If you have a side venture or are self-employed, the business income will form part of your active income as well.

Passive income refers to income from enterprises in which you are not actively involved. For the majority of people, this is likely to be interest from government or corporate bond holdings and dividend from stock, fund or unit trust holdings.

Active Income

For most of us, the type of industry and job will determine a significant portion of your active income. How you navigate your career (skills development, job switch, salary negotiation etc) will largely impact the monthly active income you receive now and in the future.

You must understand the nature of your active income well, especially how stable it is. Given that you are more likely to start off with active income comprising most of your total income at the start, the key is to ensure that the source of this active income is stable and increasing over time. Whether your salary is high or not does have an impact on how long this journey to Financial Independence will be. However, the more essential point to note is that the more regular and consistent your salary is, the more it allows you to plan and work on improving your personal finance and investment situation.

Ideally, you can develop another source of active income such as from a side-venture. This can be useful in the event of job loss and any other contingencies. In fact, it's something that we are still trying to work out ourselves. We understand its importance but the effort and time needed to build it up on top of having to work can be a real buzzkill. Just have to keep trying!

Passive Income

Most people already receive some form of passive income - interest from your bank accounts. The difficult bit is to develop other sources of passive income. However, it's still important to maximise the interest earned from your bank accounts. Cash holdings for savings and investments may be idle but you should try to increase the rate of return on them, especially in a low interest rate environment like Singapore. It's surprising how many people here have no idea what is the interest rate on their bank accounts and end up earning 0.05% - 0.25% pa. It's actually possible to earn at least 1% pa on most of your cash holdings and I will write about this in future posts. My opinion is that you should learn about this bit first before going on to invest in bonds, shares, ETFs etc. At a minimum, you would have picked up valuable research & analysis skills that will be useful to your investing journey.

The other common source of passive income is rent from real property. This can be from renting out a room or the entire property. It's a highly popular source of passive income because most people can understand how to generate it. I suspect it's because we all played Monopoly when we were young and it's actually one of the earliest & significant financial education influence we were exposed to.

The last source of passive income from bonds, shares, ETFs etc is probably the hardest to pick up. It requires some level of natural interest in finding out more about these financial assets and learning about the businesses you are investing in. The time taken to monitor these investments depend largely on your strategy. However, the upfront investment of time to learn and build your portfolio will almost always be significant. Nevertheless, the payoff will be worth it as long as you have the belief to see it through.

    Wednesday, 24 February 2016

    Start Index Investing

    Where to start?

    All too often, we get caught up with our busy lives and our time is spent on work, family, leisure etc. We understand the need for personal finance and investment but seem to have no idea where to start. I usually recommend getting your personal finance stuff in order first i.e. savings accounts, credit cards etc. It's a one time exercise that ensures that you maximise the interest earned from your cash holdings and the rebates/rewards earned from credit cards spending. I will eventually post more information on how we approach our personal finance situation but thought it might be good to touch on the investment side for now. If you have already assessed your personal finance status or do not feel that it will make a difference, the next bit should be more relevant.

    How to start index investing?

    There's no point in me re-writing how to start index investing with the Standard Chartered online equities trading account. You can refer to this post from Turtle Investor for an introduction on that. What I would highlight is the need to understand the type of foreign currency settlement accounts that will need to be set up when you invest in overseas ETFs. In our case, we have the USD, GBP and EUR settlement accounts based on our selection of international ETFs.

    Since there is no minimum commission on the Standard Chartered online equities trading account, it's a good way to start building your exposure to equities in your portfolio. By investing small amounts monthly into the local equities, local bonds and international equities ETFs, it will start to accumulate over time. Once you get comfortable with the index investing strategy, you can start to increase your monthly investment amounts into the ETFs. The key is to be consistent in building up your ETF portfolio and try not to time the market by buying and selling the ETFs. This dollar cost averaging technique works well over the long run and you have to give it time to see the results.

    Passive Income

    We receive annual, bi-annual and quarterly dividends from our ETF and Share portfolios. We try to ensure that dividends are received every month based on the payment dates for the ETFs and shares. Monthly updates of the dividend income received can be found here.

    The aim is for the 2016 dividend income received to reach S$5,000 by the last update of the year.

    We receive bi-annual and monthly interest from our bond holdings and cash in savings accounts. We try to invest in Singapore corporate bonds for a higher return instead of the Singapore Savings Bonds (SSBs). We also look to maximise the interest rate on our cash holdings in Singapore and Australia. I should post information on our bonds, wholesale life policies and investment cash holdings separately. For now, I shall call it the Other Portfolio and you can find a snapshot here. Monthly updates of the interest income received from this Other Portfolio and the rest of our cash holdings can be found here.

    The aim is for the value of the Other Portfolio to reach S$150,000 by 31 Dec 2016. 

    The other aim is for the 2016 interest income received to reach S$5,000 by 31 Dec 2016.

    This will mean that the goal is for the 2016 passive income received to reach S$10,000 by the last update of the year. Again, given the 10 year timeframe for this journey to Financial Independence, it's important to have numerical goals every year to track our progress on our passive income received.

    Share Portfolio

    Our Share portfolio consists mainly of Singapore and some Australia stocks with a focus on dividend paying stocks. As mentioned in my previous post, the size of our Share portfolio is larger than the ETF portfolio as we had only recently started building up the ETF portfolio. That being said, the aim is to increase the size of the ETF portfolio until it is about the same size as the Share portfolio. Since we have decided on a bigger focus on ETF investing for our portfolio, I would think the size of the ETF portfolio should eventually outgrow that of the Share portfolio over the long term.

    I have opted not to disclose the individual stocks that we own but the industries they are in as well as the investment amounts and percentages. A snapshot of our Share portfolio can be found here.

    I will try to provide end of month updates on our Share portfolio as to the transactions we have undertaken for the month. We plan to mainly average down on our current stock holdings and possibly expand the number of stock holdings. It's already taking up quite a bit of time to monitor the performance of each of our stock holdings and increasing the number would put us at risk of losing track of their performance. The growth of the Share portfolio should be slower than that of the ETF portfolio and this is in line with our strategy to have a bigger focus on ETF investing.

    The aim is for the market value of the Share portfolio to reach S$120,000 by 31 Dec 2016. Given the 10 year timeframe for this journey to Financial Independence, it's important to have numerical goals every year to track our progress on our total portfolio.

    Tuesday, 23 February 2016

    ETF Portfolio

    The way we have constructed our ETF portfolio is such that we should have exposure to local equities, local bonds and international equities. In theory, a portfolio of 100% equities should provide the best returns for a couple of our age over the long-term. In practice, the volatility of the 100% equities portfolio can be a real test of your risk appetite. Turtle Investor has written a good post about how the ABF Singapore Bond Index Fund can act as a safe harbour during volatile times and I recommend it for an understanding of why we have it in our portfolio.

    Our ETF portfolio is smaller than our share portfolio but we intend to build it up until both portfolios are about the same size. The idea is that the ETF portfolio has a lower dividend yield & volatility but the share portfolio has a higher dividend yield & volatility. A snapshot of our ETF portfolio can be found here.

    I will try to provide end of month updates on our ETF portfolio as to the transactions we have undertaken for the month. Generally, we invest more in months where the markets are doing badly and less in months whether the markets are doing well. The aim is for the market value of the ETF portfolio to reach S$40,000 by 31 Dec 2016. I will be interested to see how our performance would be by the last update of the year.

    Choice of ETFs

    I thought about re-writing my posts but decided against it. Might as well summarise the content I have been covering so far and go forward from here. It's more fun that way! Exchange-Traded Funds (ETFs) have started to form a significant part of our investment portfolio. MoneySense has a good article on ETFs and I recommend it as an introduction to what they are. Basically, ETFs are open-ended investment funds listed and traded on a stock exchange, which track or replicate a specific index such as a stock index. Since ETFs are passively managed, their fees are usually lower than those of actively managed investment funds.

    We have selected the following ETFs for our portfolio:
    The first three ETFs are listed on the Singapore Stock Exchange (SGX) and the next eight ETFs are listed on the London Stock Exchange (LSE). The links provide information on the details and holdings of each ETF. The trading and dividend currencies of these ETFs are SGD, USD, EUR and GBP, which is a currency diversification strategy we use to reduce the foreign exchange risk of our portfolio. The holdings in some of the ETFs overlap but they largely cover the major equity markets - US, Europe (including UK), Emerging Markets and Developed Asia Pacific (including Japan). This is a global diversification strategy we use to reduce the concentration risk of our portfolio.

    Our Story

    This is my second time writing this post. My first self-hosted blog (also The Finance Smith) on Wordpress is no longer active. To be honest, I'm still not sure what I did that caused the Wordpress blog to be deleted. All I remembered doing was updating the template and the next thing I know - I had to reactivate my Wordpress login details and my blog was gone!

    Since it was a relatively new blog, I did not have that many posts on it (still, it was hours of writing!). But I didn't back up the content so I lost all those posts. Needless to say, that experience was enough to make me try Blogger. Besides, I realised I liked writing and creating content but wasn't so keen on managing my own self-hosted blog. I reckon Blogger should do fine for now. Let's see whether this blog gets deleted in a month's time. I can't keep re-starting my journey every month on a different blog!

    The About page should have information on what this blog is about and you can have a look to see what type of content you can expect to find. This post is about my background and why I started this blog. Since this is my second time writing this post, I just realised that I can refer to myself as Mr Smith and my wife as Mrs Smith. Just something interesting I thought of before having to re-introduce myself.

    My wife and I met in university while studying in Melbourne. We graduated in 2009 and worked in Melbourne from 2010 - 2011 before heading to Sydney for work from 2012 - 2013. We moved back to Singapore in 2014 and have been here ever since. We learnt basic personal finance and investment skills from living together overseas since graduating and this is probably something I will mention more in future posts.

    Having worked for a number of years, I started to wonder if it is possible to work because I want to and not because I have to. When we were living in Australia, we worked to get salary income that pays for our rent, utilities, groceries, entertainment etc. A portion of our salary income was designated as savings and another portion designated as investments. We were so caught up with building our life in Australia that we never really focused on increasing our investments.

    After our return to Singapore to get married in 2014, we started to focus much more on our personal finance and investment skills. The idea that we should not rely on our jobs as our only source of income became a goal. Hence, the aim of this blog is for me to document our journey as a couple (two working professionals) towards Financial Independence. I will write about our personal finance and investment decisions and their impact on our net worth. To hold ourselves accountable, I will try to post actual and percentage figures of our assets, liabilities, income and expenses i.e. net worth.

    As with any goal, the timeframe will shape the path I take. 10 years. That's how much time I have given us to achieve Financial Independence. By 23 February 2026, we should be in a position to work because we want to and not because we have to. This means that we should have sufficient monthly dividend and interest income to cover our monthly expenses (both discretionary and non-discretionary) without any salary income. For the second time on my blog with the same name, let's begin on this journey!=)