Are you aware that money comes in various colours. Money uses can be segmented into four different types. In this article, Dr. Jeffrey Chiew talks about the four Colours of Money.
The FIRST type is SERIOUS MONEY
Serious money is money to be used for serious needs such as education, retirement, medical expenses, long term care and others.
In this type of money, we are not too concerned with a high rate of return but a fair rate of return and at the time when it is needed most.
Typically, the financial products used for this kind of purpose are life insurance, annuities, endowment, medical plans, education policies and fixed income securities.
Most financial planners would likely to recommend tax exempted products such as insurance and annuities because of the tax advantages and its self completing features.
By self-completing, it simply means the fund would be there irrespective whether the payer (the person paying the premium) meets one of life contingences such as death, disability or critical illnesses.
The SECOND type is BORROWED MONEY
Some examples of borrowed money are credit card expenses or bank overdrafts. Most financial planners would recommend the repayment of credit card outstanding amount because of the high interest charges. For instance, it does not make sense for a person to put, say USD15,000 in fixed deposit earning 3% interest per annum and paying interest of about 15% per annum in credit card and outstanding amount.
If you have to borrow money, then the total returns from that investment must be sufficiently high to cover the cost of funds. Since most overdrafts are on free floating rate, a margin must be provided in the event that the interest rate rises.
The THIRD type is LEVERAGE MONEY
Leverage money is typically found in investments such as properties. For example, when a purchaser buys a house, he usually puts in 20% of the house purchase price and borrowed 80% from a financial institution.
When such a situation arises, then the purchaser is said to be using leverage money. Leverage money is simply using a small amount of money to acquire a large asset. As such the total returns must be sufficiently attractive before an intelligent purchaser uses leverage money. By total returns, I am not just referring to rental income but also capital appreciation and tax savings, if applicable.
The FOURTH type is IDLE MONEY
Most Filipinos put too much money into their bank accounts. Unfortunately, for many depositors, safe investments does not mean profitable investments. With the current low interest regime, most bank deposits are earning interest rate of about 4% per annum. It would certainly not be a good hedge against inflation, more so if your personal lifestyle is in the medium to high spectrum. Usually, financial planners add a premium on personal inflation rate.
CPI Inflation Rate + Lifestyle Inflation Rate = Personal Inflation Rate.
The CPI stands for Consumer Price Index. The reality, in an affluent society, is that we consume more than the basic “basket of goods”. Thus, if one uses imported luxury items, or is funding a child education overseas, then he should costs in a lifestyle inflation rate.
So, if it is not that great to put money in bank deposits, what would be an appropriate amount. Financial planners agreed that 6 months of annual income would be sufficient for Emergency Fund and the rest should be invested. What investment classes would you invest would depends on your risk profile.
Generally, investors are divided into THREE Categories:
The FIRST group is Risk Conservative. They typically do not like to take risk and invest in very sound instruments such as fixed deposits and similar line of investments.
The SECOND group is Risk Moderate. They are willing to take some risks for higher returns. They may invest in some equities such as through unit trust or investment linked products. If they purchase stocks they are likely to go for the blue chips.
The THIRD group is Risk Aggressive. They are adventurous and usually willing to take risks by investing in speculating stocks and businesses.
The general rule of investment is the higher the risk, the higher the return and the lower the risk the lower the return.
If you do not have money to invest, you are probably a poor saver. To be a good saver, you need to have a proper mindset towards money management.
Most people believe that:
INCOME – EXPENSES = SAVING
If you have this type of mindset, you will probably be not saving very much or even none at all. Most people after receiving their incomes proceed to pay off their expenses and thus have very little to save.
A powerful concept towards saving is:
INCOME – SAVING = EXPENSES +
Let say, you want to save 15% of your income, the first thing you need to do is to put the 15% into a saving vehicle (preferably compulsion or semi-compulsion) before you pay off your expenses. That way, you would be able to accumulate a nest-egg for meeting certain life events that you have planned. One very good example of income minus
saving equal expenses is the Hong Kong Mandatory Provident Fund , Singapore Central Provident Fund and the Malaysian Employees Provident Fund. It is so powerful that it usually accumulate to quite a significant amount for most people. Try it, it works like magic.
|Dr. Jefferey Chiew
ChFC, CLU, CFP, RFP,Malaysia, RFC, LUTCF, CIAM, DBA
Author of Best-Seller, The Millionaire Formula
Asia Chairman - International Association of Registered Financial Consultants