Tuesday, August 3, 2010

Personal financial management

A meaningful program was aired via Ai FM this morning. I'm here to share some points regarding the topic.

Just when everyone wants to be rich, they normally do not have a definitive idea of how much of a wealth or asset should they possess. In simpler term, most people in general are actually not aware of what is the eventual wealth for them to attain financial freedom. Even simpler, how much is enough? They may say they want to earn a lot of money, have big houses and cars and other luxurious materials like jewelleries and so on. This is the misconception of the group of public about being rich.

By the concept of scarcity in economics sense, the wants and needs of individuals are always unlimited as opposed to their resources (time, money, skills, etc). Having that said, ones would normally get tied up by liabilities in pursuit of the materials as the cash outflow is faster than the cash inflow.

According to the guest of the program (陈凯顺, if i got it right), financial freedom is the state when our reserved resources can self-sustain/fulfill our needs and wants without needing us to work or find the external income. That would mean that at our retirement (say 50 or 60), we can still lead a desirable lifestyle using money from savings, investments, or business for ten, twenty, thirty years or so on until we die. That would also mean that we need a substantial amount of reserved resources which can generate sufficient cash inflow by themselves. Apparently, I couldn't agree more on his perspective about being rich.

He also mentioned about a golden rule for personal financial management which says the personal income should be broken into a ratio of 2:1:1:6 as representatives for investment, kid's education, insurance, and expenses.

2 for investments including bonds, mutual funds, stocks, real estates and so on.
1 for kid's (tertiary) education fee when they finish high school, or marriage fee.
1 for insurance (to protect for emergencies that need huge sum of money)
6 for expenses including food, transportation, rental, entertainments, parents and so on.

NOTE: Prior to this income breakdown, it is important to have upfront a saving of 6-12 months of your current income so that you can cash out for emergencies or unforeseen events (i.e. out of job).

Of course this is just one of the example out of so many strategies to personal financial management out there. And different individuals have their own constraints and situations to which they are bound within, and thus need different strategies to go about it. The key point to make here is that it is important to learn about it EARLY, execute it EARLY and probably do a review from time to time. Why bother to start EARLY? Well, simply we want to take advantage of the compounding, a process of generating earning on an asset's reinvested earning.

Being the greatest mathematical discovery of all time (quoted by Albert Einstein), here is how the compound interest works the magics. The formula is:

[Future worth = capital x 1.06^n], where n is number of yrs;

Take 6% interest rate and capital as 10,000, then:

n= 1, thus FW = 10,000 x 1.06^1 = 10,600
n=5, thus FW = 10, 000 x 1.06^5 = 13,382.26
n=10, thus FW = 10, 000 x 1.06^10 = 17908,48
n=20, thus FW = 10, 000 x 1.06^20 = 32,0271.35
n=30, thus FW = 10,000 x 1.06^30 = 57,434,91

If one is to plot it in graph, one can see that the graph accelerates fast with increase in the number of years. It takes reinvestment of earning and time, therefore it's critical to start it early.

Back to the Ai FM program, I find it very insightful and particularly useful for ones who are "green" about personal financial investment. Indeed an excellent program.

The final words of wisdom from the guest: ones may earn less but financial freedom is absolutely achievable by having a good financial management. Ones who earn a lot but may remain money slave forever if they do not manage their wealth properly.

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