Wednesday, March 17, 2010

10 good money habits

Tue, Jan 06, 2009

The Straits Times
By Lorna Tan
Many of us are only too glad to bid farewell to 2008, a year marked by much fear and panic resulting from the financial meltdown. Across the globe, unemployment rose, petrol prices rocketed up (before easing slightly) and house prices plummeted.

Financial experts warn of another tough year ahead.

But just because the outlook is bleak, this is no time to bury your head in the sand and hope the sun is shining again when you pull it out.

The start of any new year, let alone a year such as this, is an opportune time to dust down some of our old, longstanding financial habits, priorities and assumptions and make new resolutions.

Here are 10 good money habits to help you do just that.

1 Take stock of your cash position

The standard financial advice during ordinary times is to have sufficient cash set aside to cover at least six months of your monthly household expenses.

With the current economic downturn, having six months may not be enough, says Ms Anne Tay, OCBC Bank's vice-president of group wealth management. This is because we should cater for contingencies such as pay cuts, involuntary leave or an unexpected job loss.

Fundsupermart research manager Mah Ching Cheng suggests that a good rule of thumb is to save up to 12 months of your monthly expenditure, depending on how risk averse you are.

This means that if your monthly expenditure is $2,000, a buffer of up to $24,000 would be a good amount to keep in a deposit account.

2 Set a realistic budget

This is considered by Mr Patrick Lim, associate director of financial advisory firm PromiseLand, to be the most basic good money habit and tool to control your finances.

A realistic budget that is drawn up and adhered to will go a long way towards helping one live within one's means.

'By keeping track of where every dollar is spent, the budget shows where the money goes to and how much is left over,' he said.

In fact, why not go a step further, raise the bar and pose a personal challenge to yourself to become debt-free within a reasonable timeframe, says Alpha Financial Advisers manager Cai Zong Zhen.

Another tip is to review your budget every 12 months, or when your circumstances change, such as when you receive a windfall or inheritance, or when you have a new addition to your family.

3 Paying yourself first

A related habit to budgeting is to adopt a disciplined approach to saving.

Every month, allocate a portion your income to savings, insurance and investments to create wealth, before paying for your other expenses. Increase this portion when your income goes up, such as when you have pay increments or annual bonuses.

To up one's savings, Ms Tay recommends reducing 'wastage' in one's daily spending. For example, avoid impulse buying, dine out less and consolidate shopping trips.

'Buy in one go rather than make frequent shopping trips because you tend to spend less with fewer trips, and look for cheaper alternatives or substitute goods and services if you need to spend,' she added.

4 Start a regular savings plan

When building your liquidity, look out for regular savings plans that pay higher interest rates. Examples are the OCBC Monthly Savings Account and DBS Bank's MySavings Account.

The former allows customers to set aside monthly amounts from a minimum of $50 to a maximum of $5,000. For savings below $800, the interest rate is 1.08 per cent a year. For savings from $800 to $5,000, the interest is higher - 1.48 per cent a year. The tenure is fixed at 24 months and the rate remains unchanged during the two-year period.

Customers cannot change the monthly contribution amount once it is committed, but they can save more on an ad hoc basis. For the additional amount that they save on top of their monthly commitment, they get interest of 0.8 per cent a year instead. The full amount, including the additional savings, can be withdrawn only at the end of the 24-month period.

DBS' MySavings account offers greater flexibility in terms of the monthly savings amounts and the tenure.

Customers can choose to save a minimum of $50 to a maximum of $3,000 monthly and there is no fixed tenure, so a customer can opt to save for as long as he wants.

The interest is paid monthly. For amounts between $50 and $290, the interest is 0.45 per cent a year; for $300 to $790, it is 1 per cent; for $800 to $1,490, it is 1.2 per cent; and for $1,500 to $3,000, it is 1.5 per cent.

DBS Treasures customers, or those with at least $200,000 with the bank, enjoy higher rates of 1.3 per cent, 1.4 per cent, 1.5 per cent and 1.6 per cent respectively.

But do note that there's a penalty for withdrawal.

The monthly interest on the total balance will earn the first-tier interest rate when there is a withdrawal, a failed deduction of the monthly savings amount or if the account is closed during the month.

5 Managing your debt

This has become more important with the financial turmoil, says Ms Tay.

Her advice is to avoid using credit as people tend to spend less when using cash, since cash transactions have the psychological effect of helping to curb unnecessary expenditure, compared to 'plastic' or other non-cash transactions.

In fact, use this opportunity to calculate your debt servicing ratio. This is basically a guide to how much of your take-home pay - that is gross pay less 20 per cent employee CPF contribution and personal income taxes - is used to pay debts.

Debt payments are monthly expenses that you are committed to, such as your mortgage, car loans, personal loans or even credit card debts. A healthy debt servicing ratio - derived from debt divided by income - should be 35 per cent or less.

To put it another way, out of every $1,000 of after-tax and CPF income, you should spend $350 or less in debt repayments.

If you have to spend via credit cards, adopt the habit of paying your bills in full each month. Avoid rolling over your balance and accumulating debts at a high interest rate of 24 per cent a year.

For instance, if you have a credit card bill of $10,000, the interest payable at that rate for six months will be $1,200, plus any late finance charges you may also incur.

6 Adopt a long-term view for investments

A recent study by British insurer Aviva on savings attitudes indicated that Singaporeans have a short-term outlook of five years or less when it comes to financial planning.

The insurer advised Singaporeans not to neglect their long-term savings and investment needs when faced with the current short-term economic challenges.

Another reason to take the long view regarding investments is that the current crisis may drag on longer than expected.

Also, be aware of the possibility that you may not be able to unwind quickly to avoid suffering a loss, cautions Ms Tay.

But exactly how many years constitutes a long-term view?

Using historical data, Fundsupermart worked out the probability of getting positive returns against the number of years that investors stay invested.

The findings suggest that the longer the holding period, the higher the probability of positive returns and the greater the expected return.

Says Ms Mah: 'After studying historical probabilities using the MSCI World Index, we found that the probability of positive returns increased to 100 per cent for both the 15-year and 20-year holding periods, while there was a 96.7 per cent probability of a positive return for a 10-year holding period.'

This presents a strong case for having a longer holding period of 10 to 20 years when investing in the equity market.

7 Understand your risk appetite

This means finding the optimal asset allocation that fits your risk profile.

Asset allocation is an important factor to consider when restructuring your portfolio.

Fundsupermart recommends investors who are more conservative to hold a portfolio with 80 per cent in bonds and 20 per cent in equities. On the other hand, an investor with a more balanced risk outlook should consider holding 40 per cent in bonds and 60 per cent in equities.

Last year, bond funds outperformed equity funds. Therefore, the bond proportion of your portfolio is likely to have increased, given the crash in equity markets. As a result, rebalancing the bond and equity proportions in your portfolio to the initial weighting is necessary.

For the equity portion of the portfolio, Ms Mah recommends a core and supplementary portfolio to better control risks. The larger core portion of the portfolio consists of the more broadly diversified regional equity funds (such as the United States, Japan, Europe, Asia ex-Japan and emerging markets), and the smaller supplementary portfolio consists of narrowly focused equity funds such as single-country or sector-based funds (such as Singapore, India, China and Malaysia).

While the market was booming in 2007, you may have added a few of the higher-risk emerging market equity funds.

However, now is the time to see if it is absolutely necessary to have so many of these funds in your portfolio.

If you have five funds in your supplementary portfolio made up of individual Bric, that is Brazil, Russia, India and China equity funds, you should consider either redeeming the Bric fund or some of the single-country funds. The rationale behind this is to try to consolidate your holdings.

As you boost the number of funds in your portfolio, you are likely to see overlaps between regions or sectors. You might even find that you are overly exposed to a certain region or sector.

8 Go for low-cost and resilient funds

Fundsupermart uses three basic selection criteria for its recommended funds list. Firstly, it recommends only funds with a track record of at least three years. Secondly, it favours funds with lower expense ratios - what investors pay to the fund manager on an annual basis.

For bond funds, low expense ratios could range from 0.25 to 0.75 per cent, depending on the nature of the fund. For example, emerging market funds and high yield bond funds typically have higher expense ratios.

For equity funds, which are actively managed, a rule of thumb would be an expense ratio of 2 per cent and below.

Finally, Fundsupermart measures the fund's resiliency during a market slump. Some funds are more resilient than others during times of volatility.

To identify resilient funds, it scores them by looking at their performances during different time periods. For example, if they held up well in comparison to their competitors during periods such as the Asian financial crisis, the technology bubble or the current global financial crisis, they will be scored higher.

According to Ms Mah, two funds - First State Dividend Advantage and Aberdeen Pacific Equity - are relatively resilient in contrast to their peers and the expense ratio is below 2 per cent in the last reported annual reports.

9 Contribute to the Supplementary Retirement Scheme

The main purpose of the SRS account is to provide disciplined savings to accumulate funds for your golden years. It also helps cut your personal income tax, as you can claim tax relief on your SRS contributions, up to the maximum annual sum of $11,475.

The contributions may be used to buy various approved investment instruments and the returns are accumulated tax-free. You can open an SRS account at branches of DBS, OCBC Bank and United Overseas Bank.

However, do note that withdrawals from your SRS account before the retirement age of 62 is subject to tax and incur a penalty of 5 per cent.

After the retirement age, withdrawals from SRS are still subject to personal income tax, but one can choose to spread the withdrawals over 10 years, and only 50 per cent of the withdrawals will be taxable.

This means that a retiree who has no other income at the age of 62 will be paying zero or very low tax when he withdraws his SRS funds as he will fall under a low tax bracket. This reduces tax payable since it is a deferred tax scheme. At 50 per cent tax savings, SRS funds that are withdrawn over 10 years will incur zero tax if the chargeable amount for tax computation is less than $20,000.

It is too late to contribute to SRS to enjoy the tax relief on last year's income but you have the whole year ahead of you to do so for this year's income.

10 Pick robust stocks

In current market conditions, it is essential to understand one's investment timeframe and objectives.

Equally important is the selection of stocks that will meet one's investment goals, says Ms Carmen Lee, head of OCBC Investment Research.

As market conditions are still fairly volatile, risks will continue to prevail. For investors with a lower risk appetite, it is advisable to invest in blue-chip companies with established business track records and sustainable business models. This is vital in recessionary market conditions, as it means that the organisation will have the right business models to ride out difficult times.

Examples of blue chips are SingTel, M1, StarHub, SembCorp Marine, Singapore Press Holdings (SPH) and Straits Asia Resources. Other stock picks by Ms Lee include Ezra, Midas, Tat Hong, Pacific Andes and Sino-Environment.

Companies that have been through a few business cycles are also better equipped to understand and deal with the challenges in a downturn. A good case to bear in mind is the Internet bubble in 2000-2001. Several high-profile Internet companies that mushroomed during that period are no longer in existence.

Another factor to watch out for is the management of firms, since they are the drivers and executors of the business, says DMG & Partners head of research Terence Wong.

It is important for the company to have a strong balance sheet and cash flows. Valuations tell you whether the stock is worth investing in. The company may have the best fundamentals in the market, but if it is overpriced, it is not worth investing in. Look at ratios like price-to-earnings or price-to-book and compare these guides to share values with industry averages.

Looking ahead, Mr Wong believes markets are likely to get worse before recovering, as the reality of job losses, pay cuts and less-than-stellar economic figures hit home.

'In the near term, it is best to invest in some defensive plays such as SPH, StarHub and ST Engineering, while investors with a longer-term horizon can look at economic bellwethers, as they will be the first to pick up,' he says.

'Don't be surprised if the stock market decouples from the real economy in 2009 and shoots up towards the later part of the year. The Straits Times Index made powerful runs in 1998 and 2003, two of the worst years for the Singapore economy over the past decade.'

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