Tips from a financial planner

Rajen Devadason, a Securities Commission-licensed financial planner with MAAKL Mutual Bhd provides some insight to three key questions on financial management. He is also CEO of corporate mentoring consultancy RD WealthCreation Sdn Bhd.

Given the growing uncertainty globally and rising inflation, what would you recommend investors to do with their money?

Three things manage your money better, delay your retirement and work your money harder.

Rajen Devadason

When it comes to managing money better, mature adults might consider going down the do-it-yourself (D-I-Y) route through extensive personal reading and studying, or choose to hire a financial planner.

A good place to begin the vetting process would be the CFP (Certified Financial Planners directory of the Financial Planning Association of Malaysia //www.fpam.org.my/fpam/cfp-directory/list-of-featured-cfps/)

Those who opt for the D-I-Y route should begin by getting a handle on their personal net worth statement and personal cashflow statement.

For younger Malaysians who wish to learn how to manage their money better, there is a brand new, free educational initiative launched by Bank Negara and run by its agency, Agensi Kaunseling dan Pengurusan Kredit called POWER! managing your debts effectively.

When it comes to delaying personal retirement, the reason is easy to comprehend. Our lifespan can be represented by a long ruler. Those who are middle aged, are at about the mid-point of that ruler, let's call it point A. The point at which we retire is some distance to the right of where we are now, we'll call that point R. Our life in full retirement is represented by the remaining distance between R and the end of our time on earth, which I'll call point D.

If we delay retirement, we increase the distance between A and R, thus raising our lifetime's total active earnings. This will translate into more money to last through a reduced time period, represented by the new point R and the unchanged point D.

Finally, in terms of working our money harder, we need to figure out a way to grow more aggressively our initially unspent ringgit to stay ahead of inflation's erosion of our future purchasing power.

Given the surge in prices of several asset classes last year such as property, emerging market currencies and equities, should people continue to put their money in these portfolios or should they look elsewhere?

Blind diversification can lead to unwise over-diversification. This can result in what legendary fund manager Peter Lynch referred to as “diworseification” in his excellent 1989 investment classic One Up on Wall Street.

Intelligent diversification on the part of smart retail investors should mirror the route taken by the most economically successful individuals. We should aim to follow the leaders in this game of wealth accumulation.

In the annual World Wealth Report published each June by Capgemini and Merrill Lynch Wealth Management, there is an analysis of where the world's richest individuals invest.

The five asset classes listed are cash, fixed income, investment real estate, equities and alternative investments.

According to the latest (June 2010) report, the projected breakdown of high net worth individuals' financial assets for 2011 is 13% cash, 31% fixed income, 35% equities, 14% investment real estate, and 8% alternative investments (a catch-all category that includes structured products, hedge funds, foreign currency, commodities, private equity and venture capital).

Two reasons for food and fuel inflation are supply constraints and debased currency. In my opinion, the bigger reason of the two is the ongoing, seemingly unstoppable, gradual erosion of the true purchasing power of fiat currency, which is the type of paper money the entire world is awash with.

Whether we're talking about the greenback, euro, yen, sterling or even our very own ringgit, what we call “money” nowadays is fiat currency, which is money that is backed by nothing other than general confidence in whichever government issues the currency.

In the evolution of money, mankind has moved through the barter system to commodity money (where coins made from precious metals like silver and gold were used) to representative money (where a certain amount of a precious metal backed each currency note) to today's fiat money.

As such, wise investors should brace themselves for extreme volatility in different investment markets this year. Those who arrange their affairs to always have some cash at hand will be able to react best of all meaning most profitably when short-term price collapses take place.

The key to success is dynamic asset reallocation that permits us to effectively buy low and sell high among the various asset classes we choose to populate our personal portfolios.

Furthermore, over the very long term, the single best major asset class of all has been equities. Since equities represent business ownership and since the capitalist free-market system is the best man-made economic system humanity has ever come up with to create wealth, it seems to me that even in the future, equities will reign supreme but only over the very long term.

My advice, therefore, is always have some equity exposure, either directly in stocks or indirectly through well-chosen, well-managed unit trust funds, in any serious wealth accumulation programme.

I also like commodities, both hard and soft, because of the ongoing debasement of fiat currency and the inexorable growth of our planet's human population. There are now 6.9 billion people alive. Later this year, that should cross seven billion.

Within that context, commodities represent the very “stuff of life” that we need to feed, clothe, warm and move ourselves.

Finally, as Malaysia continues to prosper, the opportunities available in judiciously selected investment properties should be excellent. However, for those who either don't have enough money or interest in real estate or to buy directly owned rental property, purchasing well selected listed REITs or REIT funds is a safer option.

Although I continue to have bond fund exposure in my own portfolio, the expected exported inflation from the West to the emerging markets through repeated rounds of quantitative easing (printing yet more fiat money) will mean interest rates in Asia will continue to rise throughout 2011 to counteract those inflationary moves.

Since bond prices move inversely to interest rate movements, my view on fixed income products this year is somewhat muted.

Also, 2011 will be volatile, possibly further exacerbated by waves of dissent throughout the Middle East.

As such, those smart investors who retain sufficient levels of cash to take advantage of short-term dips in the equity, commodity and property markets, in particular, possibly caused by hot money suddenly leaving a sector or entire region, will do especially well.

If someone has extra cash, should he or she balance the ledgers by cutting down household debt or should they stomach the debt given the low interest rates?

As someone who has had to battle with excessive credit card debt twice in my life, I'm strongly inclined to advise my clients and your readers to focus on paying down as much bad debt as possible.

Bad debt is spent on direct consumption (such as charging new clothes and fancy meals on credit cards that are NOT paid off in full each month) or incurred purchasing bad assets that go down in value over time.

There is no reason for the financially savvy to worry too much about paying off good debt, which by definition is debt taken on to purchase good assets that appreciate in value over time or that cause more cash to flow in to us than flows out from us for repayments on the good debt.

It is also good discipline to use at least a small portion of extra cash and a predetermined slice of regular income to flow into a long-term savings and investment portfolio.

That portfolio, to begin with, should focus on bank savings and bank fixed deposits.

After that, additional savings can be allocated into money market funds. As the level of sophistication of a new saver-investor grows, a dollar-cost averaging programme into a well selected portfolio of equity funds ranging from domestic funds to international funds, right now focusing on China, Indonesia and the entire Pacific region, should result in excellent long-term returns, over periods of a decade or more, that stay ahead of inflation.