The Physics of Personal Finance

Here's an article written by Efren L. Cruz, stating how managing your personal finance is like riding a bike!
Read on ...


Have you ever wondered what keeps you upright when riding a bicycle? A bike remain upright when it is steered. Please note, also, that the faster the bike is moving forward, the smaller inputs need to be in order to balance the bike.
Applying sound personal finance is much the same as riding and balancing a bike. In life, we want to get from point A, say a situation where money is scarce, to point B where abundance of money allows us to focus on the more important things in life.

For a safe ride, however, you need to know how to balance your bike in much the same way as you balance your finances. Things like unnecessary spending, low income, poor saving habits, wrong investments, bad advice, greed, and fear can throw us off balance much like the cyclist. It is, therefore, critical to maintain that financial balance.

One way to make it easier to do that is to have forward motion, just like with a bicycle. And what is the most practical way of attaining enough of this forward and sustainable motion? The answer is investing. My apologies to Cebu Pacific for paraphrasing their slogan, "It's time every Juan flies." But indeed, it is high time that every Juan invests as well.

Before we continue, let me make it clear that investing is not all about making money. Investing is all about making the future more affordable, of attaining that forward and sustainable motion. In fact, if you relate investing to corporate activity, no corporation has stated "making money" its mission or vision. The same should be true for the individual.

Suppose you are 40 years old now and you want to enjoy a 20-year retirement period upon reaching the age of 60. Let's assume that your total retirement expenses will amount to Php500,000 per year using today's pesos. With an inflation rate of 6%p.a., the total future value cost of your 20-year retirement would be over P64 million. If you have only P1 million in savings at the present time, you would need to save roughly P263,000 a month for the next 240 months ([60years old-40years] x 12 months in a year) to arrive at your P64 million at age 60. However, if you were to rely solely on your P1 million by investing it now, you would need to make it earn just over 23%p.a. Add P10,000 a month to your investments for the next 240 months and your required return goes down to 18.5%p.a.

Of course, earning 18.5%p.a. is very tough, especially in this current era of low interest rates. This is why investing in non-guaranteed investments like bonds, stocks, and even in your own business makes all the more sense. The risk is higher, but so are the returns. To a certain extent, putting your money in more risky investments becomes a necessity. You may want the safety of ordinary bank products like time deposits. But, if the net return to you of these products is lower than the inflation rate, you are better off consuming than saving or investing.
Yet, how can you mitigate the risks with non-guaranteed investments? Simple. Just observe the following rules of investing:
1. Assess your risk and return preference.
2. Do an inventory of your resources, which include Size of funds, Expertise and Time or what I would call
the SET rule.
3. Search for investments and/or businesses that will match your answers to #s 1 and 2.
4. Form a portfolio of investments and/or businesses (don't just put all your eggs in one basket).
5. Monitor and review your performance regularly.

Just as an added note, if under the SET rule, you may find that you don't have much money to invest, you may opt for pooled funds like mutual funds and unit investment trust funds. With a mutual fund, for example, all you need is P5,000 or $100 to open an account. If you have the money but lack the expertise or the time, you may opt to hire financial advisers. If you have all of the requirements under the SET rule, then you can go straight to the markets and do your investing yourself.

Going back to the humble bicycle, we know that once we learn that skill of riding a bike, it would be difficult to forget it. Similarly, learn personal finance. Once you get the hang of it, you will remember it for the rest of your life. Cheers to you, Juan.

Efren Ll. Cruz is a registered financial planner with the RFPI USA. He is author of the bestselling books, “Pwede Na! The Complete Pinoy Guide to Personal Finance” and “Pwede Na! The Complete Pinoy Guide to Retirement & Estate Planiing”.


Related Posts Plugin for WordPress, Blogger...

Related Articles: