IPP Financial Advisers Senior Financial Service Manager Alex Ang shares how financial consultants can help clients determine what are the most important factors to consider when revising financial plans that help clients prosper during an economic downturn.
By Alex Ang
Despite Singapore’s push for greater financial literacy and nurturing a financially well-informed population, many young people still hold the perception that financial planning is not for them. I’ve spoken to many young adults, amongst them are those just embarking on their careers. The general perception is that financial planning is a topic for those mid-way into their career and have deeper pockets, or for those in their fifties and just years away from retiring.
They often opine that it’s too early to learn about financial literacy and from their perspective, it is easy to see why they think so as graduation is still fresh in their minds and their career had just taken off. Retirement seems like abstract topic that happens decades later.
However, the truth is that retirement makes up only a portion of financial planning and taking early steps towards proper financial planning helps them secure their financial future. For example, it is immensely crucial for ensuring that they have sufficient funds for when they buy their first home which could be as soon as one, two years later.
At an age with relatively few financial commitments, it is the perfect time to maximise savings to build up capital for future investments.
I would always tell my clients that the younger you are when you develop your financial strategy for your future, the easier it is to achieve your goals.
How to kickstart this journey with younger clients
I have observed that younger clients tend to be less financially savvy than more matured clients, with them, it is starting from ground zero; a clean slate for building a robust financial foundation.
Firstly, it is crucial to assist them in ranking their financial objectives, priorities and goals. Typically, their top priority is to grow their savings as they are only just earning money. For good measure, I would also do a cashflow analysis by going through a comprehensive income & expenditure statement to spotlight areas where saving habits can be improved.
Secondly, to ensure our younger clients can tide over unforeseen circumstances suchlike covid-19 as well as unexpected job retrenchment, I will always strongly recommend my clients build up a reserve of funds for emergencies equivalent to 3-6 months of their monthly expenses.
Thirdly, forming the foundation for any financial plan will always take a bottom-up approach that starts with Protection (which includes hospitalisation cover with rider), Savings and lastly, Investment.
I often use three main concepts to break down the benefits of early financial planning: holding out in the stock market, the power of compounding interest, and lastly, the rule of 72.
These concepts are relatively easy to understand and accessible to all clients regardless of their financial knowledge and experience.
Holding out in the stock market
Since the 1970s, the world has suffered multiples crises and periods of difficult turmoil that have hit financial markets with massive sell-offs. There was the oil crisis, Black Monday, the Gulf war, Dot-com bubble, 9/11, the subprime mortgage crisis, the European debt crisis, Brexit, Covid-19, among others. Over and over again, we saw periods of economic instability and crises that caused thousands of investors to panic and rush to sell their assets at the low. Many were frightened at the thought of losing everything if they continue to stay put with their holdings.
Yet if an investor had put a dollar into the global equities in 1970 and kept it through all these catastrophes, that dollar would have multiplied 59 times by end of 2017. No matter what happened or how bad things seemed to be at any crisis, the financial market will always be recovered and subsequently rose even higher. All an investor had to do was wait.
As acclaimed investor Warren Buffett once said, “The stock market is a device or transferring money from the impatient to patient.” Thus, with a longer time horizon, it enables a person to be more patient as well. Starting early also means you will be required to save less to get better financial results in future.
The Power of Compounding Interest
To help my clients grasp the concept of compounding interest, I would share with them how investing early allows one to grow their money faster and, more importantly, with a smaller investment amount.
What does this mean? Imagine a person with a time period of 30 years to accumulate USD 1million vs another person with 20 years to accumulate USD 1million, often a time, the person with shorter time horizon to accumulate USD 1million will face a steeper uphill journey in saving up for retirement.
Let’s consider an example. John is an early starter, who invested his first dollar ten years before Steve. Steve has put off investing for ten years before finally making his first investment.
Assuming both invest USD 1,000 monthly at 5% ROI (Return of Investment) per annual, at the end of 30 years, John would have made USD 420,497 versus Steve who would make USD 416,631. What’s also important to note is that Steve who had to shell out USD 240,000 over 20 years – twice the investment capital of John.
John only needed to invest USD 120,000 over ten years. After the first ten years, John had stopped putting in new money and allowed the initial investment and capital gains to continue growing.
Even 20 years of ‘late and more work’ is not enough to make up for the lost time.
A question you can ask your clients is whether they are aware the time it takes to double their money in a bank account which gives 0.125%.
Using the Rule 72, we would be able to share that it takes approximately 572 years.
A widely used formula around the world for investment purposes, Rule 72 is a mathematical formula to estimate the number of years required to double your money at a given interest rate. It is a useful way of explaining the effect of compounding interest.
Applying Rule 72 to Fixed Deposits at an Average Annual Return of 0.8%, it will take 90 years for your investment to double.
For Endowments, at a 3.5% AAR, it will take 21 years.
And you’ll see that for Shares or Equity Unit Trust (6% AAR), it would take just 12 years for your investment to double.
As you can see, it provides an honest, eye-opener way of understanding this effect.
Financial planning is essential to ensure that you maintain and grow your financial wealth over time. Your financial consultant should work with you to help optimise your income and savings efficiently to help you reach your financial goals even as your priorities change. Smart financial planning will not only provide financial security for you and your loved ones throughout your life and through retirement, but also ensure that you leave an enduring legacy for your children, your grandchildren and generations to come.
Firstly, Wealth Protection protects what they already have and their future worth. Secondly, Wealth Accumulation focuses on growing what they already have. Thirdly, Wealth Management optimises what they have. Fourthly, Wealth distribution is about passing on what they have to the right people.
During my career, I’ve observed that clients whom have built up financial literacies are more empowered to manage their money more effectively, and this helps them build a stronger foundation for retirement. And yes, the financial markets always reward long-term investors.
Just like our CPF contribution, always pay yourself first. Do not save what is left after spending, instead, spend what is left after saving. Again, to quote the wisdom of Buffet, “Someone’s sitting in the shade today because someone planted a tree a long time ago”.
(Ed. Alex Ang is a Chartered Financial Consultant and Senior Financial Service Manager at IPP Financial Advisers. Ang says he has consistently won accolades for customer service and, in his first year with IPPFA, Ang was lauded as a Top Rookie Achiever. He is now one of the Top 10 Advisors in IPPFA since 2015, and is also an 11-time qualifier of the IPP Chairman’s Roundtable and an IPP-Apex Top Advisor. Featured image by Photographer Tirachard Kumtanom.)