Posted in Investing, Liabilities and Debt, Personal finance, Savings

The Five ways to SIP

SIPIn India, the mutual fund industry has popularized this term for drip investing, dollar cost averaging or similar. The full form is “Systematic Investment Plan” and allows normal people to invest in Mutual Funds gradually and is proven to build wealth over a long time. 

For me, there is a bigger SIP in Personal Finance – Sleep in Peace. 

It may sound like RIP – but lets keep life going strong in these trying times. We will do another article on that, and in personal finance terms we will call it Retire in Peace.

SIP is a concept that is important throughout your earning and retired life, and defines a way you can manage your Personal Finance to effectively “Sleep in Peace” every night.

As we know with the current COVID-19 situation, many people are losing sleep over their financial situation.

While some can still be corrected with discipline, those following the basic principles of SIP will be unaffected by such pandemics and sail through it.

The Five components of a SIP method

1. Emergency Fund – The sleep in peace fund

The Emergency Fund is the first of SIP rules. It can be called the Sleep In Peace Fund too.

In the current situation where everything is uncertain from jobs to ability of paying mortgages and bills to medical situations, there cannot be a better cushion than possessing an emergency fund.

People who have not been able to build this fund, are now feeling the brunt of their careless handling of personal finances.

One essential comfort zone

2. No Debt – borrower is slave to the lender (there is no good debt)

In US, due to low interest rates on some loans like mortgage and auto-loans, some experts justify using leverage to build your wealth. While that may sound smart in good times, in trying times like now even a so called good debt can nosedive to a bad debt.

For example, the government is now directing banks to suspend mortgage payments (for a short period, of course), giving stimulus to real estate investors and trying to bail out or let leveraged people and businesses go down.

So greed and over-smartness with debt are now taking the sleep away from people who have bought and financed huge houses, expensive cars, invested into rental properties with no-money-down. Here are 3 situations where not having an emergency fund and being over leveraged, is disastrous now.

  • You spend more than 30% of your income in mortgage payment. If you lose your income, even the emergency fund will quickly run out paying the mortgage.
  • You bought an expensive car with bank financing and very low down payment. The auto-loans will not get any relief from Government, and your car may be repossessed in case you fail to make the payments. Also the payments could have been used in more protective ways, if the car was bought with cash in the first place.
  • You invested in rental properties with low down payment (< 20%). What happens now when many tenants are refusing to pay rent due to financial hardship or even just taking advantage of the situation (evictions are deferred now). You still need to pay the bank their share of interest and principal.

The universal truth about Dave Ramsey’s 7 baby steps

3. Do the real SIP – invest in a disciplined way

Now we come to investments and the real SIP (Systematic Investment Plan).

This process addresses two damaging financial behaviors – fear and greed.

I will not rant about the philosophy behind SIP or DRIP investing, it is pretty well known and over-emphasized in investment circles.

The advice from the legendary investor Warren Buffet applies now more than ever.

Be fearful when others are greedy, and be greedy when others are fearful. 

However in the Sleep In Peace method – be neither, irrespective of what others are doing. 

Keep investing with a plan. I have rearranged my India portfolio recently (just before the market crash) and apparently could have done better.

  • In a zeal to restructure my asset allocation, I invested a large part held in cash into the equity markets in Jan 2020. Little did I know, the markets would come crashing down in another month or two.
  • However I was not overzealous on Equity. I kept a larger part in simple fixed deposit (bank CD), so as not to go overweight in one asset class, Equity. 
  • The current market situation does not affect my peace, since the money I invested into equity markets is planned to be held for a long time (possibly till I retire). 
  • I could have done better if I remained patient and deployed it in smaller chunks over several months  – the real SIP. 

So that’s from a recent personal experience –

If you want to Sleep In Peace, invest with SIP – the systematic investment plan. 

Know yourself and your investments

4. Define and invest in your goals

No matter what is happening in the world, nothing can derail you in personal finance if you manage your finances based on your goals.

Every person has life goals like buying a house, opening a business, travelling the world, educating your children and RIP (Retire in Peace).

If you allocate your money to the various goals and keep adding to the corpus month after month in your earning years, then in trying times such as now – you have nothing to fear. Some of your goals are funded and some are in the process of getting built-up.

Just continue doing what you were doing.

The worst case scenario can be that one or two goals may need to be postponed. For example, if you were trying to retire early and lost your job or income, you may have to work longer for a few years more. But that does not completely cripple you or force you to liquidate your retirement funds.

A simple method of asset allocation

5. Pay your taxes and file your return on time

Taxes and death are certain – everything else is uncertain. 

There is no way to avoid taxes (except the legal ways to reduce or defer it – consult a CPA) and hence every personal finance system has to take into account – taxes. Not paying your due taxes and trying to be over smart, can really take your sleep away.

Whatever it takes, plan for your taxes throughout the year and pay the legitimate share to Sleep In Peace. 

In the US, Internal Revenue Service and in India, the Income Tax Department are both quite aggressive in following up with cover-ups, non-payment and mistakes. And for working professionals like me, who has to deal with both – there is no other way than honesty, prompt action and discipline in keeping track of your tax liabilities and payment obligations.

Keep your documentation up-to-date and file away returns on time to avoid major headaches.

Five components of a personal finance system

Conclusion – Ride the wave and learn something new

While this is the time for great financial worries and the clouds of a multi-year recession looming over us, there could not have been a better time for us to introspect and re-organize.

This is the time to take a hard look at your financial and other priorities in life. Locked down inside our homes, with more family time and me-only time – when is a better time to introspect and find your real dreams? 

When the world was open and running, the rush of the morning and the fatigue of the evening left little for us to think beyond the next day.

If you want to sleep in peace when all this is over, maximize this opportunity and start something new.

I am working on starting a financial coaching business where I can help people with their finances globally. What better time to serve the world than now and next few years? 

Who moved my cheese? How to deal with changes in financial plans

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Posted in Budgeting, Investing, Liabilities and Debt, Personal finance, Savings, Spending

How to manage your cash flow

A company which is listed in the stock market has to publish 3 essential financial statements.

  • The balance sheet
  • The profit and loss statement
  • The cash flow statement

Briefly, the balance sheet shows the health of the company at the reported time, profit and loss statement shows how much profit the company is making after all expenses and taxes, and the cash flow shows how the company is generating the cash from its operations as well as investments.

Free Cash Flow (FCF) is an important metric that is used by investors to evaluate the real worth of a company. 

In personal finance, while balance sheet (Your net worth) and profit and loss (how much you are making and spending) are important, managing the cash flow is key to achieve your financial goals.

In this blog, we will talk about how to manage your cash flow – no matter whether you earn a lot or earn an average paycheck.

Most people do not manage their cash flow, forget about doing a budget or any other conscious form of tracking.

At the end of the month or year, we wonder where all the money earned went.

Conventional ways of managing cash flow

There are several techniques Personal Finance experts have championed time and again.

  1. Do a budget, track every dollar. 
  2. Create an envelop for groceries, utilities, fun etc.
  3. Use separate accounts. 
  4. New automated solutions like Stash, Digit etc. 

All of these are good methods, but the problem is sticking to the discipline of maintaining it day after day, month after month.

Isn’t that boring and worrying at the same time? Few issues with these approaches are:

  • Writing down expenses every day
  • Stuffing that envelop and counting the money every time before spending
  • Keeping track of multiple accounts
  • Not knowing how much the AI driven savings app is going to deduct next month

So is there a simpler and better way?

Just like most posts in this blog, I seek simplicity and automation.

The simpler way of managing your cash flow

There are 4 goals to managing the cash flow every month.

  • Invest for the future
  • Save for the short term
  • Pay your bills 
  • Spend the rest

In fact, any wind-fall is also a one time cash flow, and can be fit into the same framework.  Lets say you got a bonus of $1000, for example, the Govt is sending a check to all Americans. And if you want to keep it simple, allocate 25% to all the 4 goals.

  • Invest $250 in your long term (retirement, child education) plans. The market is down and you can invest $250 in a mutual fund or an ETF. 
  • Save $250 for any short term goals that you have. It could be added to your monthly savings goals, towards anything like vacation, buying that new phone, or simply emergency fund. 
  • If you have consumer debt, why not allocate some to pay it off? Use $250 to pay off the highest interest or smallest balance credit card. 
  • Now you have $250 to splurge on. Buy that favorite book, order the special meal or decorate your home. 

But how do we automate and manage the cash flow every month?

  • Invest – Direct deposit investments. In fact most employers have systems to auto-deposit 401-k investments or direct deposit to your chosen brokerage firm. 
  • Save – Auto transfer to a savings account from your checking account. 
  • Pay Bills – Setup auto-pay with your credit card or debit card. Set the bill payments mostly towards beginning of the month. 
  • Spend – Use your debit card to spend – it will tell you when the money runs out. 

Once setup, the only stress you have is the last bullet, where you have to make your spending within the limits, or rather the residue after all obligations are set aside or paid off.

How it can snowball into Financial Freedom

As you get consistent with stashing money away for investing and savings, those may generate additional cash flow or assets which will come back to bolster the spending budget.

Thus cash flow is a virtuous cycle once set up the correct way. Lets take some initials and approach this from a math perspective.

  • J – Job Income
  • R – Retirement
  • I – Investment
  • S – Savings
  • B – Bills
  • E – Expense
  • P – Portfolio Income

J + P = R + I + S + B + E

I can produce P in terms of interest, dividend or rental income.

silver and gold coins

In the wealth accumulation years, the goal should be to increase J, so that I can be increased, which when invested can increase P. P is added to J and a part reinvested, saved or used.

As you reinvest P, it will generate more P till at a point, J becomes less and less important. 

This cash flow situation is called Financial Freedom.

Conclusion

We just presented a simple and fully automated cash flow management system for personal finances. It does not take much discipline and will power to stick to it, once correctly setup.

This is also explained in more detail in the post The SAFE plan – Simple, Automated, Flexible and Efficient .

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Posted in Investing, Personal finance, Savings

A simple method of asset allocation

As I started to write this post, I decided not to rant about the Corona Virus and its effects anymore. The last two posts were dedicated to the topic and frankly it is becoming a little bit weary to add to all the deluge of information and opinions on it.

Let’s look at the current situation as nothing unexpected, at least financially. Being a financial blog, let us generalize this to another black swan event, and not worry about the statistics of no. of confirmed cases vs. deaths etc.

What is a Black Swan event?

A quick Google search yields the following:

An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict. This term was popularized by Nassim Nicholas Taleb’s book “The Black Swan: The Impact of the Highly Improbable.”

Lets leave it to that and consider we are in the midst of one such situation.

The keyword in the above definition is “would be extremely difficult to predict”. 

No matter what financial experts say about the markets, about investments, using sophisticated algorithms to trade stocks, the fact remains that such events are not predictable by even the multi-PhDs of Finance.

In the beginning of 2020, most of us did not know that a black swan event is so much closer, although experts have been predicting recessionary clouds for last 2 years or more.

The effect of such an event is the havoc it can do to your savings and investments. Yes savings too, as we don’t know which banks or financial institutions will go under the water, and whether government stimulus can rescue them.

It may be a rare event so far, or some rescued in 2008 but we cannot guarantee with every black swan event. Just in Feb 2020 (when it was still normal business), a very large private bank in India went bust taking with it hundreds of thousands of dollars worth of deposits of very normal people. Ironically the bank was named “Yes” bank.

Similarly by end of March 2020, the stock and mutual fund portfolios are down 20%-50% depending on how much risky the portfolio was to begin with.

The only respite from all of this is to maintain a good asset allocation as each investment avenue has its own risks. Some of the typical risks are:

  1. Cash – Banks going down and Government struggling to insure the deposits.
  2. Stocks – Markets tumbling for an extended period of time due to economic fears.
  3. Bonds – Risk of default as even good companies’ bonds can turn into junk debt very quickly. Lot of mutual funds in India were invested into Yes Bank bonds. Long term bonds can also run into interest rate risk.
  4. Real Estate – Somewhat resilient but affected by vacancy, interest rates, unemployment.

If your finances are severely affected by this storm, how do you achieve a good asset allocation once the clouds are gone and the sun is shining again on the stock market?

KISS – Keep it simple, stupid

Its not overly complicated although some financial experts make it so. Let’s say I want to hold 25% each of the 4 asset classes and distribute my assets accordingly.

Here is a step by step method on how to achieve this. It is better done in an Excel sheet as the calculations can be automated and even graphs can be plotted, although equal allocation is easy to visualize anyway.

  • List down all your assets into one column which comprises your Net worth including your home and any other property you own.
  • Now in a second column, list the value corresponding to the asset. Be conservative, do not add any speculative value.
    • For your home, just take the equity value that you have.
    • For stocks or mutual funds, take the present value.
    • For any bond investment, take the invested value or the expected maturity value (if the term is not too long).
  • Now add 4 columns for the asset classes.
  • The chart should start to look like this. Here is a simple example of a $100,000 Net worth.

Asset Allocation Table 1

  • Now based on the asset class for each, fill the right side columns in the right proportions. For example the mutual funds  may consist of equity funds, bond funds and REIT funds in equal proportions. For each mutual fund, a look at the fund report will reveal the proportions of these asset classes that it invests in.
  • Fundrise is just an example of a private REIT that is considered real estate asset class but in paper form. It is only for illustration and I am not an affiliate of the investment fund.
  • Once you allocate the numbers to the 4 asset classes and add up each column, it will become visible how your asset allocation is skewed.Asset Allocation Table 2

 

  • A visual inspection of the numbers reveals that this portfolio is heavily skewed towards Real Estate due to the largest investment in the Home. This is true for most people, as their largest investment is their home.
  • A more vivid depiction of this can be drawn using the Excel chart.

Asset Allocation Table 3

  • How to balance it? There is no ideal asset allocation as it depends entirely on the person’s situation, age, risk appetite, goals and many other factors. It is only after this simple analysis that one should approach a financial coach or investment adviser.
  • For example, if the person (who’s portfolio we have just analyzed) is not happy with the Real Estate skew, he can allocate future investments more towards Equity or Bonds (or even Cash), than buying more real estate or paying down his mortgage aggressively.
  • Being overweight in Home Equity can mean house poor and the person will find it difficult to raise funds or access cash in times of emergency or other life goals.

Conclusion

The beauty of this asset allocation method is that in a simple exercise which takes less than 10 mins and one sheet of Excel, you can look at your entire financial picture.

  1. It gives you a quick overview of your Net worth.
  2. It gives you the current asset allocation you have.
  3. It tells you where your financial situation is vulnerable to market, liquidity or economic risks.
  4. It tells you what action you need to take (whether to sell some or boost up another) regarding the various asset classes.
  5. It directs how your future investments should be structured.

The value of this exercise is immense and a good asset allocation can let you sleep in peace when the entire world is savaged by another Black Swan event.

photo of building during daytime
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