Step-by-Step Guide to Financial Planning
When people think about financial planning, their first response would be to avoid it because the idea of it seems complicated. Most of the people I talk to try to avoid it as much as they can until a situation arises for eg. having a baby on the way, the financial stress of feeding a new life and raising the kid till he or she is an adult, or a person somehow realizes he or she is nearing 50s to 60s and not sure if their savings are enough for them to lead a comfortable life after retirement, or the fact that the entire family is in chaos over the inheritance when a person passes on.
Contrary to what most people think, financial planning doesn't have to be complicated. There are 4 pillars to it which I will be sharing in the next few paragraphs.
The most important pillar of financial planning is to be prepared for any unforeseen circumstances; this means to have an Emergency Fund and your Health Insurance in place. This pillar is one that most people find it unimportant, but in actual fact this forms the basis of financial planning.
So what is an emergency fund? As the name suggests, it is to be utilized only in the event of an emergency such as a job retrenchment. It is advisable to allocate 6 months of their expenses for this fund and store them in a place that is liquid and easily accessible - this means not in stocks, property, fixed deposits or endowments. A high yield savings account will be good enough for this. Some avenues I often recommend to my clients are Singlife, Stashaway and Singapore Savings Bond.
When it comes to protection needs, the most important coverage is your Hospital Plan because of the hefty hospital bills in Singapore. Yes, you may think that you have a Medishield Life that can cover you - but do you know that you do need to pay a deductible and a co-insurance portion, which can come up to a sizable out-of-pocket expenses as well in the event of hospitalization? To avoid that scenario, it is advisable to get a hospital rider with any of the 7 insurers in Singapore and keep your out-of-pocket expenses to only $3000. Did you know that a simple knee joint replacement surgery on one leg can cost up to $34,000 in a private hospital? Imagine what a dent would that cause in your savings should you be lacking hospital coverage!
After this is settled, you may want to take a look at Income Replacement in the event of a disability or critical illness - which is mostly your term or a whole life coverage. While your hospital coverage takes care of your medical bills, you will still need an 'income' to take care of yourself and your dependents such as your kids or your parents - unless you have sufficient savings to cover your expenses in the long term, or you have regular income stream despite the situation. But let's be honest, do you really want to work when you're already so tired and stressed up from all the treatments? You may already have a Dependent Protection Scheme (DPS) that insures you $70,000 for Death, Disability and Terminal Illness until 65 years old, so you can take this into consideration when planning how much to be insured. Typically, the guideline to be insured for death and disability is 10x your annual income. The purpose is to ensure that your dependents will not have financial difficulties without you providing for them at least for the next ten years. For Critical Illness, the general guideline is 5x your annual income because the treatment for intermediate and late stage critical illness normally takes that long.
The next pillar of financial planning would be Wealth Accumulation. After the first pillar is taken care of, you can move towards this stage. This means making your money work harder for you so that you can reach your financial goals faster - be it owning a property, a car or your ideal retirement age.
Want to retire at 45? How much will you need to have at that point in time? Are you purely saving your money and earning a measly interest rate of 0.05% in the bank or are you investing? How much do you need to invest such that you'll accumulate this amount at this interest rate? There are many instruments out there to do so depending on your risk appetite and preference. If you are an active investor, you might want to dabble in the stock market but if you are more of a passive investor, you can consider instruments like ETFs or Mutual Funds. Many people prefer ETFs due to the low fees, but are they really better than Mutual Funds just because of this factor? If you’re super risk averse and need something capital guaranteed, you may want to look into endowment plans.
One of the things that financial advisors do is to combine a mixture of instruments to help you with different financial goals.
Moving up the pyramid, the next pillar would be Wealth Preservation. After accumulating all that wealth, you wouldn't want it to be eroded by inflation, right? Hence, wealth preservation seeks to put all this money into safe assets such as gold to preserve its value. People tend to confuse wealth preservation with wealth accumulation, but I often use the analogy of 'transferring your money in your bank account to another bank account with a higher interest rate to preserve your value'. Wealth accumulation often involves putting your money into riskier assets as opposed to wealth preservation since one involves growing your wealth, while the other involves 'storing' your wealth. Usually, we advise clients who’re at this stage to store their money into instruments like annuities or low risk dividend funds.
Last but not least is Wealth Distribution. This pillar seeks to ensure that there will be no chaos over the inheritance or assets when one departs from this world. We have all read the news and watched so many TV series where the entire family falls apart because of inheritance. By doing a will or nomination before one departs, it can prevent all these from happening, as it will be written in black and white the percentage and the assets that will be given to selected parties, instead of following the intestate law. Contrary to what most people think, you do not need to have a lawyer to do up a will. If you have any policies with a death benefit component, you can seek your advisor to do a nomination for you.
Fun fact: did you know that term plan is a popular instrument for parents or for older folks to leave behind a sum of money for their future generation?
Each of these pillars are important at different stages of our life. If you are a young working adult, wealth accumulation may be your focus as compound interest works best with a long time period. If you are a retiree or a pensioner, you may want to focus on wealth preservation because of a shorter time horizon.
If you have any questions, feel free to reach out to me on telegram @itsaurelia or join my telegram channel #AdulTINGwithAURELIA, where I share useful insights for Young Adults.
Shu Ting is a FSC with close to 2 years of experience. In her free time, she likes to do canvas painting and make song covers. You can reach her at her Instagram @chroniclesofshuting.