Are Your Debts Good or Bad?

Debt is like a double-edged sword. It can help you, but it can harm you too. Making good use of debt can create wealth for you, but mishandle it and you can possibly be put into bankruptcy.

Therefore, we should learn how to use debt wisely to let our money grow. Debts can be classified as bad debts and good debts. Here’s a table showing annual interest rates of various types of loans currently:

CURRENT INTEREST RATES FOR VARIOUS LOANS
Type of Loan Interest Rate
Mortgage 1.8% – 3.75%
Education 4.6%
Car 5%
Renovation 5% – 7%
Personal Unsecured 14%
SME Unsecured 5% – 10%
Credit Card 24%

Bad Debt

bad debt

What types of debt should be considered bad? Any expense-related debts can be classified as bad. Examples include taking a loan for travel and taking up a hire purchase with interest for your home furniture.

This is because the value of these purchased goods usually drop after you purchase them. For example, after getting a new TV at $3,000 hire purchase, the value of it drops by $500 in the following month.

Another popular form of debt comes from something almost all of us use – credit cards. If used smartly, credit cards can help us enjoy discounts and savings when we make purchases from relevant merchants. On top of that, it allows us to carry less cash in our wallets and makes payment convenient. However, if you were to delay your credit card debt repayments, the interest payment can be as high as 24%. Let’s say a person has just charged $10,000 to his/her credit card today and defaults on his/her repayments for the next 3 years. Based on the rule of 72, the total debt would have grown twice the size 3 years later. Yes, that’s a whopping $20,000!

Therefore, please think twice before you use your credit cards or when taking up bad debts. You may land yourself in huge financial trouble if you fail to make repayments on time.

Good Debt

mortgage

A loan that helps you to acquire an asset which can potentially earn a higher rate of return than the loan interest rate can be classified as a good debt.

Mortgage and business loans are examples of good debt. In fact, the interest rate on mortgage is the lowest among different types of loans which we can get. Although a HDB Housing Loan is at 2.6% per annum currently, you can potentially earn a higher yield if your house is timely sold in the future. At the same time, CPF Board credits a return of 2.5% per annum into our CPF Ordinary Account (CPFOA). This means that your HDB Housing Loan interest is offset to 0.1% annually.

Many successful entrepreneurs have also benefited from the use of good debt. Through the use of business loans, small enterprises are able to expand their businesses. Large companies are able to grow even bigger.

Another example of good debt is your education loan. The knowledge gained through your education allows you to acquire a good job and earn living. It is definitely a worthwhile investment.

In summary, leveraging on good debts to grow your wealth is one of the important principles to growing rich.

Be careful not to over-borrow

Here’s a warning – do not over-borrow, as you may get yourself into trouble. How do we ensure then, that we do not over-borrow?

Your monthly debt repayments should not add up to more than 35% of your monthly salary. If your monthly salary is $4,000, then your monthly debt commitment should not exceed $1,400.

Avoid bad debts and use good debts smartly – this is a sure way to create great wealth for yourself.

Manage Your Wealth Like a Football Team

Just like managing a football team, managing your wealth properly requires a good team of players in 3 departments – defence, midfield and forwards.

In a game of football, let’s imagine if we have a team with a great goalkeeper and defenders but without strong forwards, will we be able to win? Well, the best possible result may perhaps be just a draw. In reality, when it comes to managing wealth, many people have made the mistake of being too conservative.

footballA dangerous thought which they have is keeping all of their savings in their bank accounts, assuming it is the most reliable way to make their money grow. However, they have forgotten the fact that bank interest rates can never keep up with the pace of inflation. Over a long period, the savings of these people will diminish in terms of purchasing power.

On another hand, can a football team do without a dependable goalkeeper and defence? The answer is certainly no. When facing the fierce attacks of an opponent, a team with a weak defence will be in shambles and suffer terribly. Similarly, without proper insurance cover to protect our wealth, if any disaster strikes, a rich man can very quickly become a poor man. Therefore, just like managing a football team, managing your wealth properly requires a good team of players in 3 departments – defence, midfield and forwards. With this analogy, let’s look at these 3 departments in wealth management.

1. Defence: Emergency Fund & Insurance

As the saying “Saving for a rainy day” goes, we should aim to keep an emergency fund of 3 to 6 times of our monthly expenses. This sum of cash will come in handy when events like a salary cut or retrenchment happens. For this emergency fund, we can save our money in bank savings accounts, fixed deposits or money market funds.

At the same time, we should also purchase insurance. For instance, hospitalisation insurance covers your medical bills in case of an accident or critical illness. Surgical fees can amount to over tens of thousands of dollars, and treatment for long-term illnesses such as kidney dialysis can cost more than $20,000 annually. With adequate protection, it gives you a peace of mind that unforeseen circumstances are prepared for. To understand your insurance needs, you can refer to an earlier post here.

2. Midfield: Endowment and Moderate Risk Investments for the Mid-Term

A strong midfielder has to be able to support the forwards and help out in defence. You can think of putting your money in investment instruments with moderate risks, such as savings endowment policies and balanced funds which invests in a mix of fixed-income (bonds) and equity, some with a larger portion in bonds. Alternatively, you can set aside a pre-determined amount to invest every month in global funds. This strategy of dollar cost averaging can help your money grow in the mid-term.

3. Forwards: High Yield Investments

With a solid defence and reliable midfield, if you have a surplus of cash and wish to grow it, you can put your money in investments with high returns and high risks. Such investments include real estate, stocks, currencies or sector funds. For those of you who actively keeps an eye on the stock market, you should have a super-sub forward – an opportunity fund. Every crisis comes with an opportunity. Whenever there is a global stock market recession, we are presented with an opportunity to buy stocks at very low prices, like it were the Great Singapore Sale. If you had bought DBS shares in early 2009 when the price was $7 per share, you can sell them off at $16 per share now and earn a huge profit.

Here’s to your financial success by managing your money just like a football team, or for the matter, any other team sports which requires a defence, midfield and forwards.

4 Smart Steps to Financial Freedom

Financial freedom is defined as the state of not having to work actively and be able to sustain a desirable lifestyle. You will have the ability to make choices, to spend time with your family and loved ones, to travel the world or to pursue a lifelong interest which you haven’t been able to. All these can be done without worrying about money. Read on to find out what are some steps which you can take in your pursuit of financial freedom.

1. Create a budget

budgeting

If you are earning an average annual income of $50,000, in 35 working years you will earn a total of $1.75 million in today’s dollars. If inflation averages 3%, this becomes $3 million. But how much are you likely to save? Some people may say, “If I earn more in future than what I get now, I will be fine.” But in reality, this is easier said than done.

Whether we earn $2,000 per month or $20,000 per month, we ALL have a problem with saving money. The more we earn, the more we tend to spend. People who have worked for at least a few years can testify to that. Some fresh graduates earn about $3,000 per month. Three years into the workforce, some of them draw as much as $5,000 to $6,000 per month. Guess what? They feel poorer than they first started out. This is naturally so when you have multiple credit card bills, a car loan to service, a family to support, gym membership fees and many other expenses.

Therefore, it is wise to do a monthly cash flow budget, so that you know where your money goes. It is perhaps the first step to finding the extra dollars for saving and investment.

2. Protect your family and yourself

Our government consistently sets aside 20% of national budget on defence. Without a doubt, protection is of utmost importance. Isn’t it only appropriate that we allocate 5% to 10% of our income to defend against untoward circumstances?

Once you have set aside an emergency fund of 3 to 6 months of your living expenses, you should get down to taking care of your protection needs. This essentially means insuring You, because You are your greatest asset. We should be buying as little insurance as you need. But for most people, these protection needs are quite a lot.

3. Live well below your means

frugal

Being frugal is the fundamental of wealth building. Yet, too often, we have the false impression that all millionaires lead an extravagant lifestyle, which is exactly opposite from the truth! People whom I talk to who are financially carefree are usually living well below their income. They still pamper themselves with the occasional indulgence and frequent holidays. But trust me, these people do their sums.

You should always discuss with your spouse on both your spending habits and hopefully arrive at a consensus. A couple cannot accumulate wealth if one of them is a spendthrift. Few can sustain lavish habits and simultaneously build wealth. Singaporeans generally build wealth by keeping a tight budget and controlling their expenses.

Remember, “The lower your lifestyle, the greater your true wealth”. How so? Say A earns $50,000 a year, spends $20,000 in a year and has $200,000 in saving. B earns $300,000 a year and spends $250,000 in a year and has $1.5m in saving. A is wealthier than B because if both of them lose their income, A can survive for 10 years based on his saving of $200,000 whereas B can only live for 6 years. Wealth is the duration your savings can last based on the lifestyle you are used to if you stop work now.

4. Don’t plan to save cash

Look at your monthly budget. You should have $600 left over every month and save $7,200 a year but where is the money? From my experience, Singaporean can’t save cash, or they simply save only to spend it all later. These folks faithfully put aside $600 every month, only to wipe it all off with a long December holiday. Some prefer to splurge on furniture and electronic gadgets, others on cars and home renovations. The money disappears naturally.

A typical Singaporean worker’s mindset is “I work so hard so I need to spend money to pamper myself.” Notice the logic, work hard and spend hard, work harder and spend harder. The only solution to this vicious cycle is to ensure that you have some form of disciplined and regular savings to help you set aside a certain percentage of your income every month.

Some practical tips are listed below:

  • Get yourself started in a profit participating insurance policy, variable life policy or “Buy Term and Invest the Difference”. Just get started on “something” and see it through!
  • Be persistent in setting aside at least 10-15% of your income every month; never waiver in this.
  • Immediately invest or allocate any unexpected windfall you receive, like a bigger than usual bonus. Chuck it away before you spend it away.