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Tuesday, September 22, 2015

Should I Invest Or Insure? (Part Two)

In the previous post, I discussed two factors to help you decide whether to invest or insure. We continue with a discussion of the other three factors mentioned. Do remember that there are other considerations, but the ones I discuss are the ones most frequently raised or talked about when I meet my clients.

Time Horizon

Used as a gauge for financial advisers to recommend where clients will invest their money in, time horizon would refer to a time period in which to achieve your financial goals. This is where there is a clear delineation between investment and insurance.

I often use a single question to give my recommendation to clients as to where they will invest in: "What are you investing for?" This seemingly simple question can open the discussion into bank account balances, lifelong dreams and purpose in life, but in a less romantic but more numerical sense, it gives me a specific number to base my recommendation on.

A 30 year old who wishes to begin saving for retirement has a good 30 years ahead of her to attain her goal. But a 22 year old who wants to travel to India in a couple of years will not have a lot of time to allow his funds to grow. Couple that with the fact that a 30 year old will (statistically) have a more regular, higher paying job and some money already in her savings account, compared with the 22 year old (who is just starting out, and may realize he is in the wrong company or even field), and probably is still busy "partying it up" at each payday, and their time horizons will affect where they will invest in - or if they should even be investing at all.

This is why when I meet parents who have very young children, I cannot help but advise them to begin investing for their child's education ASAP. In investing, a longer time horizon tends to be equated with a larger fund value, and given the cost of college education these days - and the fact that schools can legally increase this amount every year - it would be wise to begin investing NOW. (Actually it should have been yesterday, but spilled milk and all.)

In contrast, insurance proceeds are triggered by an event - usually death, but sometimes, the onset of an illness (depending on the type of insurance product). The time horizon is instantaneous (all one needs is for the event to occur), and which is why those with dependents should consider insurance as being more imperative than investments. You need time to maximize the latter, but no such requirement is needed for insurance.

(Courtesy of assetquest.com)

Age

In both cases, it is in one's best interest to get in while you are young: Invest early, insure early.

As previously mentioned, in investing, one needs the element of time on one's side, in order to maximize potential gains. When you look at the charts of funds available for the general public to invest in (and I'm excluding those that are considered high-risk, speculative or derivatives), the price per unit goes through a series of ups and downs on a daily basis, but are generally in a line that slopes upward. Over the long term, most funds perform in this fashion.

Even when the Asian financial crisis hit (which saw a noticeable dip in fund performance), if the investor did not pull out his funds (which was still a paper loss at that point), he would have recovered by last year, and even surpassed it, especially if it was in a mutual fund, where the investment is spread throughout several companies and even industries.

I've had clients who withdrew their funds after less than a year of investing, and predictably, most of them "lost," especially since they said they wouldn't need the funds until 20 years later, and which is the information I used to recommend them placing a portion of their money in equities (stocks). Whether out of need, or that they wanted to place it elsewhere, given that funds have an entry fee, management fee and the timing of the withdrawal, chances are an investor would be suffering a loss.

I mention this because it is important for clients to remember that the information they give their financial adviser should be accurate, because it is the basis upon which we give our advice. In the same way that you go to a doctor and he doesn't give you antibiotics without first asking you about your condition, we only give recommendations based on the information we receive.

Insurance premiums are pretty much age and health based - and this is something that makes sense statistically. When one is younger, chances are great that you are healthier and free from most diseases or illnesses, which result in lower premiums. Rates are computed in part based on the mortality and morbidity experience of age groups, and it's no wonder that if you were to get the same product, a 59 year old would be paying much more than someone who was 21.

A word of caution, though. The age when people are getting tumors and life threatening conditions is getting younger, based on my experience. I've had a 31 year old client who was denied insurance coverage because of a tumor (even though it was benign). I also remember another client who worked out everyday (he was in his 40's), and did not want to consider getting an insurance plan for himself (he is single but his parents depended on him financially).

Out of the blue, he calls me one day and asks to meet with me - with the news that he now has cancer, owing to family medical history. (One thing I pointed out a year before when I was encouraging him to get protected with life insurance). It may be our stress levels, our lifestyles, but whatever the case, the age when people contract these diseases has become earlier.

Insurance is a strange product because you have to get it when you don't need it, and you can't avail of it anymore once you do.

Current Financial Condition

If you only had 100 pesos left and it is still three days to payday, would you opt to buy dinner or the pair of shoes on sale?

Many of our buying decisions are based on "how much do I have in my wallet?" This, I feel, is because most of us are content in living from paycheck to paycheck. As a country, we have one of the lowest savings rate in Asia. We have not inculcated in ourselves, and especially our children, the discipline of setting aside a specific amount from our paycheck, to remain untouched and only to be used in emergencies. This is a topic that deserves a separate post, but I mention it because in giving financial advice, it is important for advisers to know where a client is right now in order to make an informed recommendation.

If one has limited funds, or especially a pressing need for immediate funds, it would not be wise to either insure or invest. If we are at a level where there is no safety net, then that should be a financial adviser's first priority: to recommend that a client first make sure s/he has enough funds in a savings account to ensure personal needs and emergency needs can be met if the need arises.

One might argue that an insurance product is a safety net. True, but only if the daily needs are met, and can be reasonably met in the near future. Only then should a client begin to assess the correct insurance product for him or herself. Other than need, cost is also a factor - and if needed, a client could consider getting a term (temporary) insurance first (lower premium), which is most likely convertible to a permanent plan, which costs more.

As stated previously, money for investing is something you should be prepared to lose. This is why you should gauge - honestly - that the amount you are putting up for investment makes up only a part of your overall financial plan, and one that doesn't impinge or take away from funds for other purposes. Only by assessing your current financial condition truthfully can you make a realistic estimate of how much you can or should be investing.

Financial advisers can only do so much - the action portion of this equation belongs to each and everyone of us. I've had my fair share of people whom I've encouraged to either invest or insure, but they've delayed for a myriad of reasons. The only thing constant is that those who acted - they invested or insured themselves - are always in a better position financially than those who did not, who dilly-dallied, and wasted time letting their money grow, or already contracted diseases that they have been rendered no longer insurable.

Financial knowledge is good , but it doesn't benefit you until one acts on it.

Friday, September 4, 2015

Should I Invest Or Insure? (Part One)

This is a question I get asked often as a financial adviser. The short answer to that is: it depends. (Or as my friend who likes to joke a lot says, it defense.) The long winded reply has to do with many factors - including, but not limited to: purpose, number of dependents, time horizon, age and current financial condition.

In my years in the financial industry, I have noticed many clients have been given mismatched products in relation to their needs. This may be because the client was given not too well informed advice, or the vendor did not know (or did not care to know) the financial status of the client, or the client was taken in (in the vernacular, nasilawan) by the returns promised that s/he didn't read the fine print: returns not guaranteed, paying period could be a lifetime, or the risks are all your own, among others.

Let's tackle the factors listed above.

Purpose

It may seem like a basic premise, asking a client why they met with a financial adviser in the first place. But in an effort to make more sales, some bank employees or insurance agents end up being product pushers - even if the client has no need for the particular product being shoved face first.

This is why financial education is important. Similar to Maslow's hierarchy of needs, in financial circles we also have a guide in order to help a client better assess and understand what financial needs are more imperative to achieve first, before moving on to the next level.

The lowest level of this guide is ensuring you have enough cash and liquidity for your emergency and daily needs. This safety net is an amount that should equal around 3 to 6 months worth of salaries. Notice the qualifiers "emergency" and "daily", which means it can cover both expected expenses (like your weekly grocery shopping) and the unexpected events (like a car needing massive repair from a car accident).

The next level would be protection - ensuring that those who are dependent on your income for survival will be taken care of should the breadwinner be taken out of the picture. I come from a Chinese family that had serious (cultural) reservations about ever mentioning death, so I understand clients who find it an unpleasant topic, but the more you put off this discussion, the more it becomes difficult to manage financial affairs if the breadwinner dies.

There will be burial or cremation related expenses, final medical and hospital bills to deal with, estate taxes on properties left behind, and the specter of "how will we earn for our daily needs" has to be answered at that moment, because life goes on for those left behind despite a horrible loss.

Investments form the last level, and these are purposely relegated last, because they should be entertained only if you have excess funds to do so. The simplest reason I can give for this is because investments, by definition, are never guaranteed. As part of one's financial portfolio, these should be funds you are prepared to lose and write off should the investment not perform to expectation. Yes, there are ways to manage risks (like diversification), but it will never be absent and an investor will have to take that as part and parcel of the investing world.

Therefore, if all you have in your bank account is 20,000 pesos, using it all in buying the equivalent amount of shares in a mutual fund would be unwise as it leaves you with nothing for the first two needs. I mention this specifically because I have met clients who eschew saving for emergencies or insurance, but whose eyes light up the moment the word "investment" is bandied around and are ready to "go all-in," to use gambling parlance, rather fittingly.

Number of Dependents

If there are people who are depending on your income for their survival or needs, then you have a dependent. This relationship is easiest to understand in a parent-child relationship. Every need the child has - food, shelter, clothing, transportation, tuition fees, school uniforms and supplies, all of these are supposed to be provided by the parent who is the breadwinner of the family.

It stands to reason that the child will be financially distraught if the parent dies and the source of income is discontinued. If the spouse is a housewife or househusband, then this will mean a drastic change in occupation, from homemaker to a member of the working force. (And which raises new questions, like who will now bring the children to school? Who will take care of the daily chores since no one will be available during the day to do them? How will the surviving parent now fetch the child from school, whose classes end at 2 PM, when work hours end at 5:30 PM?)

Having insurance will alleviate many of these valid concerns. The surviving spouse will have ready funds for immediate needs like the bills that come like clockwork, and do not stop just because the breadwinner has passed on. S/he may also hire a yaya (nanny) or tagaluto (cook) to help with the chores. Most importantly, having ready funds buys time for the remaining parent to look for a job, which we all know is one thing that is not easy to come by.

(Image from moneychoice.org)

In the insurance industry, it is quite often more difficult to introduce the concept of insurance to single people, seeing as they do not have immediate dependents. The reason "no need" is true - at first glance. However, with people living longer these days, a new demographic has come up: parents who depend on a single child's income. Since one or both parents are now retired, if they haven't saved for their retirement, a child is often culturally obligated to foot the bill, so to speak, lest a melodramatic scene with the line "pinag-aral ka namin sa mabuting eskwelahan!" (we sent you to good schools) should come to pass.

Adding to that cultural pressure, single people are often "tapped" into being benefactors of their siblings who are married but unable to provide adequately for their own families, having 5 or 6 kids to boot. I have clients who come to me, complaining that their sister would "guilt" them by saying "napaka-selfish mo naman, tulungan mo naman kami sa gastusin, wala ka namang pamilya, eh!" (you are so selfish, come on, you have to help us with our expenses, it's not like you have a family of your own) and having a financial burden they didn't even sign up for.

A newer concern for single people is who will take care of them when they get a major disease, like a heart attack or stroke. Being without the traditional support of a family, they will have to rely on fending for themselves - and true enough, I have clients who come to me specifically for this purpose: health insurance, which ensures they will have a ready fund should a catastrophic illness strike. We have made advances in treating illnesses like cancer, that they are already seen as surmountable nowadays, but at the end of the day, you need funds to avail of them.

Whether you are married with kids, married without kids, single with kids, or single by choice, it seems inevitable that you will have dependents. It would be prudent to prepare for it while you still can.

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I will discuss the last three factors mentioned above in my next post. Having been in this field for a number of years, I can say that even when armed with sound financial information, people tend to procrastinate on acting on it. Reading materials can only do so much - the will to act will come from you.