11th December, 2020 by elmads

WEALTH ACCUMULATION

The 3rd and 4th steps are under the Wealth Accumulation phase, this is the exciting, yet overwhelming part of financial planning for most people. In here we will be learning how to make our money work for us through passive income by investing, and how to reach the target amount of money needed to obtain our financial freedom. We will also be learning different strategies namely basic fundamental analysis, tax regulation strategies and many more. All of these are interrelated to one another in order to fully maximize the growth of our hard-earned money. Do not fret, I will guide you into this, for us to reach our own financial goals.

3. Investing

It is to allocate money in the expectation of achieving profit in the future. Nonetheless, there is always a risk that is tied up to investing, we either can gain money or loose it as well. The general goal of investing is to supersede inflation of our economies. The average inflation is around 3% yearly that is why the goal of investing, depending on our time table, is to attain more than the said median inflation. In here, we aim to be an investor which studies all of the facts of an investment, in order to mitigate the risk of losing our hard-earned money, and not to be speculators. That is because speculators base their assumption mostly on price action rather that the underlying facts about the company which is where the risk can be studied and seen.

Moreover, there are various investment vehicles that can be used depending on our time horizon of short-term, medium-term and long-term goals. Investing is a topic of its own, but for financial planning, investing is based on how we will achieve our financial goals based on our time frame. The following below are the strategies that we can take based on our investment horizon.

• Short-term horizon – usually this is from day 0 to 3 years span. These are our regular savings in banks, such as savings accounts, checking accounts, certificates of deposit and etc. This is what most people commonly use worldwide, especially for those persons who do not want to invest their money into risky assets or does not have the time to learn about investing. The advantage of this type of investment vehicle is that our capital is protected and does not fluctuate in amount. It is for capital protection, the downside is its interest payments, as it is always lower than inflation. This is the reason why savings accounts are only used for short-term purposes such as for travel fund, a small part of our safety and security funds, personal expenses fund and others. The impact of inflation will not be significant for its time horizon and at the same time we are still getting returns from our capital even if it is a small amount of money.

• Medium-term horizon – this is usually from 3 to 10 years span. Investors invest their money in marketable securities, mostly bonds, preferred shares and stock shares. The commonly used security in this horizon is bonds, in here it will be us giving money into either the government, a company, or a municipality as a mode of debt. It will be these institutions who owes money not us. In return we will be receiving a fixed amount of income called interest/coupon payments, per month or quarterly, over a certain span of time depending on the bond contract. Let’s say that we took a government bond worth 100,000 GBP for 10 years, the interest rate is 2% per year. The government then will give us 2,000 GBP (100,000 x 2%) each year for 10 years as an interest payment. At the end of the contract they will return the whole 100,000 GBP they owe, so in total we gained (2,000 GBP interest payments yearly x 10 years) 20,000 GBP.

The safest bonds are government debt securities, because the government is less likely to go into bankruptcy unlike corporations. The return on bonds are usually around 2-4% which is hovering at the average 3% inflation. Our goal here is to preserve our capital from inflation so that it will not be eaten away. The downside of bonds are their sensitivity to central bank interest rates, it seldom supersedes inflation and does not remarkably grow our money.  

• Long-term horizon – this is usually more than a decade/10years. Stock market investing is the most popular and widespread method of investing, you always hear and see it from the news that the markets are either going up, down or stagnant. Stock market is like a celebrity in the finance world, people cannot stop talking about it, the reason behind this is because people make a lot of money from it. It sounds like a scam isn’t it? well the market itself is not a scam, but how we approach and invest in it will depend if it is a scam by losing money, or a blessing when we do it right. we might also hear news of other people who gained a hefty sum of money by day trading. Trading is another way to gain money from the stock market, it is a different religion compared to investing, they have the same goals with long-term investing, which is to grow our money from the market, the only difference is the approach to attain this objective. Traders base their decision on the price action of the market, whereas investors base it from the underlying business operations and general performance, not its stock price.

Stock market investing is volatile in nature, price goes up and down, that includes our invested money. Due to its nature of volatility, it has been highly advised by financial planners to invest in the market for the long-term because the market generally goes up if we base it in years and decades. Whereas, when we look at it in the short to medium term, it tends to go up and down, which causes loses to the investors due to lack of knowledge and mostly predicated to their emotions when they sell at a loss. Same as spending and saving money, investing is also 20% knowledge and 80% behavioural. Nevertheless, if we are able to gain knowledge, find our own investing strategies and control our emotions, then the markets will certainly reward us with monumental gains in the long-term horizon. That is the greatest advantage of long-term investing, and at the same time we will crush inflation year on year when we do it consistently.

Moreover, there is another long-term investment asset class that average people like you and me tend to forget, because of the required hefty some of money to be able to invest in it, plus we need to go into debt if we really want to invest in it and do not have the full amount of money to purchase one. This is the Real Estate asset class. Unlike stocks, if we invest in Real Estate we have the physical asset which we can touch and see for ourselves. I have discussed this further on my blog titled “5 Basic Asset Classes”.

People generally save and invest money in the long-term time horizon for their retirement fund or for their young children’s education fund. That being said, See and learn from the greatest investors of all-time. Namely, Warren Buffet, Charlie Munger, Peter Lynch, Benjamin Graham, Seth Klarman, Ray Dalio and many more. Learn not just their investing strategies but their discipline and mind set. On how they achieved their financial goals in life and what drives them to do it. 

4. Taxation

Oh my! oh my! one of the most dreadful word that we do not want to talk about. Tax always takes a big chunk of our gross salary each month, the tax deduction depends per country, but on average it takes around 20-30%. Also, almost all that we purchase are being taxed such as clothes, food and transport. We cannot seem to get away from tax, that is why most individuals do not bother to think about it and just live their lives disregarding tax in their minds. This is because they know that they cannot do anything about it anyway, it is what it is. Well, my dear readers it is not what it is, there are ways to get away from the tax man himself. These are the simplest strategies to avoid taxes which are knowing our tax allowance, maximizing non-taxable investment accounts, and long-term investing.  

• Knowing our tax allowance – As an employee like you and me, we need to know how much we get taxed per month for our own awareness, and also to know our tax allowances per year. This will be different depending in the country we live in. Here in the UK the tax allowance for tax year 2020/2021 is 12,500 GBP, that means we will not be paying tax until our salary reaches more than 12,500GBP. I will just emphasize how it works, because some people get confused how tax allowance takes place. We will only start to pay income taxes if we exceed the 12,500GBP of our tax allowance threshold of our own salary. Another explanation is that employees are allowed to receive a certain amount of income before having to pay income tax. I hope this makes it crystal clear. Take note that tax allowance changes per year for most countries. All the information about the UK tax allowance can be found on the government website at www.gov.uk.  Check your own country’s tax allowance benefit, it is usually found in the government’s webpage.

• Maximizing non-taxable investment accounts – some people do not know this but there are investment accounts that are not taxed by the government as long our money stays in this non-taxable investment accounts. This differs in each and every country as well. Here in the UK, we have various non-taxable accounts but the most popular ones are Individual Savings Accounts (ISA) and Self-Invested Personal Pension (SIPP). Both are shielded from the taxman (There are numerous differences which I will discuss further in my future blog) In an ISA, the money we place in this account is based after our income has been taxed by the government (Net salary), while in a SIPP it is our income before tax (Gross salary). Our money inside these investment accounts will not have capital gains tax(the tax deducted when we sell an asset at a gain of our money invested) or dividend tax(the money given by companies to its stockholders). Mind blown! Just imagine that there is no 10% dividend tax and no 15-25% capital gains tax! that is why each and every individual in the UK must maximize these accounts. By the way, the maximum money we could place in this tax year 2020/2021 in an ISA is 20,000 GBP while in a SIPP is 40,000 GBP. As much as possible always maximize the allowed money that can be placed in these non-taxable investment accounts.

In addition, the Philippines have a non-taxable account as well that are not widely known by the public, these are the PAGIBIG MP2 and Personal Equity & Retirement Account (PERA). MP2 is somehow same with bonds if we base it from how we get money from it, because in MP2 our capital will be returned after 5 years while the government branch of Pagibig will be paying a yearly dividend(just like an interest payment given to us). The dividends in mp2 are tax-free dividends, the downside is that there is no capital appreciation so we will be only gaining money through dividends. Whereas, in PERA the income earned by the investment products we are invested in will be tax-free from both capital gains and dividend gains.

You need to dig deeper on these different non-taxable accounts in your respective country, in order to maximize the benefits of not being taxed on your investments. It is basically free money if you get to think about it, so why not grab the opportunity! 

• Long-term investing – This investing strategy is tax efficient because long-term investing strategy does not buy and sell securities at a daily or weekly basis. The reason why we stay away from frequent transactions is because of capital gains tax. It is the tax deducted from the profit that we gain from properties or investments. This tax differs in each country too, here in the UK the capital gains tax is 20% of our total gains. To illustrate, let’s say that we invested 5,000 GBP in a stock named XYZ today, then we sell it after 3 months for a total gain of 10,000 GBP. As per capital gains tax rules our total gain will be just 8,000GBP (10,000GBP total gains, minus 2,000GBP as capital gains tax). So, the larger the amount of money we buy and sell, the larger will be the amount of money that will be deducted to us as tax, plus the frequent the transaction we do the more money will be deducted as well. Ouch! It is what you call a tax bomb in investing.  

WEALTH DISTRIBUTION

Step 5 is the last part of financial planning. It is distributing our own wealth to our significant others. Just like what is happening right now, baby boomers are now transitioning to transfer, not just their wealth but also their legacy to their children. It is considered the greatest wealth transfer of all-time.

5. Estate

People always think of achieving their goals in life and are very motivated to do whatever it takes to attain it, which is one of the formulas to success. Yet, most of us seldom think what happens next once we reach the peak of the mountain, or what do we do when we die during our journey to the top? Where will be our hard-earned assets, money and properties go if that happens?  

This is not about the need for an emergency fund because for sure we are way past that stage already when we are at the level of estate financial planning. In this level we are already considering ways on how to distribute our wealth when we pass away. We do not need to have a large amount of money or assets before planning for it, we can start as soon as we are accumulating wealth. No one knows when we are due to die, that is why planning for this as early as possible will give us a sense of security, that even if we die now, our wealth will be given based on how we wanted it to be distributed.

For example, we have marketable securities, cash in banks, and properties, then due to unpredictable event we pass away without any estate plan in place, while our family does not know what and where are our wealth is. This might even cause a problem within family members due to their own self interest which really happens in this kind of situations. This is called an estate battle between family members. The hardest part of not making an estate plan is that our assets might not even go the people who we want to receive it. This is can happen because there are special rules for how our estate will be distributed depending in the country we live in. Planning for it makes sure that these assets go to our loved ones, not to other people or the government. Here are the various steps that can be taken when sorting out our own estate plan.  

• Value of our estate – We need to know the lists of our assets and where it is located. We need to have a hard estimate of the value of all of it, not just our assets but our debt liabilities as well, only if we have one. (I have a blog showing you how to do this which will be posted within this month.)
• Have a talk with your beneficiaries – No one in this world wants to talk about the inevitable death that can happen to us, because it is hard to fathom the eventuality of death. That being said, we still need to do this for our family’s sake and ourselves as well, in order to have a set of system when the eventuality of our passing happens. Sit down and have a conversation with your loved ones about this, yes it will be an arduous, emotional task and they might not even take it seriously. This will boil down to us, on how we will be able to push through with this conversation. Next is to tell them what are your assets, where can it be found and how much it is or the rough estimate. It is better if we could write it down, or place it on the notes of our phone or on our laptop, then tell them about it. I had a conversation with my wife about it already and it did not go well, she got annoyed with me but I just kept on going and showed her my assets, cash and where it could be found. I know she understood everything even though she showed that she did not, it just frightened her that I opened up a topic about it, considering that we are still young. Nonetheless, mitigating risk is never about our age, I just want the best for my wife and family. Life is full of happiness when it is up but sometimes it goes down too, this is where we thank ourselves for planning and being prepared for it.
• Secure a will and testament – As much as possible find a good solicitor who specializes in wills and who can assist us with writing our will. It is wise if we could seek advice first before making one, then check if the solicitor is licensed with relevant professional body like the regulation authority and law society. Make sure that we have witnesses before signing our will for legal purposes like our family members. Once everything is sorted out, we now then can sign our will. Lastly, store our will safely; either we leave it with our solicitor, in a bank or in a very secured place in our home. 

Additionally, you can also do the “Green Box Exercise” approach by Michael Girdley. (See below)

“Here’s how it works:

Collect all the info your loved ones will need after you’re gone.

Put it in a box. (Preferably green.)

With a roadmap to find everything.

This will save your family, lawyers, etc, from having to puzzle out a million loose ends.

Here’s what I put in mine:

• Personal stuff
  • A “START HERE” document that lists everything in the box
  • Letters to your spouse/children/parents
  • Any mementos and to whom you’d like them given
  • Copy of your Will
  • Copies of your power of attorney documents
• Business
  • Org chart(s) and contact information
  • Recommendation on who to trust and how
  • List of trusted advisors (lawyers, accountant, CPA, etc)
• Asset
  • Personal financial statements
  • Details of any trusts
  • Copies of physical property titles (cars, houses, etc)
  • Personal portfolio information and access
  • Personal property valuations (jewelry, etc)
• Final to-do lists
  • List of personal and business people that should be notified
  • Any instructions not addressed in your Will
  • Funeral/burial instructions

Of course, this box has sensitive information in it.

You could put it in a safe or fireproof cabinet.

Or a safety deposit box at your bank.

The important thing is: make sure your family knows where to find it.

This is a big bunch of stuff.

So I gave myself time to put it all together.”

— Michael Girdley

“ESTATE PLANNING is an important and everlasting gift you can give your family”

— Suze Orman.

Contrary to popular belief, you don’t necessarily need to have a lot of money or assets to start an estate plan. Estate planning can be initiated at any stage of life, and it is beneficial to start early. It allows you to have a clear plan in place, protecting your loved ones and ensuring that your wishes are followed in the event of your incapacitation or passing. As your financial situation and life circumstances change, you can update your estate plan accordingly to reflect your current needs and goals.

Personal finance is about finding a balance in life. It’s not about excessive spending or extreme frugality, but rather being practical and enjoying life with a pragmatic point of view. Taking care of your financial affairs through estate planning is a responsible way to secure your family’s future and provide them with lasting peace of mind.

To Sum It Up

This finishes the full step by step, Do-It-Yourself basic financial planning guide for everyone. This is an overwhelming task to do, you know why? Because financial planning is a lifetime process, we take it one step at a time. There is no one set of financial goal that fits everyone, it will vary on our age, experiences, people around us, our beliefs and ideals in life. The only constant factors in financial planning are the motivation to achieve our financial dreams no matter what obstacle is placed in front of us, and the courage and willingness to take control of our finances.  

My dear readers, as you have read my blog entry from start to finish, you probably have realized one factor in managing our wealth, that we do not need advance knowledge about finance, as long as we know the basics of how to utilize our money in order to obtain what we want for ourselves and our family, in the short, medium and long term of our lives. It is not money that dictates if our lives will be miserable or full of happiness, but it is the choices that we make.  

I end my basic financial planning blog with a quote from a Russian-American writer and philosopher, Ayn Rand 

“Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver.” 

-Ayn rand

Knowledge is my Sword and Patience is my Shield,

Evan Louise Madriñan / elmads

If you have not read the first part of this blog, just click on the link below.

Link to “Part 1 of the Step by step, Do-It-Yourself Basic Financial Planning”

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.