By Steven Peeris, Research Analyst

1/12/2013 Personal Finance By Steven Peeris, Research Analyst NUS Students Investment Society NATIONAL UNIVERSITY OF SINGAPORE

TIME IS MONEY TRADING TIME FOR DOLLARS What are we getting paid for when we go to work? Our experience? Our precious qualifications? What is it that our employer is paying us to do? Realistically, we are getting paid for our time. All the other factors like experience and qualifications serve to value-add the amount we get paid, but the basic element that is really being exchanged in an employer-employee relationship is time. Your employer is not going to pay you just because you have experience, or because you have top qualifications from an Ivy League university. You have to physically put in the time to do good work for your employer before you get your first paycheck, and so on. Experience and qualifications simply increases the amount you are paid on a monthly basis, because you are expected to produce better quality work and shoulder more responsibility during your work hours. What is going on here is that you are trading time for dollars. In order for you to earn more money, you need to work more hours. And regardless of your experience or qualifications, the equation of trading time for dollars will always be a linear equation, as shown below : H N I (Hourly Wage Dollars) X (Number of hours worked Time) = (Income) As can be seen from the equation above, the only way for you to make more money just by working will be to work longer hours (or find a higher paying job). The amount you can earn in a year will also be fixed. If you earned $3000 a month and worked the full 12 months, that works out to $3000 x 12 = $36,000. You ll never earn more than $36,000 in a year without putting in more hours, or finding a better paying job. This is the result of a linear equation.

THE TIME FOR MONEY TRAP A SLAVE TO YOUR JOB Notice, that from the linear equation, there is also another much scarier possibility. What if you stopped working? No work = No Income. Yes, I know, it s pretty obvious that no work means no income. But look at things a bit differently, even if you were employed, wouldn t you feel trapped in that cycle of having to work in order to maintain your lifestyle? That s the Time-For-Money trap. The time-for-money trap basically means you have become a slave to your job. In order for you to enjoy your current lifestyle, you have to keep on working to keep the income flowing so you can make your many payments at the end of the month. Highly-paid individuals at the top of the salary pyramid are richer and definitely more well-to-do, right? Wrong. Even highly paid individuals can, and do, fall into the time-for-money trap. Yes, they can afford nicer and more expensive things, but they would still be slaves to their high-paying jobs just to keep up that comfortable lifestyle. Let s look at a simple example below : WORKING PROFESSIONAL IN A HIGH-INCOME JOB Gross Income per annum.. $ 180,000 Income Tax Bracket deduction $ 15,000 Net Yearly Income.. $ 165,000 Monthly Income $ 13,750 Monthly Expenses Mortgage on a nice private property $ 4000 Loans for 2 cars. $ 2000 Insurance coverage (Health, Life). $ 500 Expenses for 2 children $ 2000 Entertainment, Dining Out, Shopping.. $ 1000 Domestic helper (Maid).. $ 1000 Utilities Expenses. $ 700 Other costs (ERP, Road Tax, Petrol etc.). $ 1000 Savings. $ 1550 TOTAL $ 13,750

As you can see, even high-income people, can fall into the time-for-money trap. Their hourly or monthly earnings are no doubt much higher, but they are still trading time for dollars. When you trade time for dollars and fall into the time-for-money trap, the income you are creating is temporary. Income creation is temporary because it is only being actively created when you are working. ACTIVE INCOME vs PASSIVE INCOME (Temporary Income vs Residual Income) Passive income, also known as Residual income is a much more stable form of income and requires very little effort to earn. Passive income is income generated by activities other than you working. Working is considered to be your active income as you have to actively work for it. Passive income is income that you did not have to work for. It is illustrated in the example below : INCOME EARNED ACTIVE INCOME $10 per hour X 100 hours of work = $1,000 PASSIVE INCOME $10,000 investment earning 10% p.a = (10,000 x 0.10 = $1,000) $1,000 As you can see, that $10,000 investment has saved this worker 100 hours of work. The income generated from the $10,000 investment is passive, as he did not have to work for it. This is an example of making your money work for you. EARN TO INVEST vs EARN TO SPEND Once you spend the money you ve earned, it s gone. You now have to carry on working to keep on producing your active income in order to keep on spending. But when you invest your money wisely, those investments can provide returns that help to boost your income. As you keep the investments growing, the returns grow with it. Once your investments are sizeable enough, you might even be able to consider retiring! That s the whole point of earning to invest. When you invest the money you earn, you re growing your income. You are essentially putting money in places that help you make even more money. You can and should just keep on doing that, because once you get started, any amount made no matter how small, can be rolled over towards making the next investment. And in due time, you find that the more you keep on investing, the more your income grows from the returns of those investments.

More Investments = More Passive Income = More Overall Income From the diagram above. You can see that investments add to your overall income. The more of your active income you devote to investing, the more passive income you can generate and this just keeps on adding to your overall income as time goes by. So what does this all mean? It means that it is wiser to earn to invest than to earn to spend. When you earn to spend, you have to keep on working to keep on spending. But when you earn to invest, you make sacrifices early in order to build up your investment portfolio faster. But this is a wiser decision to make because those investments add to your income. You can make faster and larger investments and this helps build your passive income quicker. Think about it. When you finally get a job, would you want to immediately commit yourself to a car loan for the next 5 years and get caught in the time-for-money trap just to keep on making your car payments every month? Or would you rather invest a good amount of money within those 5 years to build up a passive income, and then once sizeable enough, allow the passive income to pay for the car? When the passive income is enough to cover your car s monthly installments and maybe some car related expenses, the car is practically free for you to use. This is because even if you stopped working and did not have any active income, your passive income (which you don t have to work for), is what is actually paying for the car. So technically, you no longer have to work to keep your car. Now imagine if you could do this for all the other expenses in your life? It means you could retire, because passive income which you don t have to work for, is now able to cover all your expenses. The golden formula [PASSIVE INCOME > EXPENSES] =Don t need Active Income (Retire!)

OPTIMIZE INVESTMENTS AND RESTRUCTURE YOUR DEBT Optimize Your Investments Value For Your Investment Optimizing your investments is actually quite straight forward. The main idea here is to get value for your investment. Don t get confused with value investing, that is another topic and concept altogether. What you are doing here is looking for investments that are the best value for your money. You actually do it all the time when you go shopping or eat out. For example, when you dine out, and you want a drink of Soya Bean, you actually have options available. All you need to do is be calculative of the amount you are spending against what you are getting in return. A simple example of this is shown below : Drinks Stall A : Soya Bean can drink 330ml $ 1.10 Drinks Stall B : Soya Bean packet drink 250ml $ 1.10 Which drinks stall would you buy from? It should be Stall A, because Stall A gives you better value for your money. You are getting more Soya Bean for the same amount of money as compared to Stall B where you get less Soya Bean for your money. You can apply this to any investment using the Return On Investment (ROI) formula. This is why banks and property developers always like to advertise how much interest or potential returns they can give you. Between choices of 2% or 4% interest, it s pretty obvious you would pick the higher interest rate. But what happens when the rate is not given to you? Return On Investment = Total Returns Total Investment Value x 100 The following table will compare two investment options most commonly available. $1,000,000 Investment Property (Private Property In Singapore) Fixed Deposit (A Fixed Deposit In A Bank) $2,500 rental per month x 12 $1,000,000 x 3.4% Annual Returns = $30,000 = $34,000 Return On Investment (30,000 / 1,000,000) x 100 = 3% (34,000 / 1,000,000) x 100 = 3.4% Property values can be unstable. Investment is stable. Value does Other Factors Housing prices can go up, but not drop but nor does it rise. could also come down.

As can be seen, you get more returns investing your money in a fixed deposit. The fixed deposit is giving you more returns for your money and so, is of better value. It is advisable to note however, the stability of the investment. Property can look attractive at one point in time while rental rates are up, but property prices can always come down which reduces the value of your capital originally invested. Rental rates could also drop, reducing the returns you receive. Fixed deposits on the other hand, preserve your capital and give you fixed returns. The value of the investment is stable as it wouldn t drop or rise, the rate of return is also stable and gives you stable returns. The Rule of 72 One simple method that can be applied to an investment is the Rule Of 72. The rule of 72 is a method to determine the approximate time taken to double the amount of money invested. You take 72 divided by the rate of return on that investment. 72 Rate of return = Years taken to double 3% 72 3 = 24 years to double 4% 72 4 = 18 years to double 10% 72 10 = 7.2 years to double

Restructure Your Debt Make Debt Cost You Less So far it has been well established that for investments, you would pick the option that has the highest interest as that gives you the best returns. And it is obvious that when it comes to loans or debt, you would pick the one with the lowest interest rate. That aside, the focus here will be to restructure your debt. Meaning, if debt is going to cost you, let s try to make it cost you less. Let s zoom in on credit card debt. Credit cards can charge up to 24% per annum, which works out to 2% per month. If you ve managed to rack up some large credit card debt, you now need to pay it off slowly every month. But each time you delay payments, credit card companies will just keep on charging you late fees plus the interest. This keeps on inflating the amount you owe and you ll perpetually owe them. Why not consider taking out a bank credit scheme to pay off the credit card debt, then pay back the bank instead? Some people have commented that such an action doesn t make sense, because you are simply borrowing from one lender to pay off another lender. But analyze it closely. Credit Card Bank Credit Amount Owed $10,000 $10,000 Interest Rate (Monthly) 2% 1.4% Monthly Payments $200 $140 Amount saved annually by using bank credit [($200 - $140) x 12] [$60 x 12 = $720] As you can see, when you use bank credit to pay off your credit card instead, you pay less every month. You save $60 every month. This translates into annual savings of $720. The concept here is to basically make sure your debt costs you less. So why don t people use bank credit? That s because bank credit doesn t offer discounts and deals for restaurants or movie tickets. Credit cards do that. Credit card companies know they need to cut deals with businesses to give their cardholders good deals and discounts to entice them to spend. The more a customer spends, the more they owe and the more the credit card company will earn. What about people who have multiple credit cards and limited bank credit options? With many credit cards in question, try to pay off the credit cards with the highest interest rates first and not the credit card with the largest amounts owing. Credit Card A Credit Card B Credit Card C Amount Owed $15,000 $8,000 $6,000 Interest Rate (Monthly) 2% 4% 6% Monthly Payments 300 320 360 This one s costing you the most every month!

SUMMARY OF INVESTING Not all investments are risky. As you saw earlier, some investments like bank fixed deposits are safe and stable. The 2 main things to remember about investing are your risk and return. How much are you willing to lose? And how much are you hoping to gain? The general rule is of course the same : High Risk = High Returns Low Risk = Low Returns Let s take a look at some common asset classes that are available to retail investors. Asset Class Equities (Stocks) Property (Real Estate) Description A stock in a company represents part ownership of the company. Stocks can be traded to earn capital gains or invested into for the longterm in which case your returns are dividend payouts from the company. When investing into a company, you should analyze the fundamental aspects of the company. Check the financial health and strength of the business. Check how management runs their operations. Read through the annual reports to analyze how effectively money is managed and to check up on the growth prospects of the business. Buying an actual physical property. Property tenures can be 99-Year lease, 999-Year lease or Freehold. 99-Year lease means after 99 years, the land goes back to the government. Freehold means the property is free to hold for the owner. 999-Years is generally considered freehold as the time frame is impractically long. (999 years is almost a millennium!) Property yields returns in the form of rental for the owner/landlord. Real Estate Investment Trusts (REITS) are basically a group of properties of a particular type that is packaged into an investment package that is sold to investors. Your returns are then paid out to you according to how many units of the trust you own. Property (REITS) For example, a group of shopping centers can be grouped into a trust. The income earned is then paid out to the unit holders of the trust. Income is derived from the rental of the commercial shop units, retail space, and sometimes even parking garage profits. REITS provide an avenue to invest into property without actually having to own and manage a physical property of your own.

Asset Class Bonds (Fixed-Income) Description Bonds are often labeled as fixed-income securities. Bonds are basically financial instruments that allow corporations and governments to borrow money from the public. When you buy a bond, it will have a maturity date which is when the principal amount is due to you, and a coupon rate which is the interest rate that is payable to you. Your returns are basically the interest that is paid to you on the principal amount you have loaned when you bought the bond. ($1000 bond, 5-Year Maturity, 10% p.a. $100 each year for next 5 years) Fixed deposits are amongst the safest and most stable investment option available. Basically you commit a principal amount to the bank for a specific period of time, and the bank will compensate you with a more attractive interest rate than standard savings accounts. Banks in each country will follow the general interest rate trend of the country. If it is a low interest environment, then all the banks in the country will be offering almost the same rate. It doesn t make sense to put money into a fixed deposit of 1% when the inflation rate is 3%. That means prices rise faster than the value of your money. Cash (Fixed Deposits) One good trick to remember here is that you don t always need to keep your money in local banks or in the banks of 1 particular country. You can park your money overseas in various foreign banks that pay much higher interest rates. Different countries can have varying interest environments at different times due to monetary and economic policies. So 1 country could be low interest, while another is high-interest. Tracking foreign exchange rates will be good as you can effectively time your transaction to catch the best exchange rate when transferring your money over. But don t worry about the exchange rate too much though, remember the interest rate is still good and it provides you with good stable returns. So focus on the fixed deposit for its cash flow benefits. In conclusion, it is always wiser to earn to invest than to earn to spend. Invest your money wisely and build your passive income steadily. But never invest what you cannot afford to lose. The overall objective of all this is to achieve the golden formula of [Passive Income > Expenses].

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