Hi Everyone, last week I wrote about Personal Net Worth and why it’s the best metric to use as a benchmark for your financial goals. Today I will be diving deeper into the concept, and introduce a term called “Financial Health”, which you can use to assess the state of your finances. I will also suggest that the extraordinary times that we are living through now indicate that it would be wise to place a premium on liquidity, and to rely less on leverage to accumulate assets.
What is Financial Health?
Just like measures of your physical health – flexibility, strength, and cardiovascular health; financial health is measured by liquidity, resilience (low debt ratios), and the ability to go the distance (high savings rate).
If you would like to find out more on how you measure up against your fellow Singaporeans – there was a survey done by OCBC last year that surveyed 2,000 Singaporeans, in what they call “Singapore’s First Financial Wellness Index” that covered the same metrics that were introduced in the ST Invest article. Similarly, I found BlackRock’s Investor Pulse for Singapore quite informative in understanding where Singaporeans stand when it comes to the financial health.
Why Financial Health is Important
Much like your annual health check up, it’s important to do a regular review of your finances from time to time. No time like a pandemic to remind us of our own mortality and the importance of looking after our health – the same goes for the economic crisis brought on by Covid19, and its impact on our finances.
Financial Health, in a nutshell, is how well your finances respond when things do not go according to plan.
Everyone has a plan until they get punched in the face.Mike Tyson
To paraphrase Iron Mike above – a lot of the financial products that you may have been peddled just don’t stand up to the test of time, or to “non-normal” conditions like what’s happening around us right now (such as the unprecedented use of the word “unprecedented” to describe our current situation).
As I’ve alluded to in my introduction, I’m referring to investment portfolios that rely on leverage (e.g. structured products or real estate properties) to amplify their returns. Sure, they could show you a good back test, constructed using “average” parameters from a period where markets behaved “normally”.
This means that they work most of the time, but when they don’t work – they REALLY don’t work!
95% of all financial history happens within 2 standard deviations of normal, and everything interesting happens outside of 2 standard deviations.Richard Kayne, Founder of Kayne Anderson Capital Advisors
And that’s what happened in March this year, when US realized that Covid19 was not just a virus confined to Asia, most market participants sold whatever they could, in order to meet margin calls on their other levered positions. This liquidity crunch resulted in market mechanisms malfunctioning and correlations between asset classes breaking down, at least until the Fed stepped in to soothe markets.
If you were invested in illiquid assets (such as private assets or real estate), and were also financially extended (by leveraging to invest in stocks / real estate) – March wasn’t a good month for you. And in case you were wondering, no I do not consider cryptocurrencies as liquid assets – you need to convert into Fiat (usually USD) to trade in and out of your positions, and the exchanges are not as robust as the major stock exchanges that have had a much longer track record.
What iP2I recommends
The financial pain from Covid19 has not been evenly spread – some sectors are hurting more than others, such as the tourism industry, which accounts for 1 in 10 jobs globally. Also, given the tendency of people to find their partners in the workplace, chances are high that you and your SO could both be working in the same industry – this means that you could lose both incomes in a dual-income household at the same time.
Further, if you are a freelancer – the nature of your work means that you experience significant income volatility every month (up to 30%). Depending on your specialty and industry, you could see your entire pipeline for the next few months evaporate overnight due to social distancing measures.
What Covid19 has taught us is that we may need more emergency savings than previously thought, and that more of our net worth would need to be liquid in a black swan / generation defining event (which is somewhat untrue IMO, as Millennials are now the Double Downgrade Generation) .
Therefore I propose the following targets that one should strive for in order for their Financial Health to be “Covid-proof” and to not have to consider putting your healthcare needs on hold due to financial concerns.
- Household Liquidity Ratio: 6-12 months Income
- To be prudent, you may aim for 6 months of INCOME saved instead of just seeking to cover loan expenses
- If it helps you sleep better, you can save up to 12 months of income
- Cash to Net Worth Ratio: 30%
- I would shoot for a higher cash target, as I prefer to be nimble in taking advantage of opportunities in the market – I actually invested more in March
2. Debt Ratios
- Total Debt Servicing Ratio: <40%
- If your ratio is too high, you should consider downgrading your house, or skip owning a car
- MSR (Mortgage Servicing Ratio) is set at 30%, so you have 10% left for your car/credit card loans
- I’m currently at 0% debt, and will likely use CPF to cover the mortgage on my BTO when it comes + defer owning a car till I have kids
- Debt to Asset Ratio: <50%
- Assets here include Property Values, which usually take a dive in a downturn, while the outstanding loan amount remains the same – if you are over-leveraged, you may be forced to sell at a lower price than you would like in order to maintain Loan-to-Value (LTV limits)
- Note: I did not change the target here from the ST Invest recommendation
3. Savings & Investment Rate
- Monthly Savings Ratio: >20% Saved; >10% Invested
- I doubled the minimum recommendation of 10% savings, and would suggest that you can look to invest 10% of your salary every month through an RSP (into UTs, ETFs, Stocks) or via a roboadvisor. Personally, I invest 10% each month through a roboadvisor (MoneyOwl) into a 100% Global Equities Fund. From time to time, I also top up my Interactive Brokers account depending on market conditions and whether I have new trade ideas – this account is mostly invested into US and Chinese Equities.
How often should I measure my Financial Health?
If you are struggling to hit your savings targets each month, I suggest monitoring on a weekly/monthly basis to ensure that you remain on track – use an aggregator like Seedly/Financial Butler to find out more about your spending categories and patterns. This is akin to monitoring your weight on a regular basis to figure out the effectiveness of your diet and exercise plans.
Once a month/quarter, take stock of your investments and decide whether you need to rebalance or top up your investment accounts. To minimise trading costs, rebalancing is best done with fresh funds.
On an annual basis, much like your annual health check up, you can take a more in-depth look at your finances. If you have an insurance agent that you trust, this is a good time to have a look at your insurance coverage and decide whether you are comfortable with it. I would also take this time to make adjustments to my investment portfolio using my bonus, and make my SRS contributions and investment allocations for the year. Depending on your life goals, you can also look at adjusting the amount of CPF OA that you have, and potentially moving some of that into SA, or use it for CPFIS investments. More will follow in a later post.
If your goals have changed in the past year, you can use UP Plan to model those changes to the trajectory of your Net Worth. It’s helpful to visualize the impact of those changes, as that helps with prioritising what you really value in life.
Plan for your Financial Health, like you would for your Physical Health
So there you have it – Financial Health and why you need to care about it, especially during this health crisis. Leave a comment to let me know whether you agree with my recommendations.
Happy Sunday, and thanks for being here. One more day till the end of the Circuit Breaker – please continue to stay safe and well.