Now that you know how much cash surplus you have at the end of
every month, I am sure most of you cannot wait to start the ball rolling.
How and where to invest that will generate the most passive
income at the shortest possible time. Though I applaud your enthusiasm, sorry
that I have to be a wet blanket. Before we learn about investment we need to
know how to manage cash first.
In order to do that, the first step is to know how much cash you actually have now. It doesn't have to be
accurate to the last cent but your number must be relatively accurate.
I am sure by now you have heard of the oft-repeated phrase
"Cash Is King". To some extent it is. Most especially during the economic
downturn.
You might be able to grab some good bargain that cash strapped
people cannot. So bear that in mind when you do your investment planning.
Point to note though is that in this modern world most people
don't actually keep real hard cash. Unless your banking system is totally messed
up like what happened in Cyprus, modern people keep their money in the bank and
"cash-like" assets such as unit trusts and shares.
Homework:
Go through all your bank, provident fund, unit trusts and share statements.
This should be easy because it is just an extension to your earlier assets
listing. Please also include the amount that people owe you.
I will now introduce a new concept called "liquidity". In accounting term,
liquidity is defined as "the ability
to convert an asset to cash quickly."
The faster you can convert the asset to cash the more liquid it
is. That is why unit trusts and shares are considered "cash-like" due
to their liquidity. Since they can be traded, you can sell them on any working
days to convert them to cash.
Another criterion to determine the liquidity of the asset is
that it can be sold without affecting the asset's value. The less affected the
value is, the more liquid the asset.
Due to the effect on the asset's value in the event of a fire
sale, I have always categorised my cash and cash-like as liquid,
semi-liquid or non-liquid.
Liquid is your "currently available
cash" like in your savings or current accounts.
Unit trusts that have similar sale and purchase value are also
in my book considered as liquid cash. In Malaysia
Semi-liquid are those that fluctuate in value
daily and those that have sales charge like unit trusts and shares.
Why do I consider them as semi-liquid? This is due to the fact
that even though they can be sold immediately for cash but if you make
desperate sale you may not get the same value that you paid for originally.
Non-liquid is of "can see but cannot
touch" variety. I put Employee Provident Fund (EPF) under this category.
Loans to friends and family can be under this category too!
In Malaysia
I recommend that you abstain yourself from doing it. This is
your retirement nest. Remember that when you get your hands on it, you are no
longer employable. So you want to make sure that it is as fat as possible.
Premature withdrawal is a no-no!
Exceptions (there are always exceptions!) only applied to highly
disciplined and knowledgeable individual. AND it must always be for the purpose
of reinvestment in a higher return fund.
Please remember always that this is your retirement fund,
so capital preservation is of utmost importance. You should never reinvest in
high risk funds no matter how tempting the alleged returns are.
I remember back in the mid-90s a lot of my colleagues were
"captivated" by the sales pitch of a Fund Manager who sold high risk
unit trusts. I am sure you have heard of the term "High Risk, High
Return".
Drunk with the dream of "Wang Besar! Big Money!" and
upset with the small return that EPF can give, they took out their money from
EPF and reinvest in the fund. The stock market crashed.
They lost a chunk of their capital. I'm not sure whether they
managed to recover back their lost capital or not after the market recovered a
few years later since no one ever spoke of that incident ever again. So be very
careful.
Some of you may ask, how about taking out the retirement money
to buy a house? Even though I'm tempted to say "Never!" but if the
housing loan interest rate is higher than the EPF return then you should take
it out provided always that you either put the same sum in a higher
return fund or reduce the loan amount further by the same amount (if you can't
find a fund that can give a higher return than the housing loan interest rate).
A bit of a tongue twister huh?
Let me give you a number example. Let's say you want to buy $250k
house. Housing loan interest rate is 6% p.a. EPF dividend is 5% p.a. Unit
trusts dividend is 8% p.a. You are entitled to take out $25k from your EPF.
Under the above scenario, what you should do is take out $25k
from EPF to pay for your house and invest your own $25k savings (that you have
set aside for the purchase of the house) in the unit trusts.
If the scenario changed, housing loan interest rate stayed at 6%
p.a. EPF dividend stayed at 5% p.a. but the unit trusts dividend can only give
you a consistent 5.5% p.a.
You should then take out $25k from EPF to pay for the house and
use your own savings of $25k to further reduce the housing loan amount.
This is what we call "opportunity
costs" management, which I'm going to cover in the next section.
Coming back to cash and cash-like category, why is the understanding
of these criteria important?
The knowledge will ensure that you will not be caught by
surprise during emergency situation or you lost a good opportunity due to illiquid
position.
To put everything you have in the liquid category will be
counter productive.
To put everything in semi-liquid can be too risky most
especially when there is an emergency. You don't want to be caught in "buy
high, sell low" situation. If you are not too careful, all your
hard-earned money can go *poof*!
Ideally you should set aside 12 months of your living needs in
liquid form. More, if you are the kind that will go panicky and can get easily
stressed up if you lost your source of income.
I know some wealth management guru said 3 months is sufficient
but I personally think that it is too short a time to get back on your feet in
the event you lost your job. Most especially if that happened during recession
time.
The rest of the money is for you to decide whether you wish to
put it semi-liquid form to cater for chance opportunity or to invest in non-liquid
property investment or set up a business.