With no savings, Michael seeks a plan to get out of the debt trap and achieve his financial goals.

Michael (not his real name), 43, is a manager in a multinational company. He is single and has been with the company for more than 12 years. The problem is, he has been unable to save his income. He has no idea where his money goes and, one fine day, decided to seek my advice.

“How do you spend your money every month?” I asked. “I spend on necessities such as food, housing loan instalments and insurance premiums. That is all normal, right?” he asked.

“Did you make any big-ticket purchases or any big financial decisions in the past three years?” I probed further.

“Oh yes! I bought a high-end condominium about three years ago, which I want to renovate. I also lent RM20,000 to a friend early this year to ease his financial burden. Could that be why I can’t save?” he wondered.

I paused a second to take a look at his finances, and said, “Your financial decisions today will determine your financial destiny. Sound financial planning will help you identify where you are and where you want to be. It also looks at how you can get there. Shall I walk you through the financial planning process?” He instantly agreed.

This is Michael. Can financial planning help him walk on a straight path towards his life goals despite the confusion and chaos in life? (image source from web)

His life goals are as follows:

1. To renovate his new condominium this year for about RM50,000

2. To get married this year, with wedding expenses projected at RM20,000

3. To put aside RM6,000 a year as travelling expenses

4. To save RM2,500 a month in an investment vehicle that enables him to generate an annual return of 7%, and

5. To retire debt free by 56 years old.

I performed a Financial Health Check (asset, liability, income, expenses/ lifestyle and emotion) analysis for him and the results are as follows:

1. Net worth (Assets and liabilities)

Net Worth RM
Total Assets 1,364,000
Total Liabilities 830,000
Net Worth 534,000
Financial Ratios  
Solvency ratio 39.1%
Debt-to-asset ratio 60.8%
Property-to-total-assets ratio 80.6%

According to the net worth analysis, Michael has a high debt to asset ratio of 60.8%. His ability to withstand any insolvency is low at 39.1%. His immovable (fixed assets) or property investment portfolio makes up a bigger portion (80.6%) and his movable or investment assets are 19.2%. His liabilities are mainly bank loans. Michael has no savings and uses up all his cash every month.

Life Goals Analysis

GOAL DESIRED ANNUAL AMOUNT (RM) START YEAR END YEAR INFLATION RATE (%) COST TO FUND @ TODAY (RM)
Retirement age   56      
           
Current lifestyle 144,562 2018 2037 3 2,215,239
Retirement lifestyle 144,562 2038 2063 4 2,348,693
Marriage expenses 20,000 2019 2019 4 19,230
Travel expenses 6,000 2018 2038 4 84,803
Renovation expenses 50,000 2018 2018 4 50,000
Cost to fund Michael’s financial goals today 4,717,965

2. Cash flow analysis (Income and expenses/ lifestyle)

Cash flow RM
Gross Income 180,000
Net Income 138,840
Expenses 101,664
Net cash flow (unallocated expenses) 37, 176
Financial ratios  
Lifestyle vs income ratio (LR) 61%
Debt service ratio (DSR) 39%
Net saving ratio 0%
   
LIR vs DSR vs NSR 61:39:0
Optimum financial ratio 40:40:20

Michael should have a net cash flow of RM37,176 a year, but this amount cannot be traced. It is considered unallocated expenses, which are expenses that Michael did not expect to have and are usually ad hoc expenses such as entertainment, traveling and medical costs.

If compared with the optimum financial ratio (40:40:20), Michael’s lifestyle versus income ratio is very high, I advised him to audit his spending to determine his basic needs and discretionary expenses.

Michael’s goals in life.

Michael’s life goals analysis showed that he needs RM4,717,965 to fund his goals.
(image source from web)

He has a capital shortfall of RM1,739,386. If he were to become disabled and cannot work, there will be a capital shortfall of RM10,566 a month.

I suggested to him the following strategies:

1.Save before spending. One hard lesson he has to learn is “:to pay himself first, before paying others”. I suggested that he save RM2,500 from his annual income and until he retires at 56.

2. To increase his investment portfolio’s rate of return from the current 5.92% to 6.99%. Currently, Michael is only invested in fixed income. I suggest that he should adopt a 20:80 approach in his investment strategies

3. Reducing his yearly travelling budget to RM3,600 from RM6,000.

4. Reduce his post-retirement lifestyle expenditure to RM63,897 from RM144,562.

5. Rent out his new condominium for RM2,500 a month.

The critical success factor for Michal is to start saving and once this is put in practice, he has a good chance of meeting all hour goal.

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