Monday, 6 September 2010

Asset Income Expense Liability Unearthed

My work had kept me quite busy for the pass few months. Luckily, through this hectic working time, my financial is the least of my worry. Yeah, festive season is coming, Hari Raya is just next week. How is preparation so far?

My baju raya, already purchased. As usual, with ridiculously great deal. Got one set of clothes only at RM29.90. My mother was shock to know that I get it with such low price. Furthermore, I never even sacrifice quality, since the clothes that I bought is red hot in color (my family theme color for this year) and made from satin (I wonder when they will make baju kurung in microfiber since I love that material, hehe).

How about duit raya? Already kept aside and even completely arrange them into each packet, ready to be distributed. The whole budget for duit raya did not even disturbed my monthly budget since unexpectedly I got salary increase last month which give me a boost in my budget.

Talking about the salary increased, although unexpected, it was well appreciated. But it does not even slightly make me feel like I need to upgrade my lifestyle or spending. However, it helps to increase my monthly savings to 20% of my salary. Up to this month, my ASB account (the investment account where I dumped most of my savings), had reached more than RM20,000. Such a satisfying feeling to see that my 5 digit savings kept of increasing every month.

Recently, I read a couple of financial book. Both of the material touch-base on the 4 quadrant of basic cashflow. I felt the urge to share them with you.

The four quadrants is Income, Asset, Expense and Liability. Let me try to explain them in my own words.

This is basically the money that you get or generated through your salary or business. The materials I read did not mention about money from loans or credit cards. But for me, that money also consider as your income which however will also affect the other quadrant which I will mention later. It is utterly crucial to have a positive income somehow. Income is the one that trigger your cash flow. I do not know why we need to discuss about money flow is you did not have income at all. :)

Where ever, whenever you spend your money, that is cashflow under expense. Your daily spending, monthly spending, bills payment, credit card and loan payment are all under expense quadrant. It is the negative side of Income quadrant. However, it is very visible and can easily be one of the target areas if you are looking for ways to tame you financial habit. Handle you expense carefully and you will enjoy better cashflow.

These 2 quadrants, Income and Expense, are easy to understand. Everyone should understand where their money come from and where did it spend off too. Because of its visibility, these 2 quadrants are mostly the areas that people look at when they are trying to cut corner monthly to make their expense well fit into their income, or is it vice versa? Hehe.

The next 2 quadrants however, are those that people tend to forget. But, the next 2 quadrants was actually what determine the consistency of a healthy financial status. The rich people look at it often. The rich care for it passionately. But sadly, these 2 quadrants are those that average people like us always do not care much.

Liability means Debt. Personal loans, credit cards, hire purchase, overdraft, home financing, ASB financing and even borrowing money from family or friends are all consider liabilities. Simply said, just open up your favorite bank website and 80% of their service offered is a liability to you. If you take up a purchase which will require you to pay back in future, clearly that is a liability. A non-mortgage or non-collateral loans are the worst one since you will not get any money back in return. A mortgage loan such as home financing and collateral loans such as overdraft over fixed deposit or ASB/Unit trust certificate might be useful in intelligent hand to turn it into profit. However personal loans, hire purchase and credit cards will drain your money.

Worst thing, liability is almost transparent. For example, purchased a car at RM60,000. Get 7 years hire purchase at 4% interest rate per annum. By the time the loan has been fully settled, you will already paid the bank RM76,800 which RM16,800 for the interest. Furthermore, by that 7 years period, your car will drop its value to RM25,000. Even if you manage to sell the car at its current market price, you will still lost about RM50,000 which about RM7,000 per year since you purchase the car. That RM7,000 per year money is consider as if you are renting the car for the next 7 years. Not that it is a total lost, but it is something that we should be considering if that money lost is creating value for the service the car rendered throughout the loan period. I was wondering, did we make this calculation every time we are buying cars? Personally I do not, and I felt such a downer.

How about other liabilities? Taking personal loans RM5,000 with 5 years tenure at 9% interest rate for example. As soon as the loan approved, the RM2,250 interest will directly charge to the loan account. How about credit cards? Imagine that you have RM5,000 credit limit, which you use RM500 monthly but only paid 5% minimum payment every month. Do you know that by 12 months, the credit card will be over limit? By that time, you already paid RM450 interest and now you have RM5,000 debt need to be paid. Even if you stop using the card that time and continue to pay 5% minimum, it will takes you another 6 years to fully settle the credit card debt and by that time, you already paid the bank RM2,550 of interest. Do you see why I said that liability is transparent?

Liability quadrant is pack with purchases or commitments that we take and service for long period of time. By that period, we will be paying a lot of money for bank charges and interest. It is a hassle to calculate every single cent of money lost throughout the commitment period and that is the reason people just do not look at it, or we close one eye to it. Thinking that the monthly payment is manageable and low, we failed to see the bigger picture. We fail to see how much our hard earn money lost for nothing just to take the service of paying in monthly basis. Furthermore, since each commitment seems to only require a small amount of money to pay every month, we kept on taking new commitments, thinking that we can afford them. By the time we realize that 70% of our income vanished just to pay the monthly commitment, only then we realize that we are stuck. Worst thing about liability, by the time we admit that it is hard to pay all the loans monthly payment, we have another 5 years or more to survive monthly to finish off the loans. If our money short in 1 month to pay the monthly debt, do you think you can survive for the next 60 months or more?

Liability is the killer and average people just do not see it. So sad. Hope that we can open up our eyes bigger and look at the full picture and just STOP making new liability and START handling the current ones.

Now this is a secret why rich people get richer. This is the magical quadrant that answers questions we average people normally ask such as, “How could rich people can afford 2 three-storey bungalows?”, “How could rich people own 3 BMWs or 3 Volvo or afford to buy a Ferrari?” or “I made RM4,000 per month but I have to work 6 days per week. I wonder how much time rich people have to work to afford their lavishing lifestyle”. The answer is Asset. Asset is something that generates money for you. If you have to work to generate money, then that is Income. If you do not have to work but keep getting money, then that source of Income is your Asset.

Example of Assets are house that you rent to others, book that you write and sell through publisher, investment that give you return every year, music or album that you write or sing and now selling hot on air, internet business with amazing hits on its site that it is almost auto-pilot or even MLM (multi-level marketing) that so successful and you do not have to work but your downline is generating profit for you.

For me, my asset so far is my investment. Current focusing on ASB (Amanah Saham Bumiputera) and portion of my money (well budgeted with its risk) also put into Unit Trust with CIMB bank. Current state, I have RM20,000 in ASB. By end of this year, hopefully, it will generate 7% dividend, giving me RM1,400. Even if I stop putting more money into ASB, every year (considering having 7% dividend), the investment will give me RM1,400 without I have to do a single work on it. Imagine if you maxed out the ASB limit of investment to RM200,000. Without doing anything, it will paid you RM14,000 per year or about RM1,200 per month. If you do not take out the capital investment of RM200,000, you will continue to get RM1,200 per month dividend without doing any work as long as the investment continue to make profit. What if you did not spend the RM14,000 but instead you dump it into other investment such as ASW (Amanah Saham Wawasan), then that investment will generate more income for you. That is why I set my long term goal of having RM800,000 in this low risk investment. Even at 6% dividend per year, that RM800,000 will paid me RM48,000 per year or RM4,000 per month. RM4,000 per month is almost my current salary but best thing is that I do not have to do anything to get it. When I reached that goal, then it is time for my retirement.

Rich people do not directly spend their income to expense or worst, liability. Instead, they pay themselves by investing it to increase their asset. Once their asset profitable and generate new income for them, then they improve their lifestyle using the income from their asset.

A carefully manage asset will not lost your capital. Due to this, the asset will continue to give you capital gain which in turn gives you more income. If your spending is controlled only to the profit instead of the capital, then that capital will continue to generate your income without having you to do work. If you continue to use that income to grow your asset, then your income will also increased. Like I said, rich people get richer. And it is all about PAYING YOURSELF FIRST.

If this is a bit confusing, let me give a basic guideline through some simple formulas.

ASSET increment = 10% of INCOME
EXPENSE monthly = 90% of INCOME
Increment to INCOME = Profit from ASSET

Example that you got RM3,000 monthly for your income:

ASSET increment = 10% of INCOME
ASSET increment = 10% of RM3,000
ASSET increment = RM300

Which means you need to put aside RM300 every month to increase your asset, for example, on investment.

EXPENSE monthly = 90% of INCOME
EXPENSE monthly = 90% of RM3,000
EXPENSE monthly = RM2,700

Means that your monthly spending or payment must NOT exceed RM2,700. This also means that monthly, your RM300 must be put off to ASSET first before you even start to spend the RM2,700 for other commitment.

LIABILITY = 20% of RM2,700

This RM540 is the only safe portion of your salary that you can spend for liabilities such as home financing or hire purchase or loans. Do you notice how small that portion is? This is because the risk is long term since you might have to commit to 7 years for example on hire purchase. So, this long tenure commitment must be manageably low.

Example that your ASSET grew, and end of the year it paid up RM1,200 or RM100 per month.

Increment to INCOME = Profit from ASSET
Increment to INCOME = RM100
New INCOME = Current INCOME + Profit from ASSET
New INCOME = RM3,000 + RM100
New INCOME = RM3,100

With this new RM3,100 income, check out the latest cashflow:

ASSET increment = RM310
EXPENSE monthly = RM2,790

See what happen when the profit from the Asset boost your income? Now:

  1. You have more money to speed up your Asset growth which in turn will bring more income growth.
  2. You have more money for Expense but still within your safe border in spending. This means you can safely upgrade your lifestyle.
  3. You increase your portion for a safe LIABILITY which means you can afford bigger car or bigger house but within a safe budget.

If this healthly cashflow were properly maintain, that is how rich people will be able to spend more or own a bigger car or house. They simply, but safely, can afford all of them because they continue to get a big amount of Income through their growing Asset.

I do not see why we do not want to do this. It is okay to start from small even if you income is small. You will see how much advantage it is once your asset pays off and give you boost in your lifestyle. Do not be too quick on increasing Expense or Liability. Just hold it off first until you really can afford it in future. Give it a try. I have tried it and I know I will be having an amazing lavishing Hari Raya this year without even spending more than what I can afford. Hope you will have a great Hari Raya too this year and hope you will manage the spending well for this festive season.

Selamat Hari Raya and Maaf Zahir dan Batin. Happy holiday everybody!

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