Know how much you spend first to know how much you need

Part of the equation to financial freedom is how much you spend, the other part is of course your passive income. As such, to achieve financial freedom, it is important to also understand how much you want to spend.

A good starting point to know how much you want to spend is to know how much you are spending now. I choose to record all that I spend daily on a spreadsheet which I categorize them into the different type of spending such as "Travel", "Food", "Entertainment", "Insurance" etc. This may sound a little trivial, however, by just doing this simple exercise, you would stand to gain the following :-

1. This act as a check on how much you spend vs. the budget that you have available. It is an excellent tool to help you keep to your budget.
   
2. When you do overspend, you will know where and why have you done it
3. You would learn to better appreciate the value that get vs. the money you spend. That way, when you plan for your future, you can better estimate how much you would likely need to be spending.

The purpose is ultimately to know the value of money better. This should never be mixed up with accounting, book-keeping and check book balancing. The latter are good exercise but they serve a different purpose. For example, balancing your check book is good practice and it will tell you if the intended payments are done correctly or not. This however, does little to tell you if the payment should or should not be done in the first place.

Several tips I can offer here. First of all, it is not about details. Use the "Lazy man's principle". It is not easy to remember every single cent you spend through the day, so you don't have to. Estimates are good enough. For example, there is going to be little difference between you spending $10.15 and recording $10. Remember this is NOT an accounting exercise. Secondly, track the amount on the point of payment and ignore the mode of payment. It doesn't matter if the payment is through credit or debit, it is your spending. Thirdly, you can use proxies, example, if you use your farecard to travel, recording the farecard topup is good enough and this will safe you the trouble to record the fare for every single trip. Fourly, technology helps. Choose a way to record that you find easiest. I personally find a PDA very useful for this purpose. Lastly, when ever you feel lazy, remember that your financial freedom depends on this.

Defining Financial Freedom

I pondered for a long while what financial freedom really is. Technically it means reaching a state when you have enough money to live the life you want and money itself is no longer a constrain. Mathematically, it means to generate enough passive income (income that is generated for you without the need for your active involvement) to cover your expenses. Simple as that.

The formula is simple, the tough part is really fitting that formula into my life and my future. It is only when you can clearly describe how you would be like and how your future would be like, that you can really start filling up the variables to the formula.

Financial freedom is only meaningful when it is taken into context of your life and future. Now, as I work towards my financial goals, I am certain that I am getting closer to my financial freedom, because I have already defined it.

Set the right yardstick for your financial plans

Everyone likes a positive return on their investment, there is no exception. The question really is how much returns. The basic yardstick is the gross return which is basically the returns on investments irregardless of time. You invest $100 10 years ago and the investment is worth $150 today, the gross returns is 50%. Simple.

It is important however remember that the purpose of investment is to accumulate a certain wealth over a specific period of TIME. With gross returns, it is easy for you to wrongly perceive that your investments are ok and your wealth accumulation is on track.

Let me illustrate using an example. Let's say, your financial goal is to have $40,000 to buy your dream a car in 10 years. Currently you have $10,000 and decide to invest that amount today and grow it to $40,000 in 10 years. That means you need to get 300% gross return on your money in 10 years. 3 years later, you look at your investments and found that it is worth $14,000. Which means you have got a gross returns of 40% so far. Should you be happy or not with the 40% after 3 years? The answer is not so obvious.

Let's consider another yardstick, the annualised returns. This is basically deriving a compounded return per year that your investment is growing at. The formula is simple, take 40k divide by 10k which gives you 4, apply a power of 1/10 to the number 4, you would get 1.1487. Minus 1 and then multiply by 100% gives you 14.87%. This is the annualised returns that you need per year to achieve your goal.

Let's go back to the example, with this annualized return, after 3 years, we should be expecting to have compounded our money 3 times at 14.87% per year. The result is an investment value of $15,157. Comparing with $14,000, although you have got a gross return of 40%, you are actually short of $1,157. Which means your investments are not meeting your requirements. If you were to compute backwards, you would find out that your actual annualised return is only 11.87%. Not bad but not good enough.

The same measure can be applied to all your investments. Remember that a financial goal is complete only with a dollar value and a time component. Even if you are making money doesn't mean you are meeting your financial goals. Therefore, when you set your financial goals, work out the annualised returns that you need to achieve and then use that over time to make sure you get to your goals.

Why do up a financial plan when you don't make sure it works?

It is a strange phenomenon. For the past 5 years, there has been lots of say about planning for retirement, growing the nest egg, starting young and it goes on. Don't get me wrong, I am not against all that, in fact I am an advocate and a true believer in planning ahead, setting that financial goal and working towards it.

What disturbs me is that although there are a lot of emphasis on doing up the long term financial plans, there is a general lack of focus on what is more important than the plans themselves, which is working the plan, tracking it and making sure it works.

When you see a financial planner today for retirement planning, they would ask you to fill up a questionaire and based on that they compute the required amount that you need to accumulate by the time you retire. All looks good on paper. It probably tells you that if you invest a certain amount monthly or yearly assuming you get a certain return on your investment per year, you will reach your financial goal and live happily ever after. That's good, all you have to do is invest an amount of money regularly and get a return on investment per year for the next 30 years. Simple enough.

Reality however is quite different. You can be a good accumulator, investing once in a while, you buy some stocks, some unit trusts, some insurance linked plans etc. You invest more when you can have the spare cash but some times there just isn't much left to invest. The fact is that our investment pattern over a period of 15-30 years is unlikely to be as simple as the paper plan. Most people after a while, cannot remember when or even how much they invest. Even if they keep all the statements from the investment companies, they can probably tell you nett nett if they make or lost money. So, what happened to the initial plan to accumulate over time and get a return on investment for 15 to 30 years? Do you really know where you stand at the moment?

How likely are you to achieve your financial goals if you are not even tracking the progress of your financial plan? Knowing what assets you own now is just not enough. For most people except the blessed few that is born with enough to retire, we need our financial plans to work in order to achieve our financial goals. And in order to make sure it works, we need to keep track of your progress.

This is what I would suggest. First, forget about tracking your investment like a company. Companies need to do annual report that is why accounts are closed yearly and a profit and loss is determine at the end of each year. For the individual that is investing for long term, the yearly report is not useful. What you should be interested in is the rate of returns on your every dollar starting from the first day you start investing. Track every dollar you invest because you need every one of them to work hard for you, not just part of your money performing well and the rest in the dumps.

You need not be the investment guru or expert but there is no excuse not to at least play the role of the manager in your investment plan. No one will have more interest in your financial plan than you. You job is to focus on the right numbers to make sure you are still on track. In my opinion, you have to do at least that to deserve financial independence and eventually financial freedom.

How many millions do you want?

Many people ask the question, "How do I get a million dollars?"

Thought I will share an interesting way to accumulate a million dollars.

Let's say, you invest 10,000 dollars today. If that money grows at a compounded rate of 14.4% a year, in roughly 5 year's time, you would end up with 20,000 dollars. Suppose you reinvest this money in the same investment vehicle and wait another 5 years. At the end of the second 5 years, you would have 40,000 dollars. Let's just assume that you keep that money invested for another 3 more 5 years. By investing 10,000 dollars today, you end up if 320,000 dollars in 25 years. Simple?

Still far from 1 million? True but consider this. Is there anything stopping you from investing 32,000 today? If not and you invest 32k today, congratulations, you have just got your million in 25 years.

Don't have 32,000 today,..., not a problem. How about 10,000 per year for 4 years?

For example, if you are 35 years old today, the scenario would look like this:-

At 35 years old, you invest $10k
At 36 years old, you invest $10k
At 37 years old, you invest $10k
At 38 years old, you invest $10k

At 60 years old, you get back $320k
At 61 years old, you get back $320k
At 62 years old, you get back $320k
At 63 years old, you get back $320k

It basically means that after you retire at the age of 60, you will get a cheque of $320k each year for 4 years. Is that enough for you or do you want more? It's really up to you!

Everyone deserves that million dollars. The question really should be "How many millions do you want?", don't you think so?

My perspective about money

My perspective about money has changed over the years. Surprising, it has not got more complex like what I had thought it would. Rather, it gets simplier the more I know.

Let me explain. There is a difference between knowing how to invest and having a perspective about money. There is a lot to be learnt about how to invest, where to invest and when to invest and I think I will continue to learn more. As for my perspective about money, it is an appreciation over the years and increasing it is forming itself to be the backbone of not just my investment philosophy but also that of my views about finance in general.

To put it in a simple sentence, my perspective about money is about "Maximising the value of my dollar today". Simple as it seems, these 7 words forms the basis of all my financial decisions today.

All decisions boils down to making choices through comparisons. Financial decisions are the same. The dollar that can be used to pay off a loan can alternatively be used for investment. To know if which choice is better in the financial terms, all you need to do is to establish a common ground for comparison. For money, the easiest yardstick and the most unbiased is usually the future value of the dollar as a result of the different choices. For example, if you can choose to payoff your 10 year loan today or alternatively invest the same amount and pay the loan by instalment over 10 years. To know which is better for you, you just need to compute the change in your networth in 10 years based on these two different scenario.

Of course, this is a simple example but the same principle can be applied in many much more complex decisions. All you need is to establish the common ground for comparison.