LCF Answers Readers' Question

Question 1
In my previous post on calculating total insurance needs, a reader remarked that by liquidating all Mr Lim's assets, it essentially means there is neither a house nor liquid cash for his family to stay and use after his death.

This is correct. Therefore, if Mr Lim does not want the house to be sold and wants his wife to still have liquid cash in the bank upon his demise, he should omit both his house market value and cash from total assets computation.

Therefore, total assets available to settle his current liabilities is now equivalent to $ (890k - 500k - 10k) = $ 380k.

His insurance needs to cover for the shortfall is now equivalent to $ (1210k - 380k) = $ 830k.

Top 10 Reasons I Invest in Capital Malls Malaysia Trust

The thing about Penang properties: the rentals are (relatively) cheap compared to their (speculative?heh) values. Absolutely absurd when it comes to the soaring properties price for the past 3 years. Bear in mind properties investment is illiquid, and huge upfront capital is required. And there's always hassle of managing your properties unless you are full time into properties investment. Another rule of thumb is a return of at least 6 percent per annum rental yield, else experts say it is just not worth the trouble.


So I recently started to invest in Real Estate Properties Trust (REIT). Capital Malls Malaysia Trust (CMMT) to be exact. Consider REITs as the unit trust in commercial/residential properties which trade on the stock exchange. Here are the top 10 reasons why I see potential in Malaysia's largest pure-play shopping mall REIT for long term holdings and dividend income. I thought it as a good way to balance the risk and return with regard to my US stocks portfolio.


1. Three iconic shopping malls
Its main portfolio includes Gurney Plaza, largest mall in the northern region. The other two are The Mines Seri Kembangan and Sungai Wang Plaza Kuala Lumpur.

The layman's explanation of: Why Switch to Fixed Income Fund during Recession

Assume that I wish to borrow a lump sum of money from you, which I am going to repay 2 years later. In return, you think you need 10 percent return for the trouble.  On top of that, you require a bonus payment of $ 1,000 at the end of each year to sweeten the deal.


We put this in a contract. To recap, the conditions are:
1. You lend me a sum of money for 2 years. 
2. I will repay this principal amount in full, exactly 2 years from the date you transfer the money to me.
3. I will pay you $ 1,000 for the 1st year, and another $ 1,000 for the 2nd year.

3 basic must-ask questions to a Unit Trust Consultant

1. How much could I possibly lose?
2. What are the upfront and hidden costs?
3. How long can I double my money compared to FD rate?


WHY?


1. Test your agent's honesty. If he/she guarantees you not to lose money, you can ask him/her if he/she is going to compensate you with his/her own money when you DO lose money. The point is, I expect the agent to give me honest info on the performance of the fund, especially in 2008, without sugar-coating or with manipulated marketing material. As an investor, I know I got to be realistic; for instance, no equity fund will make money during recession. But if you are an agent with integrity, I might end up buying the same fund from you than someone who's misleading me or giving me empty promises.

Be calculative of your unit trust investment return

Say, you invest $ P in the best unit trust exactly for 1 year. You read that your unit trust profited by A % per annum the same year.

Digest this...

Your profit is A LOT LESS than A%

Unit Trust Risk-Return Part 1: The Sharpe Ratio

In any financial investment, risk and return go in parallel. Guaranteed return is known as risk-free return, and almost always refer to either Fixed Deposit rate or Malaysian Government Securities coupon rate. If you are buying government bond such as Greece, it is no longer risk free anyway! FD rate seldom goes beyond 4%; here's a summary of the current risk free rate of return (FD).


Sharpe ratio of an investment refers to how well the investment generates a return taking into consideration the risk. Risk is high when the investment nature has high volatility - tendency for its value to soar or to plunge excessively within a specific timeframe when benchmarked against the overall market activity.

Stark Reality: Child Education Costs & The Endowment Policy

Create Now, Save Later
So I read a reader contributed article (Personally Speaking by Hazel Leong) in Personal Money Sept issue, on why she felt that generic endowment insurance plan is insufficient to meet her child's education funds requirement in 20 years. 


The key takeaway here: Guaranteed lump sum rate of return in 2 decades time is even less than the current risk-free rate of return for Fixed Deposit of 3.15 percent.

In Excel, use the formula: Rate(20,4800,0,-120000) and you get 2%. 

And she further illustrates that an engineering degree currently costs about RM 150,000, with the assumption that the cost of education doubles every 10 years. I do not know how she came up with RM 150,000; but it could not be anywhere in local public or private institutions. An engineering degree at Multimedia University, my Alma mater, is currently tagged at RM 50,000. Therefore, let's take this as baseline for calculation below. Overseas studies are really, the privilege of the rich, and they are not any man on the street like the rest of us. Moreover, there are factors such as exchange rate fluctuation which we could not anticipate in the future, so let's be realistic and keep things simple.

*assume the education doubles every decade

Second key takeaway here: Endowment plan payout in 20 years can only fulfill one third of your child's education cost plus living expenses in the same timeline.

Now, the contributor advocates properties investment but I am not going into details of her plan here although it is very ideal if you have the cash for at least 10% down payment of the properties value, plus other closing costs.  Whatever the investment vehicle, everyone has their own preference. Just be prudent to balance the risk versus return.


Anyway, below are my estimation of the investment needed now to cover education cost of RM 370k.

Save  Now, Create Later

If anyone starts to allocate RM 10k today into investment vehicle of your choice with moderate return of 6 percent per annum, with yearly top up of RM 9.6k, he or she will be able to cover his/her child education cost in 20 years. 

RM 9.6k per year translates to setting aside RM 800 per month, with father and mother each contributing RM 400. Do-able right?

And you still have surplus of RM 14k, which can be used as down payment for your child's first car when he or she starts working after graduating.

Bear in mind this is only for one child. What if...

a) You have more than one child?

b) You child desire to study medicine, and he/she is capable of - you don't want to kill their dreams right?

Securing a scholarship though, is an added bonus. But I will only using EPF Account 2 for children education as last resort, because it will surely jeopardize my retirement plan.

The Downside of Active Self Investment

There is no insurance element in it, unlike endowment plan. The insurance component of endowment plan will provide the insured amount compensation to the proposer (parent) in the event of death or total permanent disability of the child. I do not think this is critical. On the other hand, if the proposer passes away/permanently disabled/suffers from any of the 36 critical illlness, the policy will sponsor the child until maturity.

To mitigate the risk of parent not able to provide financially to their child, any parent should be sufficiently insured. Like my previous CFP facilitator mentioned, if you love your family, and being the primary income earner, you should buy more insurance for yourself, NOT for your spouse/children. I am not expert in this, but probably after CFP Module 2 this semester, I could analyze total insurance needs more objectively.

Disclaimer: I am not an insurance agent.

Who am I?

An advocate of financial literacy :)

Rate of Return - the Right Way to Determine

Also known as the average annualized return or geometric mean of return, a potentially confusing term in the mathematics of finance.

Compared to simple arithmetic mean, geometric mean takes into account the time period and the effect of compounding, and is a more accurate representation of investment return.

Let's take an example something we can all relate to - unit trust fund. A hypothetical fund - Fund LCF has the rate of return as below:

Year 1: 15%    Year 2: -15%

At a glance, the "too-casual observer" will conclude that over the 2 years period, the investment return is 0% of your capital. This is arithmetic mean of return calculation. You break even.

Not true actually. Say, if you invested RM 10,000, you investment will be at RM 11,500 by end of Year 1. By end of Year 2, your money would have reduced to RM 9,775 (0.85 x 11,500). So you actually lose RM 225, or 2.25% of your initial capital.

The more accurate method to know the rate of return within the 2 years is by using geometric mean. It's really no rocket science. The calculation is as such:

[ (1+ r1) x (1 + r2) ]^(1/n) - 1, whereby r1 = 0.15 and r2 = -0.15, n = number of years, 2

...and you will get, -1.13%. This is the annual averaged loss over the time frame of 2 years. "WTF?" you asked. Unfortunately, this is the number that represents the reality in this case.