Quantifying "Financial Fragility"

How much do you think it would take to be less "financially fragile" than 50% of all Americans? According to a recent study, it may not be as much you would think.

In a paper published by the National Bureau of Economic Research, Annamaria Lusardi of the George Washington School of Business, Daniel J. Schneider of Princeton University, and Peter Tufano of Harvard Business School, nearly half of Americans say that they definitely or probably couldn’t come up with $2,000 in 30 days, an indication of the rising financial fragility of households in the US.

In the study, respondents were asked: “How confident are you that you could come up with $2,000 if an unexpected need arose within the next month?” The results show that half of Americans would probably or certainly be unable to cope with such an emergency: specifically, 22.2% say that they would probably be unable to cope and 27.9% say that they certainly would be unable to cope. According to the authors, "the $2,000 figure reflects the order of magnitude of the cost of an unanticipated major car repair, a large co-payment on a medical expense, legal expenses, or a home repair." Also, the authors clarify that respondents were asked whether they could “come up with” the funds and not whether they have them in the form of savings, an important distinction since "individuals may not rely on saving only in dealing with shocks."

So if you can come up with $2,000, or around 86,600 in today's peso, in 30 days, it means that you are better equipped to face financial emergencies than 50% of Americans. Better still, if we adjust the figure to reflect differences in the cost of basic goods and services in the US and the Philippines (using the latest Big Mac Index, for example) we should get a more manageable figure: 50,846 pesos, to be exact.

Until a similar study is done in the Philippines, we would have to make do with our rough estimate above; it means that we would have to ensure that we are capable of coming up with at least 51,000 pesos within 30 days for financial emergencies. While it does not necessarily mean that you should maintain that amount in your savings account as your emergency fund, to make things simple and to minimize uncertainty I suggest that you do just that. Of course, the bigger your household is, the bigger the figure should be. In my opinion, 100,000 pesos would be a much more ideal target for most households.

So you see, financial security is not as unattainable as it may seem. All it takes are a few sacrifices, a bit of self control, and maybe a dash of EQ. :)

Investing in Hong Kong

DEAR INVESTOR JUAN

Dear Investor Juan,

Thank you so much for creating such a nice blog. I am learning a lot from you! And what made me admire you more is the lack of ads on your site!!! :)

I read from one of your comments that you are based in HK, is that right?

I just want to know if you can suggest any good online broker where I can subscribe to Monthly Investment Plan. I'd like to buy and invest in Blue Chip stocks. Is Boom HK Limited a good choice?

My goal is long-term savings, and of course, capital growth as well.

I have an account with HSBC HK. They also have a similar plan, like those offered by BDO EIP and BPI. I haven't compared the rates yet vs Dah Sing Bank.

I already invested in HSBC's UITF - HSBC Asian High Yield Bond Fund a week ago. It is my first ever investment! It was on IPO that time and I was kinda giddy and excited to make an investment.

But when I re-computed everything... The overall net gain is just 3.5% per annum, with monthly dividends. I'll wait for 5-10 years, most probably, before I sell it, hopefully with lots of gain.

HSBC is also offering stock monthly investment plan, but I'd like to compare it first with other online brokers.

Thanks a lot,
Delphino


Dear Delphino,

Thank you very much for your flattering words. Whatever minimal income I do not earn by not running ads is more than made up for by the trust that I gain; this trust is important in reassuring readers like you that I say what I say because it's what I believe is right, not because of some self-serving motive.

Now for your questions.

Yes, I am based in Hong Kong. I've been here for around nine months. I bought my first HK security in October 2010, less than two months after arriving. In my opinion, based on my limited experience, the best securities or investment broker is whichever major Hong Kong bank you already have an account with (in my case it's Hang Seng Bank, while you have HSBC). Here are my reasons for saying this.

First, they're all basically the same. Unlike in the Philippines, most, if not all, commercial banks in Hong Kong also have securities trading licenses, so you can invest in any stock or investment fund (mutual fund or UITF) available in Hong Kong through your bank. Also, as far as I know banks and non-bank brokers charge the same fees, so there's no cost-wise advantage to switching.

Second, one thing that sets your bank apart from other brokers or even other banks is your relationship with your bank. You already know how (most) things work, and with one online platform you can conveniently manage all your other accounts (e.g., savings, investment, securities, credit card, etc.). Also, a better relationship with your bank could lead to more direct benefits in the future, like better credit scores, faster loan approval, and lower loan or credit card rates, for example.

Finally, your bank stands as the least risky choice, just because it is the alternative that you're most familiar with. In your case it's even better since you're using HSBC, which is arguably the biggest bank in Hong Kong; if you can't trust HSBC with your money, which bank can you trust, right?

To summarize, if you want to buy Hong Kong stocks or investment funds, or subscribe in a monthly investment plan like you mentioned, I suggest you just do it with your bank since there's no real advantage to switching or looking for another broker.

Regarding your fund of choice, your bond fund's 3.5% estimated annual return is decent, and comparable to similar offerings in the market. However, one thing that keeps me away from open-ended investment funds in Hong Kong (i.e., mutual funds and UITFs) is the steep fees, with most funds featuring high subscription and/or redemption fees on top of annual management fees upwards of 1.25% per year.

If you believe in the wisdom of passive investing, then you should not be paying such high fees for fund management. You can hold a well-diversified and inexpensive portfolio by investing in index exchange traded funds (ETFs), which are more-or-less behave the same comparable investment funds, but without the steep fees. These are traded like stocks, and so are also available through your bank's online platform (you should open a securities trading account with HSBC if you don't have one yet). The required minimum investment of ETFs depend on the current price and the minimum lot size, but it typically runs at 5,000 HKD.

In my opinion, a Hong Kong investor only needs to consider two ETFs to construct a well-diversified portfolio: one that tracks the Hang Seng Index and an index bond fund, weighted based on the investor's risk profile or age (i.e., a higher proportion of the bond fund for the more risk averse or older investor). As such, a majority of my own portfolio currently consists of the Tracker Fund of Hong Kong (stock code 2800) and the ABF Hong Kong Bond Index Fund (stock code 2819). However, as you gain more experience and become more comfortable managing your investments, you might want to further diversify your portfolio by investing in an internationally-diversified stock ETF or even a real estate investment trust (REIT). You can check out these lists of ETFs and REITs available in Hong Kong.

That's it. I hope I was able to satisfactorily answer your questions, and I hope you find the alternatives I presented here helpful. If you have further questions, don't hesitate to drop another line. Good luck!

Just Be Frugal...

FINANCIAL TUMBLR-ISM

... and never, ever be THEFT.

Add-On Interest: Don't Let the Numbers Deceive You

PERSONAL FINANCE 101

Say you want to buy a new laptop worth 30,000 pesos, but you don't have cash at the moment. You can finance the purchase one of two ways. You can use your credit card to buy the laptop, and be charged 3% interest per month for any unpaid balance. Or, you can get a personal loan from the credit cooperative in your office: the interest rate on such a loan is 2% per month. Which financing alternative would you choose?

The easy and obvious answer is the personal loan: from the perspective of the borrower, the cheapest credit alternative is always the best, and it seems pretty straightforward that the 2% personal loan is cheaper than the 3% credit card debt. However, as you may have already judged from the not-so-subtle clues I have laid out so far, getting the personal loan would actually cost you more than if you just used your credit card for the purchase. Why, and how, you ask? It's because interest on personal loans are almost always quoted and computed as "add-on" interest, which is different from how interest is computed for credit card charges and other types of credit. This difference could be enough to offset any advantage one option seems to have over the other, based on quoted interest rates, ultimately resulting in bad decisions like in the example above. You'll see how the two are different by looking at how interest in computed for each alternative.

Payments for Loans with Add-On Interest

We first need to specify the parameters of our personal loan example. The principal is 30,000 for the laptop, add-on interest is 2% per month, and let's say you plan to pay off everything in one year. Monthly payments for loans typically have two components: principal repayments and interest payments. Loans with add-on interest is paid in equal installments every month, and principal and interest payments are also constant monthly. The principal repayment portion comes from dividing the principal by the number of payment periods; in our example, it's 30,000 / 12 months = 2,500 pesos per month. You get the interest payment by simply applying the add-on rate to the principal: 30,000 x 2% = 600 pesos per month. Therefore, to pay off the 30,000-peso loan in one year, you have to pay 2,500 + 600 = 3,100 pesos per month for 12 months.

One odd feature that you may have already noticed in the preceding computations is that the add-on interest rate is always applied to the original loan amount, even if a portion of the principal has already been repaid. This is the primary reason why add-on interest loans are more expensive than other kinds of debt, all other things equal, as you'll see when we compare the payments for the two types of credit.

Payments for Credit Card Debt

Unlike loans with add-on interest, monthly payments for credit card debt are not predetermined or fixed; each month you can choose to pay any amount that is greater than or equal to a set minimum. Also, unlike add-on interest loans, principal repayments reduce interest in future periods, as is also the case with other kinds of debt.

To illustrate, let's say you use your credit card to buy the 30,000-peso laptop. For comparable results, we assume that you decide to pay 3,100 pesos every month, the same amount you would have paid if you took out the personal loan instead. The interest on your debt after one month would be 30,000 x 3% = 900 pesos. If you pay 3,100 pesos that month, 900 would go to interest, and 2,200 would go to the repayment of principal. Which means, at the end of one month, the balance of your debt would be reduced to 30,000 - 2,200 = 27,800 pesos. In the second month, the 3% interest rate would be applied to the balance from the previous month, 27,800 pesos, resulting in a lower interest payment of 834 pesos. Again, the remainder, 3,100 - 834 = 2,266 pesos would go to principal repayment, leaving you with a balance of 25,534 at the end of the second month. Continuing this process though the 12th month would result in the following loan repayment schedule:

With credit card debt, unlike add-on interest loans, interest declines with the decreasing principal balance, resulting in a lower total interest payment of 5,977.53 pesos (versus 7,200). This proves conclusively that the credit card alternative is cheaper than the personal loan, even if the latter features a lower quoted interest rate than the former.

Finally, the above example shows that if the credit card debt costs 3% interest per month, then it follows that the "true" monthly interest rate of the personal loan would be higher than that (definitely not 2%). How much higher, exactly? The only precise way of computing for such an interest rate would be with the use of a financial calculator or with Excel. We can get the effective monthly interest rate of the loan by using the the internal rate of return or IRR function of Excel (just like what we did in this past post about time value of money):

The result is monthly rate of 3.475%, which is close to 1.5x the quoted add-on rate of 2%.

How much interest would you actually be paying in a year with the personal loan? Multiplying 3.475% per month by 12 months (41.7%) would underestimate the effective annual rate since interest is compounded monthly (I'll explain what compound interest is in a future post), so it would be more appropriate to do it this way: effective annual rate = (1 + 3.475%)^12 - 1 = 50.67% per year. And that is why you would effectively be paying more than 50% interest per year on a 2% per month add-on interest loan.

6 Timeless Money Advice from Benjamin Franklin

Most of us just know Benjamin Franklin either as the face on the US $100 bill or as the guy who had trouble coming back home after flying his kite (you remember this story, right?). Maybe some of us are aware that he was some sort of post-renaissance renaissance man, being an author, scientist, inventor, diplomat, politician, and statesman at different points of his life. But what many of us don't know is that Benjamin Franklin was also an astute financial adviser, espousing simple and effective money management ideas that have withstood the test of time. In this post, we'll take a look at some of his sound financial advice that, although published some 260 years ago, couldn't be more applicable today.

1. "Remember that time is money. He that can earn ten shillings a day by his labour and goes abroad or sits idle one-half of that day, though he spends but sixpence during his diversion or idleness, ought not to reckon that the only expense; he has really spent, or rather thrown away, five shillings besides."

Interpretation: If you don't work, you don't earn. Being lazy is the same as throwing away money.

2. "Remember that credit is money. If a man lets his money lie in my hands after it is due, he gives me the interest, or so much as I can make of it during that time. This amounts to a considerable sum where a man has good and large credit and makes good use of it."

"Remember this saying, 'The good paymaster is lord of another man's purse.' He that is known to pay punctually and exactly to the time he promises may at any time and on any occasion raise all the money his friends can spare."

Interpretation: It is important to pay your debt (and collect what you're owed) when it is due. Delayed payments result in significant opportunity costs to lenders, and heavy penalties to delinquent borrowers. Apart from this direct economic benefit, paying on time will also nurture your relationships with creditors and build good will, resulting in an improved credit standing, higher debt capacity, and more favorable rates in future borrowings.

3. "Remember that money is of the prolific, generating nature. Money can beget money, and its offspring can beget more, and so on. Five shillings turned is six; turned again it is seven and threepence, and so on till it becomes a hundred pounds. The more there is of it the more it produces every turning, so that the profits rise quicker and quicker."

Interpretation: Money or capital may be used as a resource (referred to in economics as a "factor of production") in undertaking pursuits that create benefits -- like the development and production/rendering of a new good or service that meets a current need, for example. So, over time, money should grow as it is put to such a use and generates more value -- the essence of the concept of time value of money.

4. "He that kills a breeding sow destroys all her offspring to the thousandth generation. He that murders a crown destroys all that might have produced even scores of pounds."

Interpretation: If capital is a resource that produces benefits for the owner, then it wouldn't hurt to have more of it, and the most effective way to accumulate capital is by saving and controlling spending; "murdering a crown," or spending too much and depleting your savings, will diminish your ability to earn from investments.

5. "Beware of thinking all your own that you possess and of living accordingly. It is a mistake that many people who have credit fall into. To prevent this, keep an exact account for some time, both of your expenses and your income. If you take the pains at first to mention particulars, it will have this good effect: you will discover how wonderfully small, trifling expenses mount up to large sums, and will discern what might have been and may for the future be saved without occasioning any great inconvenience."

Interpretation: Live within your means, and the most effective way of doing this would be to track your income and expenses. Even the smallest saved amounts matter.

6. "In short, the way to wealth, if you desire it, is as plain as the way to market. It depends chiefly on two words, industry and frugality; that is, waste neither time nor money, but make the best use of both. Without industry and frugality nothing will do, and with them everything. He that gets all he can honestly and saves all he gets (necessary expenses excepted), will certainly become rich."

Interpretation: This last point needs no interpretation. Saying anything more will just diminish its truth and simple eloquence.

Financial Planning for the Rest of Your Life

A couple of days ago, on a boring afternoon at our graduate students' office, I was thinking about what I'll do after I graduate from the PhD program. Going back to the academe would definitely be my first priority, maybe here, maybe back in the Philippines. The problem with that option, regardless of how much I love it, is that it usually does not pay very well; for someone like me who's on the brink of middle age and for whom marriage and family life are just around the corner, that's not a particularly pleasing prospect.

So I asked myself, given my vices and predilections, and given the things that I want to do in the next few years, how much would I need to earn when I reenter the labor force (hopefully) soon after I graduate in 2013?

I used this sketchy plan as a starting point for my analysis:

1. Graduate in 2013.
2. Find and marry a sweet, simple, and intelligent lady after a couple of years.
3. Have and raise two beautiful children. 
4. Send my kids to the best schools.
5. Live till age 100.

That pretty much covers the important stuff. Here are all the necessary assumptions for the model:



Working my Excel magic and time value of money hocus pocus, I came up with this figure: 

100,182 pesos household income per month, gross of taxes

Now let's try to make sense of that number: is it high or low? How easily will I be able to find a teaching job that pays that much? Might be more feasible here in Hong Kong, but I would have to adjust my computations to reflect the higher prices here. In the Philippines... well, I guess I would just have to find me a sweet, simple, intelligent, and high-earning lady to marry. :)

Another way to make sense of the analysis results is by looking at the total present value figure of 21,169,012 pesos. It means that if I have that much money in 2013, the starting year of my analysis, invest at my assumed rate of return (7% per year), then I'd be set for life and I wouldn't have to worry about anything. But since I don't have that kind of money, I may just have to find me a sweet, simple, intelligent, and rich lady to marry. :D

I know that the approach is pretty simplistic, and excludes possibly significant costs like insurance and medical expenses, but it should be enough to give you a rough idea of how you'll need to prepare for your future financial needs. If you want to try it out for yourself (and check if my formulas make sense), here's the Excel file. On the "assumptions" tab, I highlighted the cells you can change to suit your specific needs or circumstances: the results on the other tab should be able to automatically reflect the changes that you make. You'll also notice that the approach is mostly "brute force," since I didn't want to use VBA macros and just stick with formulas (that's why I've hard-coded the maximum number of children as 5). If you notice any bugs, kindly point them out to me so I can make the necessary corrections.

Here are a few interesting findings from using from this tool:

1. If I stay single (household income = "n", wedding cost = 0, children = 0), I would need to earn 47,000 pesos per month to support myself, which is almost half of my original target income. This supports the argument that having a family and sharing financial responsibility with one's spouse makes financial sense since it benefits from economies of scale.
2. I would need a household income increase of 16,000 to 18,000 pesos per month to be able to support an extra child. The target monthly income goes down to 64,000 per month if we assume no children.
3. Another good reason to invest: increasing the annual investment return to 9% lowers the target monthly income to 83,000 pesos.
4. The results are very sensitive to inflation. Reducing the assumed inflation rate by 1 percentage point reduces the target monthly income by 20% to 80,000 pesos.

Now, Pinoys Abroad Can Invest in BPI UITFs through BPI Express Online (Well, Sort of...): Part 2

This was my email to BPI Express Online right after I found out that I could not complete my investment account application online. I have also attached a screenshot of the final page of the online application process to the email (view the screen cap here.)


Seriously BPI? After all that time I spent filling out forms, you want me to print them and deliver them by hand to the nearest branch? This is what you mean when you boast that you have "the country's first full-service online investment platform" on your press releases (http://business.inquirer.net/money/topstories/view/20110430-333932/BPI-offers-online-investment-services). You really think this really is the best way to tap overseas clients like myself? I mean, I have already verified my identity when I applied for my savings and expressonline accounts right? Is there really a need to see me in person one more time?

I maintain a personal finance blog that talks about these things. If nothing is done about this soon (like, next week), maybe I should let my readers know that your claim is false and they should not even bother filling out those forms since they would have to go their "nearest branch" to do these things anyway.

I really hope you can fix this annoying, unnecessary, and ridiculous "bug" soon, for both our sakes.


After reading this email several times over, I now feel deeply embarrassed for making that not-so-subtle threat: it just sounds so cheap and hollow. Even if I felt it was necessary and justified at that time, I know that I could have phrased my intentions and emotions better. For that, I apologize. Anyway.

This was BPI Express Online's a couple of days after (May 3).

And BPI Asset Management's email on the same day (view the screen cap here).


We appreciate your effort of raising your concern to us. You do not have to submit personally the forms. The following options are available for you:

         1. Personally hand carry the documents to the preferred branch
         2. Mail the documents to the preferred branch
         3. Send the documents to the branch via a representative

The branch needs to receive the documents so we can facilitate creation your investment account.

Please let us know should you be needing anything else regarding the matter.

Thank you.


Finally, my response, which is the final piece of this drama (view the screen cap here).


It's unfortunate that the other alternatives you have provided still involves significant costs, like cash to pay for a courier service or loss of goodwill (from a "representative" who would be so kind as to deliver documents for me from Hong Kong to Manila). I must admit that the idea of being able to finally manage my BPI accounts and avail of the bank's other services, particularly the one your division provides, with just one online platform, and remotely from anywhere in the world, made me feel more than a bit excited: I mean, finally, a Philippine bank is able to implement a bank service delivery system that is already standard in Hong Kong and many other countries.

Had you been able to roll out this system the way you made it seem in your press releases, you would have gotten a lot of business from me and many other overseas Filipinos looking for convenient and inexpensive ways of investing in the Philippines. But alas, that is not the case. So until that happens, I guess I will have to take my business elsewhere, and advise the people who ask me questions about such matters to do the same.

Thanks for the prompt replies, though. :)


As a post script, let me just say two things. First, in fairness to BPI, this inability of the platform to complete investment applications online is more a reflection of the limitations of existing banking laws in the Philippines than any fault on the bank's part. Second, BPI is the first Philippine bank to offer such a unified online banking system in the Philippines, regardless of its imperfections; whatever inconvenience its account approval processes might entail, the resulting improved efficiencies in making future transactions should more than make up for it.

Now, Pinoys Abroad Can Invest in BPI UITFs through BPI Express Online (Well, Sort of...): Part 1

So, I came across this article press release from the business section of the Inquirer a few days ago. Here's an excerpt if you're to lazy to read the entire thing:

"BPI asset management and trust group—a leading wealth management unit in the Philippines with close to P600 billion in assets under management—launched Tuesday night a web-based facility that allows investors to initiate mutual funds and unit investment trust fund (UITF) transactions through the Internet."

"Through this platform which can be accessed at www.bpiassetmanagement.com, investors can access portfolio information, explore further investment opportunities, subscribe to additional funds, redeem investments and make regular contributions online."

This news actually got me quite excited. You see, even before I left for Hong Kong, I had been looking for ways to manage Philippine UITF investments remotely. Unfortunately, such a service was still not available at that time--then this small nugget of good news comes along.

BPI president Aurelio Montinola III is even quoted as saying:

"We’re quite excited about this. Not only does this open investment capacity to Metro Manila clients. It opens to provincial and overseas clients which comprise a large community. And it’s going to be an active community."

So, wow, this service was even developed with investors like me in mind; that made me so goddamn special!

Don't even bother going to the website the article mentioned (http://www.bpiassetmanagement.com/), it will get you nowhere since there's no way to log in or sign up or anything. Just go directly to your BPI Express Online account and navigate to the following link:

The site will ask you to accomplish several forms, including one which assesses your risk aversion and recommends funds that best suit your risk profile. The entire process took me more than a few minutes; don't make the mistake of spending too much time on any one page since BPI Express Online only gives you like 2 minutes until it flashes the following prompt

and automatically logs you out of your session (it happened to me twice when I was trying to apply).

Eventually I reached the "final" page, upon completion of which, led me to the following message.

I was like... what... the... @#$%? I thought you guys were thinking of overseas Pinoy investors when you were developing this thing? And now, after spending all that precious time filling out forms and taking your stupid risk assessment test, you're asking me to print the forms I've already accomplished online (and presumably you already have) and deliver these lousy pieces of paper to the nearest branch? What for, my lousy signature, proof of my identity? Didn't I already give you these things when I opened my bank and Express Online accounts? What are we, still in the @#$%ing middle ages? If this is what being "one step ahead" with technology means, I'm afraid to even imagine what being left behind looks like. And by the way, I'm in Hong Kong, and the nearest branch from here is in @#$%ing Ilocos Norte, you mother@#$%ing morons!

Anyway, it took me 5 minutes tops to gather my senses and think of a more constructive way of dealing with the situation. That's when I decided to send an email to BPI Express Online. I'll show you how it went in Part 2.

Financial Frenemies: Robert Shiller vs. Jeremy Siegel

Siegel (left) and Shiller (right), from a Bloomberg article in 2002

They're both decorated professors, celebrated economic thinkers, and bestselling authors -- and each considers the other a lifelong friend. Yet, Robert Shiller and Jeremy Siegel agree to vehemently disagree on one thing: investing.

Tale of the ticker tape

In the "bear" corner:

• Name: Robert Shiller
• Home university: Yale
• Famous book: Irrational Exuberance
• Investment philosophy in a nutshell: Stocks are overpriced
• Quotable quote: "There is fundamental difficulty with advising individuals and institutions to get out of the stock market... In fact, we cannot all get out of the market. We can only sell our shares to someone else. Somebody must be left holding the outstanding shares... But it is entirely feasible for everyone to diversify better: those whose portfolios are overexposed to certain assets, such as stocks, can sell these to others who are less exposed." 

In the "bull" corner

• Name: Jeremy Siegel
• Home university: Wharton, UPenn
• Famous book: Stocks for the Long Run
• Investment philosophy in a nutshell: Stocks are cheap
• Quotable quote: "The past performance of actively managed equity funds is not encouraging. The fees that most funds charge do not provide investors with superior returns and can be a significant drag on wealth accumulation. Furthermore, a good money manager is extremely difficult to identify, for luck plays some role in all successful investment outcomes."

From the quotes above, it's clear that if there's one thing Shiller and Siegel agree on, it's that stock picking is futile and investors are better off with passive, well-diversified portfolios. So what exactly is the beef between these two? Watch the video below to find out.

Are you ready? Fight!