I speak to clients on a daily basis regarding management of their wealth. Many people aspire to reach financial freedom at some point, but most are clueless how to get there.
Financial freedom is the point in your life when your work becomes an option rather than a means of survival.
In this article, I outline some broad strategies on how you can get started along this journey towards financial freedom.
THE 4-3-2-1 APPROACH
One simple rule of thumb I tend to adopt is going by the 4-3-2-1 ratios to budgeting. This ratio allocates 40% of your income towards expenses, 30% towards housing, 20% towards savings and investments and 10% towards insurance.
While this is not a hard fixed rule, it is a useful guide to ensure you are not over-allocating resources towards any one single area while neglecting the rest.
For a young person who has yet to acquire the first property, she or he can channel the 30% portion of income towards savings and investments or set aside for the eventual down payment or renovation of the house.
A person with fewer liabilities or dependents may choose to allocate less towards insurance and more towards savings and investments so they can achieve financial freedom at an earlier age. Allocating 40% of income towards personal expenses is usually comfortable for most without compromising on lifestyle consumption.
INSURANCE AS THE FOUNDATION
In the overall wealth management strategy, insurance forms the foundation of the financial portfolio. In the event of a major illness or accident, insurance buffers your wealth against a single catastrophic event.
For hospitalisation and surgical coverage, it is a good idea to explore integrated shield plans offered by private insurers to supplement your basic Medishield Life.
These generally offer a more comprehensive coverage and provide more options when it comes to treatment.
In terms of life insurance, I tend to recommend between five to ten years of annual income worth of coverage as a guide. This will usually cover you for critical illness, total permanent disability and death.
In the event of critical illness, the payout from the critical illness cover will make up for expenses not covered by your hospitalisation and surgical plans while replacing your lost income when you recuperate.
In the unfortunate event of death, the death benefit will be paid out to your beneficiaries to take care of your dependents.
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This insurance portfolio can be supplemented by accident cover, disability income and early stage critical illness to provide a more comprehensive insurance portfolio. By structuring the portfolio with a mixture of whole life, term or investment-linked policies, most people should have no issues fitting their insurance portfolio into 10% of income.
GENERATING PASSIVE INCOME THROUGH SAVINGS AND INVESTMENTS
For someone who starts out relatively young, allocating 20% of income towards savings and investments is a good start towards financial freedom.
After setting up an emergency fund of about 3 to 6 months of your income, you can channel this portion towards instruments such as stocks, exchange-traded funds (ETFs), unit trusts or endowments to make your funds work harder for you.
If you have yet to purchase your first property, it is a good idea to channel the additional 30% from the housing into savings and investments. This gives you a head start in terms of accumulating and compounding your wealth.
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One of the common issues I face with regard to investment planning is people tend to invest without an idea what they are investing for. This is a concern because there is no time frame and estimation of the amount they are trying to accumulate.
There is no way to identify if they are on track towards what they are working for. One key step I try to do is to work out with clients exactly when do they intend to reach financial freedom and how much funds they need.
FINANCIAL FREEDOM FOR THE NEXT GENERATION
Following the right steps, most people should have more than what they require in their lifetime at some point. They should look into their asset distribution in the circ*mstance when they are not around. Estate and legacy planning tends to be an afterthought for many people.
It is common that the next generation will inherit the leftover money. Singaporeans also tend to favour property or real estate as an asset class. What many fail to realise is your best investment can very often be your worst estate plan. In particular, aproperty can be tricky if not handled properly.
For example, in handing down a property with an outstanding loan, one potential issue is if the beneficiaries are unable to take up the loan. They may have to sell the property with the intention of the giver.
They may also face market risks if market conditions are not favourable. Having a well thought out estate plan will go a long way towards mitigating these issues and assisting your next generation to reach financial freedom earlier in their lives.
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While I have outlined some broad strokes in managing your wealth and working towards financial freedom, it is important to recognise unique circ*mstances that may require different approaches. For specific advice on how to better manage your wealth, do consult a qualified financial adviser.
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From the perspective of wealth management and financial planning, the article covers several crucial concepts. Let's break down the key points mentioned and elaborate on each:
1. Financial Freedom:
- Definition: Financial freedom refers to a state where work becomes optional rather than a necessity for survival.
- Approach: The 4-3-2-1 ratio is suggested for budgeting:
- 40% for expenses
- 30% for housing
- 20% for savings and investments
- 10% for insurance
- Adaptation: The ratio can be adjusted based on individual circ*mstances and goals. For instance, those without property could allocate the 30% housing portion to savings for a down payment.
2. Importance of Insurance:
- Foundation of Wealth Management: Insurance acts as a safety net against unforeseen events like illness, accidents, or death.
- Types of Insurance:
- Medical coverage (integrated shield plans)
- Life insurance (recommended coverage of 5 to 10 years of annual income)
- Critical illness cover, total permanent disability, death benefits
- Portfolio Diversification: Supplementing with accident cover, disability income, and early stage critical illness policies offers a comprehensive insurance portfolio.
3. Savings and Investments for Passive Income:
- Allocation: Suggests allocating 20% of income towards savings and investments.
- Strategy: Setting up an emergency fund, then channeling funds into instruments like stocks, ETFs, unit trusts, or endowments.
- Property Investment: Until the purchase of property, the 30% allocated for housing could also be channeled into savings and investments.
4. Investment Planning:
- Common Pitfall: Investing without a clear goal or time frame.
- Recommendation: Establishing specific financial goals and timelines to track progress toward financial freedom.
5. Estate Planning:
- Importance: Distribution of assets and inheritance for the next generation.
- Challenges: Potential issues arise with property as an asset class, especially concerning outstanding loans, market risks, and planning for beneficiaries.
- Solution: Emphasizes the importance of a well-structured estate plan to mitigate issues and aid the next generation in achieving financial freedom.
6. Individual Circ*mstances and Advisem*nt:
- Acknowledgment: Recognizes the uniqueness of individual situations.
- Advice: Encourages seeking advice from qualified financial advisers for personalized wealth management strategies.
These concepts collectively form a robust framework for individuals aiming to achieve financial freedom through prudent management of wealth, strategic investment, insurance coverage, and thoughtful estate planning.
