Sunday, September 30, 2012

Anonymous Indignation

We Filipinos love the Internet. We share quotes, memes, photos, jokes, interesting reads, and funny videos on Facebook. We tweet the little things we do, what we eat, our thoughts, our ideas, our witticisms. We share, we like, we comment, we poke (I'm not so sure, do people still do this)? Maroon 5, the Azkals, and Oppa Gangnam Style make you happy, and stupid senators and epal politicians make us angry, and people like Jesse inspire us and make us proud to be Filipinos. The Internet divides us during elections and over UAAP games but unites us during catastrophes. We are loud and we are proud of the things we hear, do, and say online... right?

But then why are we so quiet about this?

And why does this article have 25 comments and 609 likes while this only has 7 comments (13 including replies) and 153 likes?

It's okay, these are rhetorical questions after all, so you don't really have to answer. Maybe it does not really matter, maybe there's no reason not to be quiet... and maybe in the end we will just get what we deserve.

Thursday, September 27, 2012

7 Pillars of Financial Literacy, Explained (Part 2)

In Part 1, I delved deeper into the first four "pillars" of financial literacy. In this post, we'll take a look at the remaining three pillars and see how they fit the "bigger picture."

5. Managing debt

A lot of people think that "debt is bad," but it isn't--at least not necessarily. Debt is an essential feature of the economy and society-at-large because it serves as a bridge between those who have excess funds and those who need funds. If people and institutions can't lend to or borrow from each other, then excess capital will remain idle and unproductive, economic opportunities will be unexploited, and personal needs unmet.

Debt is "bad" only if: 1) a substantial portion of the borrower's earnings go to interest and principal repayments; and/or 2) the borrower cannot afford to significantly reduce the principal balance of the debt in the foreseeable future. When one or both of these situations arise, the borrower is left with limited spending power for a considerable amount of time, or even indefinitely.

There are several ways of avoiding this "debt trap." First, remember that borrowing only makes sense for certain purchases or situations: a house, a vehicle, and some consumer durables (such as a personal computer, some appliances) if you can justify the purchase and if you can afford the payments; and emergencies. Borrowing for investments is okay only if you can earn returns that sufficiently cover interest, after considering the riskiness of the investment. Needless to say, it's a bad idea to borrow for things that you don't really need, or things that don't "last" (e.g., weddings, trips, parties). Second, if you're going to borrow, look for the lowest interest rates that you can get (for which you need to understand how concepts like add-on interest and simple vs. compound interest work) and avoid very high interest rates, such as what you get if you don't pay your credit card bill in full every month (more than 50% per year effective interest) or if you borrow from loan sharks (anywhere from 5% to 20% add on interest per month). Finally, if you're going to borrow, apart from the interest rate, ask for a quotation of required monthly payments and make sure that these are sufficiently covered by your income less essential expenses.

6. Investing

Once your "expensive" debt has been paid off and you're amply protected by insurance and cash (see Pillar #4 in Part 1), you can start setting aside capital for investment. Investing involves spending money now for the possibility of receiving more money in the future (which is what sets it apart from "saving," where you just get the same nominal amount in the future). Please note that I said that there's only a possibility of earning from an investment--"returns" are never certain, no matter what anyone says. In fact, for a lot of investment instruments there's also a chance that you'll lose a portion of your investment. The possibility that you'll earn less than what you expect or even lose some amount is called investment risk.

Investments may be broadly classified as "passive" or "active." Passive investments mostly just require capital, in exchange for periodic income (such as dividends or interest) and/or capital appreciation. Some examples of passive investments include financial instruments (stocks, bonds, mutual funds, UITFs), real estate, and speculative instruments like currencies and precious metals. Active investments such as business ventures require time as well as capital from the investor; as one of the founders of the business, the investor needs to spend some time in planning, forming, and establishing the venture, and often also in running/managing the business. Entrepreneurial ventures are covered in greater detail in the next item.

In evaluating investments, an investor needs to consider several factors which we label here as "SHORE": Scrutiny – Do you understand the mechanics of the investment? Are the company and business model sound?; Horizon – Can you afford the lockup period of the investment?; Objective – Does the investment fit your financial goal?; Risk – Are you aware of and can afford to take the risks involved?; Experience – Can you take advantage of any existing experience with this type of investment?

7. Starting and running a business

Starting a business does not just go from a great idea straight to the SEC for business registration. Some questions need to be asked first: What's your business model? How will your business make money?; Who are your customers?; What are the risks involved?; What's your exit strategy?; Are the expected profits worth the capital required and risks involved? Once you have figured out the (best effort) answers to these questions, you organize your ideas into a "business plan."

The next step is to figure out how to finance the venture. Can you cover the required capital on your own, or do you look for partners? Is it a good idea to borrow? If yes, from whom?

Finally, being an entrepreneur involves not just shelling out investment capital, but also making important business decisions. For this, a certain degree of understanding of business processes and activities is necessary. The entrepreneur must try to familiarize his or her self with the following "functional areas" of business: Finance - raising capital for projects; Accounting - keeping track of the business's finances; Operations - managing production and/or processes; Marketing - selling the firm's products/services; and Strategy -  making long-term business decisions.

There you have it: the Seven Pillars of Financial Literacy. I hope you'll find these past three posts helpful in charting your way through the deep and wide, sometimes muddy but always enlightening, realm of financial literacy. As always, comments and feedback are most welcome. Enjoy the rest of the week and have a great weekend!

Tuesday, September 25, 2012

7 Pillars of Financial Literacy, Explained (Part 1)

The "7 Pillars of Financial Literacy" that I presented in the last post is an integrative framework that provides an overview of my (and Project Be's) version of "financial literacy". It is meant to show the user the breadth and depth of the subject, and how subtopics are related to each other. Also, it is a tool that we can use to evaluate how much we already know about financial literacy, determine how much more we want to know, and formulate a strategy that will help fill identified knowledge gaps.

In this post, I will discuss each pillar in detail and articulate ideas that I will present in our "Training of Trainors" Financial Literacy Workshop this weekend.

1. Being "financially literate"

What is financial literacy and why do we have to be financially literate? Financial literacy is understanding the "language of money," not being an expert; you don't have to have an MBA, be a CFA, an economist, or an investment banker in order to be financially literate. Like it or not, money matters are a big part of everyday life; so the same way we have to know a bit of math, of history, of language, of art, of culture to be able to have a "good" quality of life, we also have to know a bit of finance--these are the stuff the world runs on.

In a more specific sense, financial literacy equips us to be able to make sound and informed economic decisions: it tells us how to identify available alternatives and how to objectively evaluate these alternatives to come up with a decision, given that outcomes depend not only on our decisions/actions but also things that are beyond our control. Finally, and most importantly, financial literacy helps us cope with and prepare for the fact that we don't know what's going to happen in the future.

2. Defining your financial goal

It's easy to know what you want--be a billionaire, be a rock star, "own a Jollibee," and so on--but getting what you want is another matter. To go from here to where (or what or who) you want to be, you fist need to do two things: know where you currently are and know exactly where you want to go.

It is important and necessary to breakdown your financial goal or dream into something that is--for lack of an equally appropriate but non-acronym term--SMART: Specific, Measurable, Attainable, Relevant, Time-bound. Reshaping your goal into something SMART does two things: it provides a way to know whether you have attained your goal or not and it better helps you figure out concrete steps that will take you to your goal. 

Knowing "where you are"--that is, your current financial status--is pretty straight forward. You get your "net worth" or "net wealth" by listing and valuing everything your own and subtracting how much you owe: if your net worth is positive and substantial, then you're off to a great start; if it's negative (i.e., if you're a net borrower), then you need to get out of that hole first before you can take the first step towards your financial goal. Then you measure your capacity to increase to your wealth--your "net earnings"--by taking your regular income and subtracting recurring expenses.

The SWOT tool which I discussed in a prior post is also useful in coming up with a plan to reach your financial goal.

3. Budgeting

I bet that a good majority of those who emerge from the second pillar will feel that they don't own enough and they don't earn enough. The best way to address both issues is to improve our capacity to accumulate wealth by boosting your income and controlling your expenses, which result in more savings.

It's also important to understand the reasons for saving, how it's not just something that we have to do, and that essentially it's just one of several ways to cope with uncertainty about the future (please read this post for more details).

4. Dealing with life's uncertainties

As I mentioned in item 1 above: one thing that makes financial literacy absolutely necessary is that we only have an unclear picture of what will happen in the future, and that some of the things that may happen can leave us in a worse financial position and take us farther from our financial goals. Accidents, sickness or death in the family, natural catastrophes, and higher costs of goods and services (such as weddings, honeymoons, tuition fees, houses, etc.) in the future are things that we have to prepare for financially.

There are three ways of preparing for these unforeseeable, substantial, and necessary future expenses: insurance, cash in the form of an emergency fund, and debt. Insurance is almost always the cheapest alternative because: 1) risk is pooled and the costs are shared among many parties; 2) we can use forms of insurance that are subsidized by the government. Cash has an implied cost (called opportunity cost) since we usually earn very little interest (if at all) on what we set aside for emergencies. Finally, we can always just borrow when we need the money, but often only at very high interest rates.

To be continued in Part 2.

Friday, September 21, 2012

7 Pillars of Financial Literacy

I prepared this mind map, with the help of Project Be, for presentation in a "Training of Trainors" Financial Literacy Workshop on October 1. You can click on the (+) buttons to expand the nodes, and zoom in and out and go full screen using the buttons at the bottom of the frame. Fully expanded, you'll see the overall scope of financial literacy (at least in my/our minds). Although there is a natural linear progression from "pillar" 1 to 7, I thought it would be more useful to present the topics this way, especially since some topics in different pillars are interrelated (as indicated by the brightly-colored curves).

You can do with this mind map as you please; I do think it is a helpful tool in evaluating your progress and formulating strategies for improvement. I'm sharing this because I think it's something we all can learn from, so I hope you will share it too. Finally, I welcome feedback and comments: Have I missed anything? Do you disagree with any of this? Is there any specific topic here that you want me to discuss in a future post?

Thank you all and have a great weekend!

Monday, September 17, 2012

10 Practical Tips: (Be) Home, Happy, and Financially Free

1. Set "SMART" financial goals

SMART = Specific – Measurable – Attainable – Relevant – Timebound. It's not enough to just say, "I want to be rich someday. When exactly? What does being "rich" mean to you, exactly?

2. Know your financial position

Before you can take the first step towards where you want to go, you first have to know where you are. Estimate your "net worth" by listing and valuing everything you own and subtracting what you owe; the result is some kind of personal balance sheet. Next, estimate your capacity to add to your wealth by subtracting your regular expenses from your monthly or yearly income and creating a personal income statement. This exercise should be able to help you come up with a SMARTer financial goal.

3. Create a budget and stick with it

We are used to this form of the savings equation:


But this implies that expenses take precedence over savings or that savings are just what's left over from spending. So maybe focusing on this form instead:


will help you meet your target savings and help you better control your expenses.

4. Identify needs vs. wants

Avoid impulse buying. Before making purchases, sleep on it--you may not want it anymore the next day.

5. Learn to say no

Turn down unreasonable remittance requests. You are not responsible for everything and everyone.

Look after yourself. Know how much you can remit without sacrificing your own financial goals.

6. EmergenTHREE

Set aside at least three months worth of living expenses for emergencies.

7. Get insured

Make sure you have enough protection: life insurance, health insurance, accident insurance.

Questions to ask: How much is the premium? What are you insured for?  Until when are you insured? How can you claim expenses? Who are the dependents, beneficiaries? What is and isn’t guaranteed? How reliable is the insurance company?

8. Control your debt

Know the terms of your loans: principal, interest rate, maturity. Keep your total monthly amortization payments to no more than 20% of your monthly salary (as a rough rule of thumb).

Pay off your most expensive loans first. Pay off any debt that charges more interest that what you can earn from an investment before you invest.

9. Grow your money

Put your money to work--invest.

SHORE – five things to think about when investing :

Scrutiny – do you understand the mechanics of  the investment?
Horizon – can you afford the lockup period of the investment?
Objective – does it fit your financial goals?
Risk – are you aware and can afford to take the risks involved?
Experience – can you take advantage of any existing experience with this investment?

10. Believe in yourself

If you don't, who will?


This list was prepared and presented by Project Be for an event for Filipino overseas domestic workers in Hong Kong on September 16, 2012.

Friday, September 14, 2012

Making Investment Decisions Based on Data, Part 3: The Optimal Portfolio


In this post, we will continue from where we left off in Part 2 and derive an optimal portfolio from among the infinite number of portfolios defined by the Efficient Portfolio Frontier.

First, we include a "risk free" asset in our universe of investments, and we define "risk free" as having a standard deviation of zero. In the real world, the closest thing we have to a risk free asset are Treasury bills which have (theoretically) zero default risk, zero liquidity risk, and zero maturity risk.

With this risk free asset, our previous model featuring the Efficient Portfolio Frontier is simplified. This time, our asset allocation decision just involves choosing some combination of this risk free asset and a portfolio P, which we find at the point of tangency between the line from the risk free asset at point F and the Efficient Portfolio Frontier.

At point F, all your capital is invested in the risk free asset and your portfolio has an expected return equal to the risk free rate Rf and a standard deviation of zero; at point P, all your capital is invested in the optimal portfolio. Other combinations of the risk free asset and the optimal portfolio should fall along the Capital Allocation Line between points F and P. In other words, if we consider the existence of a risk free asset, then the only "risky" portfolio (consisting of our equity and fixed income funds, for example) we should  invest in is the optimal portfolio at point P.

So how do we find this portfolio? The derivation turned out to be more complicated than I first imagined. Thankfully, someone already did it for us :)

Weight of Asset 1 in Optimal Portfolio = X1 = (V1S2^2 - V2S12)/[V1S2^2 + V2S1^2 - (V1 + V2)S12]


V1 = R1 - Rf
V2 = R2 - Rf

And all the other inputs are as defined in Part 2.

We can get Rf from the latest 91-day T-bill auction results of the Bureau of Treasury website. Currently, Rf is 1.249% per year. Since the returns that we use in our model are daily returns, then we need to compute for the daily Rf, or 0.0034% per day,

Using the same inputs from Part 2, we get the following weights for our optimal portfolio (consisting of BPI's equity and fixed income UITFs).

Weight of Asset 1 (equity UITF) = 10.86%
Weight of Asset 1 (fixed income UITF) = 89.14%

This portfolio has an expected return of 0.0219% per day or 8.33% per year and a standard deviation of 0.4059%. Are these good enough for you?

Because the ultimate goal of this series of posts is for us to be able to practice what theory teaches us, I have created a spreadsheet template (which you can download here) that you can use to determine an optimal portfolio given your own choice of assets or funds. All you have to do is enter the following information in the yellow cells: the expected returns of your assets, the standard deviations of returns, the covariance of returns, and the risk free rate.

At the end of the the spreadsheet, you'll notice that the slope of the Capital Allocation Line is also provided. The equation of the Capital Allocation Line is given by

R = [(Rp - Rf)/Sp]S + Rf

Where R and S are the return and standard deviation of any combination of the risk free asset and the optimal portfolio. You can use this equation if you want to invest part of your capital in the risk free asset (i.e., in T-bills or time deposits). Also, the slope of this equation is the "true" version of the Sharpe Ratio, which we first encountered in Part 1.

This two-asset model is particularly appropriate in the Philippines where only two kinds of mainstream funds/assets are available to most people. But what if REITs are finally introduced? Can we come up with a three-asset model to accommodate this "new" asset class? Yes, most definitely. Soon. :)

You can access the spreadsheet here in case you missed the link above.

Monday, September 10, 2012

Investor Juan v3.0


It's about time.

In a little less than two years, the old design had become just that--old.

It's about time I realized that my "artistry" has its limitations.

And it's about time I started paying a professional to improve the look (and credibility) of this website. As my favorite philosopher has been known to say: "Sometimes you have to pay a premium for the good things in life." Fortunately, in this case the premium is actually pretty reasonable.

This design was made by my former student, Lisha. She does good designs, works fast, and charges reasonably. If you're interested, check out her Facebook page. (By the way, I'm not paying for the design with this plug, but with REAL money.)

AND, I found out just now as I am writing this, that I have already used up the 1 GB storage quota (which I use for blog images) for my Google accounts. Now I have to pay 2.49 USD a month to upgrade to 25 GB, which isn't that bad, really...

Thursday, September 6, 2012

A Tale of Two Markets


I arrived in Hong Kong exactly two years and one week ago. I decided then to take most of my capital with me and invest it and all future earnings in Hong Kong. Let's see how that decision turned out after two years...

Hong Kong Recession Risk May Increase On Exports, Tsang Says (Sep 3, 2012)

Hong Kong’s risk of a “technical recession” may increase after declines in exports and a slowdown in retail sales, Financial Secretary John Tsang said.

Hong Kong’s economy shrank 0.1 percent in the second quarter from the previous three months as the sovereign debt crisis in Europe capped export demand. China’s slowdown is dragging on trade, weighing on confidence and encouraging the million of mainlanders who visit each month to spend less on luxury goods.

The benchmark Hang Seng Index (HSI), down about 10 percent from this year’s high in February, was little changed as of 10:19 a.m. local time. Hong Kong’s retail sales grew in July at the slowest pace since the global financial crisis. The city’s exports fell 3.5 percent from a year earlier.

Performance of the Hang Seng Index in the past two years: -6.90%

Philippine Bourse Stock Sales Poised To Pick Up (Sep 3, 2012)

Philippine Stock Exchange Inc. (PSE) Chief Executive Officer Hans Sicat said share sales are poised to surpass the bourse’s full-year target as transactions accelerate toward the end of 2012.

Sicat sees three more initial public offerings being completed this year, he said in an interview last week, declining to name the companies. That would take the annual total to six, compared with five listings in 2011. There are enough funds in the stock market to absorb new IPOs or share sales by listed companies, he said.

Overseas investors have bought a net $2.15 billion of Philippine equities this year to Aug. 30, compared with $1.33 billion of purchases for all of 2011, amid optimism about the nation’s economic growth prospects. Philippine stock trading has averaged 6 billion pesos a day this year, compared with the 2011 average of 4.82 billion pesos, data compiled by Bloomberg show.

The Bangko Sentral ng Pilipinas cut its benchmark interest rate to a record-low 3.75 percent this year to spur spending and counter faltering global demand. The $225 billion economy grew 5.9 percent in the second quarter, faster than the 5.5 percent median prediction in a Bloomberg economist survey. Standard & Poor’s raised the Philippines’ debt rating in July to BB+, one step below investment grade and the highest level since 2003.

Performance of the PSEi in the past two years: +44.48%

It was not as bad as it seems, though. In the past two years, I bought in and out of the Hong Kong stock market a couple of times and was able to break even in that period. It's a bit disheartening to miss the incredible performance of the Philippine stock market in the past two years, but I'm definitely happy for those of you have benefited from the run. I don't regret my decision, not one bit; after all (and I'm sure someone already said this somewhere sometime), regret is for the weak.

Monday, September 3, 2012

Buying a Condo: Cash or Installment?


Dear Investor Juan,

My husband and I decided to buy a condo unit for use by my 2 college students.  Instead of paying rent which is an outright "loss", we will be paying for a property which is "gain".  We have enough cash in our emergency fund (which are in 5-yr tax free time deposits at 4-6%interest p.a.) to buy the condo unit in cash and earn the benefit of 12% discount. Or pay 45% downpayment without interest in 27 months and then pay the remaining 55% lump sum (thus avoiding bank financing) and still enjoy 3% discount.

The dilemma is this: husband says we do the former--12% is way bigger than the 5-6 % the money will earn in the banks. But I choose the latter--at our age (43 and 45), we'll never know when we will have medical emergencies.  I don't want to let go of our savings, we're still earning and we'll just pay for the condo unit on a monthly basis from the money we still have to earn.

The property costs 2.6M. If we withdraw from out time deposits, we get charged 10-50% of earnings depending on the bank, the number of years still remaining, plus documentary stamps costs.

What do you think?


Dear Weng,

From a purely economic standpoint, the reasoning of your husband makes sense since the additional 9% discount (12% vs. 3%) that your get by paying for the property with cash outright is greater than the 5 to 6% you earn from your time deposits. If you want a more systematic analysis, however, there are a couple of things that you can do: (1), determine how much more it would cost you in terms of interest per year to pay in installments, or (2) compare the present values of cash flows of both options.

The table above shows the different discounts applied to the two payment options (I assumed that the 3% discount for the installment option would be applied to the gross cost). Then, we see the payments that you would have to make under each option; to simplify matters, I just assumed that the balance for the installment plan would be due in 24 months instead of 27.

Obviously, the installment option would cost you more in peso terms, but how much more would it cost you per year in percentage terms, considering the time value of money? To do this, we first get the "incremental cash flows" of choosing the installment plan over cash payment, then compute for the internal rate of return (IRR) of the cash flows. Using the IRR function of Excel, we get 9.68% per year. This means that by choosing to pay in installments rather than cash, you will pay an implied interest or cost of 9.68% per year. And since this is higher than what you earn from your time deposits, you are better off choosing the cash payment option.

Or, taking the 5% from your time deposits as your "cost of money," you can just get the present value of the cash flows from the two options. Since paying cash has a lower present value of payments than the installment plan, then you should choose the former.

Of course, there are other non-economic and subjective factors that you might want to consider in choosing a payment plan. If paying the entire amount in cash would leave your emergency fund empty, you might be forced to resort to more expensive debt in case of emergencies. However, I assume that both you and your husband are still working and would have ample insurance coverage as part of your work compensation and are capable of saving a significant amount on a monthly basis to rebuild your emergency fund fairly quickly. So maybe you can afford to spend your entire savings this one time.

If you really want to be on the safe side, however, I propose this "middle-ground" solution: get a housing loan for 1 million with an interest rate of less than 9.68% (which I think you can get from Pag Ibig), use this and a portion of your savings to pay cash and avail of the 12% discount, and still have a 1 million peso emergency fund.

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