Roadmap to financial freedom

Business/Your Money: Roadmap to financial freedom
By Yap Ming Hui

2009/03/08

IN my previous articles, I had discussed the five essential elements of financial freedom namely, spending, inflation, return on investment (ROI), time and saving. If you have knowledge of these elements it is good. However, knowing and understanding the five elements will not help you achieve financial freedom. Knowledge is only powerful when you apply it. Therefore, the challenge is to apply the knowledge of the five elements to your own real-life situation. Do you know how?

Let me share a real-life case study of Muthu. The following details of him:

- He is 36 years old and the wife is 34 years old

- He has two children age 8 and 5 now

- He works as senior manager in a multi-national corporation with RM120,000 annual income. His wife works as adminis-trative manager with RM100,000 annual income

- He has the following financial assets:

-- House: RM500,000 with RM250,000 mortgage loan

-- Unit Trust: RM30,000

-- Bank savings: RM200,000

-- EPF: RM200,000 (himself), RM150,000 (wife)

- He and his family is currently enjoying a life style of RM120,000 per year.

- He and his wife intend to retire at 55 with RM96,000 living expenses per year.

- They would like to provide RM200,000 each for their children's tertiary education.

Do you think Muthu will be able to achieve his financial freedom (assuming that he expects to live until the age of 80)?

Will he or will he not?

The best way to answer this question is to plot a roadmap to financial freedom for Muthu and it would look like chart A.

The Y axis of chart A represents the net worth amount of Muthu. The X axis represents the age of Muthu.

From the roadmap, we can see that Muthu's net worth will grow to about RM400,000 when he is 45. But it drops to almost zero at 46 when his first child goes into university. After that, it rises slightly but drops to zero again at 49 when the second child enters the university. His net worth stays there until 55 when he withdraws his EPF money. Then, his net worth grows to about RM1,100,000.

At age 57, his wife withdraws her EPF money and their family net worth grows to about RM2,450,000. From there, their net worth continues to drop. Their net worth becomes zero when Muthu is 65. In another words, Muthu's wealth will run out at age 65.

Based on Muthu's desire to have his wealth last until age 80, the roadmap shows that his current money management will not achieve all his financial needs and wants.

It is important to have a roadmap to measure our progress towards our goal of financial freedom.

By having the roadmap, we are able to know where we stand now in our journey to financial freedom, and the necessary actions to take to move towards that destination.

Without a roadmap to financial freedom, you won't know if you have enough financial resources to meet all your financial needs and wants. Without this knowledge, you may continue to over-spend and under-save. When you realise the problem at age 50 or 55, it is already too late to make any changes or take any actions.

In short, managing your personal finance without the roadmap to financial freedom is like shooting a target in the dark. You don't know where the target is and you don't know whether you have shot the target.

By knowing his current roadmap, Muthu will be able to take some actions and re-prioritise his financial needs and wants to achieve his financial freedom.

First, he can restructure his investment portfolio to achieve higher ROI. His current investment's ROI is 3.8 per cent. If he is able to achieve nine per cent ROI for his investment portfolio, his roadmap will look like chart B.

After increasing his ROI, Muthu's net worth will last longer now from age 65 to age 68. This is still not good enough. The target is to have the money last beyond age 80.

In that case, he will need reduce his life style spending during his retirement from RM96,000 to RM84,000. It means RM1,000 less per month. Muthu is willing to make the adjustment to make his wealth last longer. After the adjustment, his roadmap will look like chart C.

After reducing his retirement life style spending, Muthu's net worth will last until age 71. This is better but still not good enough.

Based on the adjusted roadmap, Muthu will need to adjust his current life style spending to increase his savings. If he reduces his current life style spending per year from RM120,000 to RM105,000, he will have additional RM15,000 savings per year. Then his roadmap will look like chart D.

After reducing his current life style spending Muthu's net worth will now last until age 83. By making those few adjustments Muthu is now able to achieve his financial freedom.


* Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, which has recently launched Roadmap to Financial Freedom service to help guide Malaysian families to achieve financial freedom.



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