Consult the Experts

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on June 1, 2020 - June 07, 2020.
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Question: I am a law graduate and I started my practice at the beginning of the year. I have a monthly salary of RM3,700 and I have opted to contribute 11% to the Employees Provident Fund. I am living with my parents and this is my monthly expenditure: gym (RM168), household and related expenses (RM700) and savings (RM1,000).

I do not have a car, so I do not have any loan commitments. I only need to contribute for petrol, which is RM200 to RM300 a month. I currently have savings of about RM3,000.

 

Here are my goals:

Short term: I want to save RM10,000 by the end of this year to start my investing journey. I also wish to get married at the end of next year or at the beginning of 2022.

Medium term: I wish to buy my first property — a landed house valued at about RM700,000. I am also looking to further my studies locally by pursuing either a Master of Business Administration or Master of Laws on a part-time basis.

Long term: I wish to open my own law firm and achieve the end goal of having financial freedom. I do not want to worry about sustaining my living costs as well as my future children’s education expenses.

 

My questions are as follows:

1. To achieve my short-term goal of marriage, is taking a personal loan a good idea if I do not want to rely on my parents for wedding-related expenditure? I plan to borrow RM50,000 to RM60,000.

2. To achieve my medium and long-term goals, are exchange-traded funds (ETFs) a safe and relatively low-risk option for me to invest my money in? I have done some research and found out that I would need US$200 to start investing in ETFs on certain platforms. Many people recommend ETFs that track the S&P 500.

3. Do you have any advice after looking at my goals?

Thank you so much in advance. > Donnie

 

Answer: 1. Let’s address your questions. I would strongly discourage you from taking a personal loan for your wedding. Personal loans are for emergencies only as they are some of the worst financial instruments to take up. Most personal loans are “flat-rate” loans, which means lenders first apply the interest rate throughout the loan tenure, then divide that by the number of months.

For example, if you take a RM50,000 loan at, say, an interest rate of 5% per annum for a loan tenure of five years, the calculation is as follows:

 

Total interest payable:

(RM50,000 x 5% x 5) = RM12,500

 

Total repaid including principal:

RM50,000 + RM12,500 = RM62,500

 

Monthly payment:

RM62,500 ÷ 60 = RM1,041.67

From this, you can see that you will be paying interest on your full principal of RM50,000 every year (equivalent to RM2,500 annually). In your fifth and final year, the amount you still owe the bank will be much less than the RM50,000 you borrowed — but you will still be paying RM2,500 in interest that year. This means the actual “interest rate” for your final year is much higher than the stated 5% (for example, in your fifth year, if you still owe the bank RM15,000, having to pay RM2,500 in interest is equivalent to an interest rate of 16.7%).

This complicated process is simplified for you with an indicator known as the effective interest rate (EIR). This EIR, which is sometimes stated by the banks, will give you a general idea of the true cost that you will be paying for your loan. The EIR for our example above is about 9.15% — almost double the stated interest rate of 5%. (Note: Please do not confuse EIR with effective compounding rate, which can sometimes go by the same name.)

Coming back to your question, if you can get an interest-free loan from your parents for your wedding expenses, that would be ideal. I do understand, though, that this is sometimes not possible. At the end of the day, you should always spend within your means.

 

2. ETFs are relatively safe and hassle-free, as long as you choose the right ones. In your situation, it is good to get ETFs that track the S&P 500. I suggest investing your money consistently each month to mitigate risks via dollar cost averaging. This also eliminates the whole “timing the market” issue.

Using ETFs means that you generally need very little direct management as there is no need to pick stocks. There is also a low risk of losses as mature indices such as the S&P 500 or Dow Jones Industrial Average will definitely go up — it is just a matter of when.

 

3. Your goals are clear, which makes planning for them easier. However, you may find it a bit of a stretch to achieve all of them at your current rate of saving (RM1,000 monthly).

 

a) Your wedding will be in 1½ to 2 years’ time, so I would not recommend deploying that money into anything risky. You probably do not want to delay the wedding due to bad market conditions.

 

b) Regarding your property purchase, please be aware of the commonly unseen costs. In your case of a RM700,000 property, assuming no exemptions, no discounts, no rebates and no government perks, the initial costs shown in Table 1 apply.

So, depending on what incentives there are when you purchase the property, you may be paying up to RM101,700 up front. This does not even include renovation and furnishing costs, which will push the figure much higher.

 

c) In Table 2, I give you a general overview of how long it will take to save for each goal, assuming you save RM1,000 a month and invest it at a consistent 5% return per annum, compounded. We use 5% as it is a more reasonable rate to consistently achieve. Of course, the costs stated are just estimates.

 

So, if you want to fund your wedding, property purchase with furnishing and private university fees, all done back to back (meaning you save up for one goal, spend it all, and then start saving for the next goal), you will take 18 years and 9 months. If you save up the full amount for all three goals and then spend it all at one go, it will take more than 15 years and 2 months.

This assumes that you save RM1,000 a month with nothing left over for holidays, honeymoon, family expenses, children’s expenses, children’s education expenses and definitely, no business set-up costs.

 

4. So, is it all doom and gloom? The answer is no. With the exception of your wedding costs, you are well within a position to fund your mid to long-term goals. The determining factor is how much money you are saving. As you are a fresh graduate with little to no financial commitments, you can definitely try to save more. For example, if you save RM1,500 instead of RM1,000, you will save about 30% of the time required to achieve a specific goal.

In summary, here is the short version of what to do to optimise your finances. First, make sure you have at least basic medical insurance, which needs little to no upgrading. You can always add other items when you are anticipating a larger financial responsibility.

Next, save and invest monthly. Depending on your risk tolerance, you will want to allocate some money to low-risk financial instruments and some to higher-risk instruments to maximise growth. As for the amount to save and invest, focus on the percentage of your income, as opposed to the absolute number. This will help keep your savings up even when you earn more.

As always with financial planning, there are no miracles. Consistency is a big factor in achieving goals. You are already on the right track. Just improve slightly and keep it up.