Money Makeover: Prepare for the unexpected

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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 9 - 15, 2017.


There are moments in life that will change everything. You may be made redundant at work, discover you are pregnant or even lose a loved one. These unexpected life events can have a deep and far-reaching impact on your financial well-being.

You cannot predict the future, but you can plan for it. And to plan for the future, it is very important to know the kind of life events that could affect you emotionally and financially. 

According to a recent HSBC report, Life Changers, the number one personal life changer is having a baby (60%), followed by marriage (57%), losing a parent (38%), divorce (37%), retirement (34%), starting a business (32%), buying a home (27%), having a critical illness or injury (24%) and others. 

The most adverse financial impact occurs when you suffer a critical illness or injury (78%), followed by traumatic accidents (76%) and divorce or separation from a partner (75%). While unexpected expenses may be inevitable, it should not derail your financial goals. In fact, the best way to handle such events is to be prepared for them in advance. It comes down to being prudent and thoughtful in creating a financial plan.

One of my clients, Mark, 47, is a successful entrepreneur earning an annual income of RM684,000. He has three children studying at an international school and a wife who is a homemaker. 

Though he earns a lot, his savings were only about 4% of his total income when I met him in 2012. His total savings in the bank and unit trusts were just RM117,000. 

Being an entrepreneur, he had chosen not to contribute to the Employees Provident Fund. Instead, he bought a number of endowment plans for himself and his family amounting to premiums of RM196,000 per year for death or total permanent disability coverage of RM1.4 million and critical illness coverage of RM1.1 million. 

He was of the opinion that this coverage, his retirement fund and his children’s education fund would last him a lifetime. His lifestyle expenses were RM46,000 per month and his debt ratio was 75%. 

While we were planning to restructure his finances, his professional licence was suspended for six months by the authorities because of a lawsuit by his client. All of a sudden, he had no income at all! 

His meagre savings could only last three months. Most of his assets were properties, which included two shoplots and a piece of land, as well as the cash value of his insurance policies. To cut back on his financial commitments and free up some cash, he surrendered four of his endowment policies, refinanced his home loan and sold all his liquid investments to sustain his monthly living expenses.

As the first step, we came up with a detailed cash flow management plan, which we review on a quarterly basis, to set up some solid emergency funds to support him for at least six months. Mark really cannot afford to be thrown off by another unexpected life event or financial misfortune. 

Table 1 shows Mark’s savings and net worth after he carried out the proposed strategies under his financial plan.

According to the HSBC Life Changers report, critical illness and injury through a traumatic accident are the two most financially damaging events that people experience. Based on the protection need and life goals analysis, it was recommended that Mark take up an additional RM5 million in death and disability insurance to provide continuous income for his family. 

Adequate coverage is also needed for critical illness and hospitalisation, which could destroy his ability to generate income for his family. A fund is also essential to settle all outstanding debts (overdraft, personal loans, mortgage and so on) and to support his children’s tertiary education in the event that he is unable to earn an income because of critical illness or unforeseen circumstances. 

Understanding the huge financial responsibility of being the sole breadwinner, Mark topped up his death and disability coverage to RM3 million, with a critical illness rider of RM1.5 million, in 2015.

By end-2014, his assets — especially the liquid ones such as shares, unit trust investments and Amanah Saham savings — had grown from RM450,000 to about RM1 million. His savings have improved significantly over the years, and so have his investments — from RM58,000 in 2014 to RM75,000 in 2015 — which are in a structured investment portfolio based on his investment objectives, time horizon, risk appetite and financial goals. 

Another review was conducted early this year and we could see the improvement in his financial well-being. Mark has cultivated the habit of saving and has been doing his best to cut out unnecessary spending. He is now able to retire at age 60 instead of 65 with the improved retirement income of RM324,000 per year, from RM190,000 previously. 

Not only can Mark provide more education funds for his three children when they turn 18, he is able to enjoy an annual vacation with a budget of RM40,000 per year as seen in Table 2.

Even with the careful planning, you may still be taken by surprise by unforeseen circumstances. Towards the middle of last year, Mark faced another unfortunate event, where his company was audited and penalised by the Inland Revenue Department for over-claiming eligible expenses. He was slapped with a tax penalty of up to RM800,000 for the tax returns submitted in 2014 and 2015. As a director of the company, he had no choice but to contribute from his personal savings of RM400,000 to settle the penalty, which wiped out all of his emergency fund and part of his investment savings. 

From the analysis, this event has resulted in a capital shortfall of RM284,000 (adjusted for inflation). The additional amount that Mark would now need to save is RM1,941 per month indexed to inflation to fund all of his financial goals. This includes meeting his retirement income needs at 60, assuming there are no more changes to other factors. 

To rebuild the emergency fund, he is willing to reduce his annual vacation budget to RM10,000 for three years as well as contribute an additional RM2,000 a month to his investment portfolio. He is thankful that he is able to make informed financial decisions to reduce the impact on his financial goals.

Life is full of challenges and unpredictable outcomes. As your life changes, so will your financial needs. Issues such as longevity, inflation, market volatility and the escalating cost of healthcare can easily impact your financial well-being. Not many of us think ahead about our financial needs at every stage of life. Having a solid financial plan will definitely help us to navigate challenges and stay on track. Failing to plan means planning to fail.

Catherine Khoo is a licensed financial planner with CWA . She was recently recognised by the Financial Planning Association of Malaysian as one of the top 3 scorers at the Malaysian Financial Planner of the Year Award 2015. For queries, email us at [email protected].