For a Healthy Bank Balance, Plug Your

Ears with Wax

Mountains of debts have been the downfall of many a man (and woman). With focus and some will power, you can prevent financial disaster. Our grandparents and a legendary Greek hero have important lessons for us in sensible cash flow and debt management, writes Paul Stefansson.

According to Greek mythology, the intoxicating call of the sirens lured sailors to their doom by driving them to smash their ships into the rocks surrounding the sirens’ island.

This may be the stuff of legends, but in our world, we run the risk of financial doom when we succumb to the call of our own sirens — banks, car dealers, electronics goods malls and countless other consumer goods companies. They sing an irresistibly sweet song: the promise of easy money.

Unlike the frugal nature of our grandparents’ generation — when people diligently saved up for big ticket items, such as refrigerators and television sets — we buy on credit.

Ironically, years ago, banks were called Thrift Organisations and Savings and Loan Associations. Today, they sing a very different song, ‘Spend, spend, spend! Maximum credit up to eight times your salary! Fast cash for whatever, whenever!’

The culture of instant gratification has outstripped our grandparents’ thrifty way of life.

The Deadly Debts of Destruction

Satisfying all your desires today and paying tomorrow is enticing, but there is a very high price to pay — prohibitive interest rates. When we yield to these siren calls, we risk not only destroying our bank balances, but also running up a mountain of debt.

The consequences are severe: crippling debt puts our retirement dreams, our desire to provide our children with a good university education and other future lifestyle goals further, if not beyond, our reach.

Only Go Into Debt for Your Home

The ideal situation, to me, is to be free of debt. However, borrowing is not always bad; it can be an excellent wealth creation strategy. For instance, I believe that we should own our homes, so a home mortgage is a necessary evil. Given that, the next best thing is to manage debt well and then work towards being 
debt free.

Odysseus has a couple of good lessons for us.

Use goals to save now, buy later

The first lesson, however, comes from our grandparents: save now, buy later. It’s not rocket science, but it is not easy to do either, especially when the marketing machines of our modern day sirens are working overtime.

The legendary Odysseus saved his crew from the watery grave by ingeniously plugging their ears with wax, thus blocking out the deadly songs of the sirens.

How can you block out the noise from the market place? For starters, make a list of your needs and desires. Next, put dollar amounts to each item (this puts things in perspective).

Now, pick out one item you really want — the one that makes your face light up. It could be flying lessons, the snazzy Volkswagen Golf GTI or that trip around the world you’ve been dreaming of. The item you pick will then be your financial priority; it will be your wax to block out the noise.

Let me tell you why this is important: the mind is a self-organising mechanism. For instance, while you’re driving down a busy road, all you see are cars. However, if you are shopping around for a new Volkswagen Beetle, guess what you’ll see? That’s right, you’ll notice all the Beetles on the road.

In the same way, having a financial priority will help you stay focused on the prize.

The next step: good budgeting and cash flow management.

Spend less, save more

You may earn a lot of money, but you don’t know where it disappears. Here’s another exercise: Check your bank statements regularly and make sure that your deposits exceed your withdrawals by a healthy amount, and keep all your bills of the past three months and categorise your expenses.

This may be tedious but it will help you work out where you have been spending your money and which areas of expenditure you can cut back on — such as fine dining, drinks at the local pub and shopping (see Table 1 — Clutter).

For instance, my transport is the latest BMWTT. Is it the latest model from BMW? No. It stands for:

B —    Bus

M —    MRT

W —   Walk

T —     Taxi

T —     Tuk Tuk (when I’m in Thailand )

For many of you, having a car in Singapore may be a necessity for the family, but there are ways to work around this, such as buying a smaller car (a Mitsubishi Colt instead of the E200 Mercedes).

Managing your budget and cash flow well means that you’ll be able to save more and get your credit card spending under control. As a result, you’ll be able to manage your debt better.

Good personal debt management — 20%

If you have debt, how do you know if it’s too much?

A good way of assessing your financial standing is to use a simple calculation — the debt-to-income ratio. This simply compares the amount of your debt (excluding your mortgage or rent payment) to your income. The ratio is best figured on a monthly basis.

As a rule of thumb, a debt-to-income ratio that is less than 20% is considered healthy.

Take Cheryl Tan for instance, whose take-home pay is $8,000 per month. She has a monthly mortgage of $1,500 and her credit card debt payments are about $1,000 per month. Her debt-to-income ratio is therefore, 12.5% ($1000/$8000 x 100%), which is pretty healthy. However, if her credit card debt payments are over $1,600 per month, she’s on dangerous ground.

If your debt-to-income ratio is over 20%, taking the following steps will help you bring the ratio down:

(i)   Shop for the lowest credit card rates

      The reason for this is obvious: the lower the interest rate (and credit card rates are incredibly high), the less interest you pay. This will undoubtedly ease your burden.

(ii) Consolidate your credit card debts in one account

      A word of caution: this is very effective in managing credit card debt. However, the temptation to make random purchases with 
recently cleared credit cards is great, and this can lead to even larger debt.

(iii) Slice up your credit cards

      Odysseus wanted to listen to the sirens’ song, so he had his men tie him securely to the mast of the ship, to prevent any fatal moves on his part. It was a drastic measure, but it worked.

      After you have consolidated all your debt on one card, my advice is to slice up all your credit cards. This may be extreme, but it’ll save you from ballooning your debt further.

The next step is to reduce the amount of debt you have. Keeping your total debt to a manageable level allows you to deal with situations such as a significant rise in interest rates or career transitions. You should be focused on, ultimately, clearing all your debt.

Investment debt — live by the sword, die by the sword

While leveraging or borrowing on credit to invest can dramatically increase your returns, if markets go up, you can get into deep trouble if they go down. Let me tell you a story about two friends: Back in 2000, Sue bought an investment property in Sydney and Steve bought an investment property in Singapore . Both properties cost $1m; both friends put down a 20% downpayment and both were leveraged (see Table 2).

Last year, they both sold their properties. The price of the property in Sydney had risen by 50%, which was great for Sue. She had made a 50% return on her purchase price and a 250% return on her downpayment. This was a great example of how leveraging can vastly increase your returns.

However, as my grandmother used to say, ‘You live by the sword, you die by the sword.’

The price of Steve’s investment property in Singapore had plummeted to $800,000, by the time he sold it last year. He had made a 20% loss on the purchase price and a 100% loss on the downpayment.

Leveraging is double-edged sword; you can either make a lot of money or you can really get hurt.

The prize

Once you are free of debt, you will feel a new-found sense of freedom, and you are much closer to that prized item you’ve been working so hard for.

There’s just one more step: set aside a cash fund for emergencies. The rule of thumb is six months of your wages. How do you do it? Save, save, save.

Saving is very much like developing new eating habits (ie diets don’t work) — you don’t see any difference at the initial stages, but with discipline and perseverance, the results are clear … and very satisfying.

When you’ve accumulated more than sufficient funds for emergencies, by all means, reward yourself. You deserve it. However, don’t forget the bigger prize — your retirement. Stick to your disciplined savings and investments plan faithfully.

Reaching Land — Your Destination

Getting past the sirens to safe waters and ultimately, to land and safety is not easy, but if you set goals and remained focused on them, you will be able to block out the tempting calls to spend beyond your means. To have a healthy bank balance, plug your ears with wax. 

Table 1

Does Spending More Make You Happier?

Source: ipac financial planning Singapore

Happiness derived from acquiring new things increases when these items satisfy your needs (food and shelter) and provide you with comforts (a car). However, when you have met those needs and comforts, additional items become clutter and happiness tends to decrease. Open some of the drawers at home and I’m sure you’ll find plenty of stuff you don’t need. Happiness has to come from other sources, such as meaningful, long-term relationships, pursuing hobbies and a job you enjoy. 

Table 2

A Tale of Two Cities

Source: ipac financial planning Singapore  

Want more? Join us at our upcoming Money Matters workshop on 1 June 2005 where Paul Stefansson will share practical tips and workable strategies on ‘Cash Flow and Debt Management’ for you and your law practice. Improve your financial health for only $21.00! Places are limited. Contact the CPD Department at 6530 0233 or cpd@lawsoc.org.sg now.