Make Your Money Work for You!

In the Philippines, most people view dabbling in the stock market as a form of gambling and as a result avoid investing therein. In fact, several years ago, I asked my dad, who is arguably the most successful Filipino executive in the international pharmaceutical industry of his time, why he hasn’t considered investing some of his retirement money in the stock market or in other similar financial instruments. He told me that the reason why he does not is that he wants to have absolute control over his money and he cannot have that with the stock market because placing your money there is just exactly like gambling where other people and circumstances dictate the condition of one’s investments. Unfortunately, I believed him.

Ironically, for a lot of Filipinos, this way of thinking about investing in the stock and money market has led them to investing in get-rich-quick scams offered by unscrupulous persons. I mean, who hasn’t heard of Multitel, Aman Futures and the like? Instead of getting themselves financially educated and patiently investing in legal and time-tested ways to grow their money, they gullibly hitch on the bandwagon of these allegedly “safe” and “high yielding” investment vehicles such as the Ponzi Scheme, also known as the “pyramiding scheme.”

Now, some people might think that I am referring to Multi-Level Marketing (MLM) businesses. I am not. Pyramiding and MLM are not necessarily synonymous. While Ponzi schemes take people’s money and use them in paying the referral commissions of those who joined earlier without trafficking any actual product whatsoever, legitimate MLM companies carry tangible products such as food supplements, skincare and cosmetics, clothing apparel, and household stuff, to name a few. To know if you are joining a legitimate MLM company, make sure that the same is a corporate entity registered with the Securities and Exchange Commission (SEC) and a member of the Direct Selling Association of the Philippines (DSAP). Moreover, be wary of MLM companies that sell cheap products at exorbitant prices. Check the prevailing market value of similar products before jumping in. In other words, don’t just rely on the testimonies of certain network marketers, even if they are your family members, but do your own research. Due diligence is the key.

As for the stock market, when you buy the shares of stocks of a certain corporation, you actually become a part owner of that business. As a part owner, you get to have a share of the business profits, called dividends. In addition, you are also entitled to voting rights, provided that your shares are common stocks. Getting into the stock market only becomes as risky as gambling if you are involved in stock trading, where stocks are bought and sold within a short period of time through the use of market trend speculation. However, this is not the case when it comes to stock investing. Although investing in stocks still carries a higher amount of risk compared to fixed income securities such as government bonds and cash deposits due to its volatility, the same can be managed through the use of the Peso Cost Averaging method. Peso Cost Averaging works by investing a fixed amount money in stocks of great Philippine corporations in regular intervals instead of just on a one-time-big-time basis. In this manner, there is no need to time the market conditions because as you buy more units the average cost per unit of investment becomes smaller. Moreover, unlike stock trading, you invest for the long term, preferably a minimum of ten years so as to realize the positive yields of your money. Investing long-term greatly lessens, if not totally eliminates, the risk of devaluating your money because instead of focusing on the present and immediate situation of the market, you look at the bigger picture where, historically speaking, stock prices of great companies always rise in the long run even after a hard fall. Nevertheless, if you are still afraid of investing in the stock market directly or do not have enough money to invest yet, then you can consider investing in pooled equity or balanced funds through Mutual Funds, Unit Investment Trust Funds, or Variable Unit-Linked Insurance. However, that will be the subject of another article!

The bottomline is, in making your money grow, financial literacy is indispensable. So before investing your hard-earned money in any of these instruments, make sure that you invest in yourself first. Read books, attend seminars, watch video lectures, consult expert professionals, or if you’re up to it, go back to school and enroll in a business, finance or law related course. In this time and age of information technology, knowledge, nay, applied knowledge, truly is power; and with great power comes great responsibility!

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What are Mortgage-Backed Securities?

Although it is not yet widely known in the Philippines as an investment tool, Mortgage-Backed Securities (MBS) have been in vogue in the United States and other western nations. In fact, these financial instruments played a huge role in the financial crisis of 2008 caused by a huge number of borrowers who defaulted on their residential mortgages. To get an idea of what that was all about, read my previous blog where I posted an article from Wikipedia about the documentary movie “The Inside Job.” So what is an MBS and how is it sold and used as an investment vehicle?

Generally, real estate investments are classified into three categories: (1) Agricultural; (2) Residential; and (3) Commercial. MBS falls under the second category. In an MBS transaction, an issuer sells bonds to investors that are backed by a pool of mortgages. Specifically, the issuer acquires mortgage loans from various third-party lenders and other mortgage loan sellers (“originators”), pools those loans, and transfers them to a trust. The trust then issues certificates that are secured by some or all of the pooled mortgage loans and pays a yield to the investor linked to the cash flow—i.e., the principal and/or interest payments—from the loans. This process is called securitization.

If the borrowers whose mortgage loans back the certificates fail to pay their mortgages, the holders of the certificates backed by the loans might not receive the yield that they expected. The securitization process takes this risk into account in calculating the price and expected yield of the bonds backed by pools of mortgages.

MBS can be backed by different kinds of loans. Mortgage loans are designated prime if the borrowers to whom the loans are made have good credit scores, the loans are fully documented, and the mortgage loans conform to specified guidelines. These loans are considered less risky to investors when securitized, and as a result, pay lower yields. Subprime mortgages are mortgage loans made to borrowers with weaker credit scores and less documentation of income or assets. These loans are riskier because the borrowers are considered more likely to default on their loans. Alt-A mortgages fall between the prime and subprime categories, often involving prime borrowers but lower documentation than would be required for a prime mortgage.

To ensure that the loans they are making are appropriate and that the borrowers can repay them, the originators of the loans have underwriting guidelines that guide their decisions concerning whether to issue a mortgage loan to a borrower. These guidelines, however, are subject to a variety of “exceptions,” which allow an originator to make loans that did not fully comply with guidelines.

When determining whether to purchase a mortgage loan certificate, an investor might consider various statistics regarding the loans underlying the securitization, which were generally provided to them by the sponsor and underwriter of the transaction (described below). These figures would generally be represented to the investor in a document called the prospectus supplement. For example, the prospectus supplement would state the percentage of properties that were occupied by their owners (“owner-occupancy rates”) and the loan-to-value (“LTV”) ratios of the loans (the relationship between the amount of the loan and the value of the property securing the loan). This would give the investor information about how likely the borrowers on the loans underlying the securitizations would be to default on their mortgages. In addition, the prospectus supplement also generally summarized the underwriting guidelines for certain of the mortgage lenders, also known as originators, and represented that the originators made loans in accordance with their underwriting guidelines.

Each securitization would be divided into tranches, representing different ‘slices’ of risk exposure.  Each tranche had its own risk profile and was assigned its own credit rating, with the most senior tranches generally being the least risky and junior tranches having a higher degree of risk exposure.  Investors would select a tranche for purchase based on their appetite for risk.

The date on which a securitization was issued is known as the securitization’s closing date.  Each securitization was assigned a CUSIP number: an alphanumerical identifier unique to that securitization.

MBS were sold to the public by large investment banks such as Morgan Stanley, Bear Stearns, Goldman Sachs, Merrill Lynch, and the Lehman Brothers as profitable and safe investment vehicles. Only time will tell if and when such instruments or those similar thereto will become popular investment instruments in the Philippines and other developing countries in Asia. When that time comes, you would better be prepared. Remember, knowledge is power!

What Caused the Financial Crisis of 2008?

To give you a basic understanding of what really happened in 2008, what follows is a summary of the 2010 documentary that I watched entitled “The Inside Job,” which  was taken from Wikipedia.

Part I: How We Got Here

The American financial industry was regulated from 1940 to 1980, followed by a long period of deregulation. At the end of the 1980s, a savings and loan crisis cost taxpayers about $124 billion. In the late 1990s, the financial sector had consolidated into a few giant firms. In March 2000, the Internet Stock Bubble burst because investment banks promoted Internet companies that they knew would fail, resulting in $5 trillion in investor losses. In the 1990s, derivatives became popular in the industry and added instability. Efforts to regulate derivatives were thwarted by the Commodity Futures Modernization Act of 2000, backed by several key officials. In the 2000s, the industry was dominated by five investment banks (Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, and Bear Stearns), two financial conglomerates (Citigroup, JPMorgan Chase), three securitized insurance companies (AIG, MBIA, AMBAC) and the three rating agencies (Moody’s, Standard & Poors, Fitch). Investment banks bundled mortgages with other loans and debts into collateralized debt obligations (CDOs), which they sold to investors. Rating agencies gave many CDOs AAA ratings. Subprime loans led to predatory lending. Many home owners were given loans they could never repay.

Part II: The Bubble (2001–2007)

During the housing boom, the ratio of money borrowed by an investment bank versus the bank’s own assets reached unprecedented levels. The credit default swap (CDS), was akin to an insurance policy. Speculators could buy CDSs to bet against CDOs they did not own. Numerous CDOs were backed by subprime mortgages. Goldman-Sachs sold more than $3 billion worth of CDOs in the first half of 2006. Goldman also bet against the low-value CDOs, telling investors they were high-quality. The three biggest ratings agencies contributed to the problem. AAA-rated instruments rocketed from a mere handful in 2000 to over 4,000 in 2006.

Part III: The Crisis

The market for CDOs collapsed and investment banks were left with hundreds of billions of dollars in loans, CDOs and real estate they could not unload. The Great Recession began in November 2007, and in March 2008, Bear Stearns ran out of cash. In September, the federal government took over Fannie Mae and Freddie Mac, which had been on the brink of collapse. Two days later, Lehman Brothers collapsed. These entities all had AA or AAA ratings within days of being bailed out. Merrill Lynch, on the edge of collapse, was acquired by Bank of America. Henry Paulson and Timothy Geithner decided that Lehman must go into bankruptcy, which resulted in a collapse of the commercial paper market. On September 17, the insolvent AIG was taken over by the government. The next day, Paulson and Fed chairman Ben Bernanke asked Congress for $700 billion to bail out the banks. The global financial system became paralyzed. On October 3, 2008, President Bush signed the Troubled Asset Relief Program, but global stock markets continued to fall. Layoffs and foreclosures continued with unemployment rising to 10% in the U.S. and the European Union. By December 2008, GM and Chrysler also faced bankruptcy. Foreclosures in the U.S. reached unprecedented levels.

Part IV: Accountability

Top executives of the insolvent companies walked away with their personal fortunes intact. The executives had hand-picked their boards of directors, which handed out billions in bonuses after the government bailout. The major banks grew in power and doubled anti-reform efforts. Academic economists had for decades advocated for deregulation and helped shape U.S. policy. They still opposed reform after the 2008 crisis. Some of the consulting firms involved were the Analysis Group, Charles River Associates, Compass Lexecon, and the Law and Economics Consulting Group (LECG). Many of these economists had conflicts of interest, collecting sums as consultants to companies and other groups involved in the financial crisis.

Part V: Where We Are Now

Tens of thousands of U.S. factory workers were laid off. The new Obama administration’s financial reforms have been weak, and there was no significant proposed regulation of the practices of ratings agencies, lobbyists, and executive compensation. Geithner became Treasury Secretary. Feldstein, Tyson and Summers were all top economic advisers to Obama. Bernanke was reappointed Fed Chair. European nations have imposed strict regulations on bank compensation, but the U.S. has resisted them. Trust remains questionable.

Joseph the Dreamer

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“Let Pharaoh proceed to appoint overseers over the land and take one-fifth of the produce of the land of Egypt during the seven plentiful years. And let them gather all the food of these good years that are coming and store up grain under the authority of Pharaoh for food in the cities, and let them keep it. That food shall be a reserve for the land against the seven years of famine that are to occur in the land of Egypt, so that the land may not perish through the famine.” (Genesis 41:34-36, ESV)

Just a few hours after writing my previous article about the importance of life insurance in estate planning, I came across the above-quoted passage during my devotions. Maybe God intentionally led me to this passage of Scripture, which totally drives home my point in all my recent posts since last month, and that is: “Failing to plan is planning to fail.”

In the Old Testament account of Joseph, we can read how he was the most favored son of his father, Jacob (Israel). He was so obviously the favorite that his brothers plotted to kill him in jealousy. Fortunately, one of them convinced the others that killing their own flesh and blood is wrong and that they should just instead leave him in the pit where he was trapped. Nevertheless, when Bedouin caravan merchants came by, the brothers instead sold Joseph to them as a slave. Then they in turn sold Joseph at the public market who was bought by an Egyptian official named Potiphar. After many successes and tragedies in his life, Joseph finally gained favor in the eyes of Pharaoh who made him ruler of all Egypt second only to the king due to his God-given ability to interpret dreams and leadership capabilities. As a severe famine was about to strike the land of Egypt and its neighboring nations, Joseph came up with a plan to dampen, if not eradicate, the effects of the imminent famine. This story of Joseph is very famous that it was made by Walt Disney™ into an animated full-length feature film entitled “Joseph the Dreamer.”

This biblical story clearly illustrates the importance of planning ahead of any undesirable circumstance that may come our way. While Egypt’s neighboring countries suffered due to the ravaging effects of the famine, Egypt remained prosperous and plentiful. For us living in the 21st century, these undesirable circumstances may take the form of loss of employment; natural calamities such as earthquakes, typhoons and inundation; conflagration; sickness; or even death. This is where sound risk management, together with effective financial planning is a must. As with everything else, financial security starts with a plan. According to Rienzie Biolena, a Registered Financial Planner, “A comprehensive financial plan is a document that outlines the goals of a person, assesses his/her financial status, and gives concrete recommendations on how to achieve those goals. Each plan is different as every person has unique status, needs and aspirations. Yet all comprehensive financial plans cover each aspect of a person’s finances – cash flow, debt management, investments, insurance, tax and estate, and retirement.”

So when is the best time to start planning for your and your children’s future in order to protect yourself from life’s uncertainties? The answer is: YESTERDAY. Remember, failing to plan is planning to fail. So what are you waiting for? Contact your legal and financial adviser before it’s too late!

Life Insurance as an Indispensable Tool in Estate Planning

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In a previous article, I talked about the importance of having a sound estate plan in securing your family’s future, not only in terms of material needs, but also in order to ensure peace after you leave them for the afterlife. Now, I am here to discuss one of the most important, if not the most important tools in estate planning: life insurance.

Several years ago, I used to think that all life insurance agents are just out to get people to buy their product, which they cannot even enjoy during their lifetime. For me, life insurance was just another unnecessary expense that will further diminish my hard-earned money in addition to my contributions for my social security, PAG-IBIG, Philhealth, and those darn taxes. I was even annoyed how these agents refer to themselves as ‘financial advisors’ when in truth and in fact; all they are are but salesmen. Hence, whenever, a financial advisor would contact me in order to talk about my ‘future,’ I avoided them like the plague!

However, when I began learning about estate planning in order to include it in my law practice, I discovered and was truly convinced that life insurance is indeed very important and that 21st century insurance agents, at least the ones I know, are real financial advisors in the truest sense. As is often said in the insurance industry: “Life Insurance is the only necessity that you can purchase today when you do not need it and something that you cannot purchase in the future when you need it the most.” In fact, it is indispensable to sound estate planning and personal finance in general. Now why would I say such a thing? Here are some of the reasons:

  • Estate Tax. We all know that taxes are a pain in the ass (Especially for men because they keep their wallets in their back pockets!) and would therefore do anything to legally avoid paying them. Imagine, if you leave behind an estate worth at least ten million pesos (P10,000,000.00), then your heirs would have to pay a whopping minimum of P1,215,000.00 plus 20% of anything in excess of P10,000,000.00 in estate taxes! Now what if the only property you left was the ancestral or family home worth P10 million? Where will your heirs get the money to pay the estate tax, which, by the way, should be paid within six months from the time of your death? The only solution left is for them is to sell their beloved ancestral house and lot and usually at a loss. That would be so sad! However, ample life insurance can quickly solve this problem for just a fraction of the amount of estate tax due that your heirs would need to pay. How? By first applying the life insurance proceeds to the payment of the estate tax due. In this way, your heir/s would be able to receive their inheritance wholly intact.

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  • Equalization of Inheritance. Contrary to what most people think, Filipinos do not have the absolute liberty to dispose of their properties as they deem fit. One example of this is in the area of wills and succession. The law reserves a certain portion of our estate to those who are referred to as ‘compulsory heirs.’ This reserved portion is called their ‘legitime.’ There are instances however that some people would want to give more to an heir, especially if they have illegitimate children because under the Civil Code of the Philippines, the same are only entitled to one-half of the legitime of the legitimate children. One of the ways a testator can equalize the share of his illegitimate children is by bequeathing to them a bigger share from the free disposable portion of his estate. The problem with that strategy however is that it can and will cause feelings of hurt and resentment in the hearts of the surviving legitimate family because in addition to the betrayal, their share in the estate of their deceased parent is even lessened due to the presence of illegitimate children; or when the free disposable portion is insufficient. But there is a better way, and that is through life insurance. By naming the illegitimate children as beneficiaries, they will be able to receive more than what the law provides for them, provided that only a sufficient and fair amount is given to them in such a way that they will not receive a larger inheritance than the legitimate children.

These are just some of the reasons why life insurance is an indispensable tool in estate planning. To be sure, there are more but those will be discussed in later articles. For now, suffice it to say that life insurance is definitely not a want or a luxury, but certainly a necessity for those who are responsible enough to take care of the needs of their loved ones even in their permanent absence. If you would want to know more about how estate planning works, consult a trusted lawyer, accountant or financial planner.