Personal Finance for Lawyers

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A lot of people think that lawyers make a lot of money. People automatically think highly of you: “Oh, you’re a lawyer, you must be rich or at least you’re getting there.” However, there is nothing farther from the truth. Of course, there are those blessed few who have made it to the big leagues and are now founding or senior partners of large and prestigious law firms. Surely, without possessing other sets of skills, in-depth knowledge of the law alone will not and cannot guarantee financial freedom and prosperity.

Lawyers usually earn in one of three ways: a) as a purely compensation income earner, i.e. as an employee; b) as a fee-based self-employed professional; or c) a combination of the first two. The problem is, especially for self-employed lawyers, as well as other similarly situated professionals, our income is wholly dependent on how much man-hours we put into working. In other words, no work, no pay! Those who use the time-billing method know this particularly well. As such, most lawyers end up working all their lives because no matter how old we get, for as long as we’re alive, our cost of living just keeps on going up to no end! Sometimes, we even proudly use it as a battle cry, “Lawyers never retire!” Verily, the stereotypical image of the “Abogado de campanilla” comes to mind: An old thin man with unkempt gray or balding hair wearing a faded barong carrying his briefcase to court. Indeed, it is such a sad and sorry sight to behold. I know because I’ve seen them. And could you imagine what would happen to them if they become too old to work or permanently incapacitated?

Generally, lawyers, except for those who are at the same time finance professionals such as CPAs, CFAs, RFPs, RFCs, CFCs, CWMs, etc., abhor numbers. To be sure, one of the significant reasons why people take up law, among other things, is because they did poorly in math and science during their elementary and high school days. Wait, I might just be describing myself here! Nevertheless, studying law and passing the dreaded bar exams do not require one to be adept in numbers. There are no complicated formulas or computations save for the determination of an employee’s minimum wage, a stockholder’s shares of stocks, or the occasional computation of taxable income; although the last one is pretty much done by accountants. The point is, lawyers, nay; most people in fact, just tune out when numbers are involved. As behaviorist Daniel Kahneman said in his landmark book, Thinking, Fast and Slow, our brains usually take the shortcut or the easier route when we are faced with numerical problems, which he refers to as the “System One” mode of thinking.

No wonder, it is because of this numerical aversion that lawyers avoid thinking about personal finance. To make things worse, society’s high regard for lawyers along with the dignity of the profession leave lawyers with no other choice but to do their very best to project success and honorability in how they dress, walk and talk. These kinds of expectations, not to mention the challenges of life itself, put a strain on a lawyer’s finances, especially if that lawyer already has a family of his own.

Having said this, learning about personal financial planning is indispensable for a person who wants to achieve financial freedom and prosperity, regardless of occupation. But the big question in most people’s minds is, “Where do I begin?” And a very good question it is indeed because personal financial planning is a process. Being a process, you should not jump from one step to another without completing the previous step. At Personal Finance Advisers Philippines (PFA), we have what registered financial planner and seasoned investment adviser Efren Cruz, calls the CD-RW approach to personal finance. CD-RW stands for the phases of or major steps in the financial planning process, which are: Cash, Debt, Risk and Wealth. Not undertaking any one of the four areas of financial management will lead to instability in one’s personal finance. Other registered financial planners divide the steps into five or twelve as do Randell Tiongson and Alvin Tabaňag, respectively. For simplicity and ease, however, we shall summarize the process to the four steps. A person hoping to get out of debt should not be investing before he reduces his debts to manageable levels. In fact, he shouldn’t be investing at all if he hasn’t yet protected his downside risks through insurance. Let me briefly discuss each phase:

Cash” pertains to improving one’s cashflow. There are many ways to do this such as getting a promotion, getting more clients, starting a business, or selling some stuff that you do not need anymore. In fact, Robert Kiyosaki refers to this as Financial Intelligence No. 1. Short-term and current savings also fall under this phase. In fact, these two steps under this phase may and should be done simultaneously if you can. In fact, being successful in this area alone would definitely have a strong and lasting impact in your financial well-being.

Debt” pertains to getting out of debt. Albeit, it is not always necessary to totally eliminate all debts because there are certain debts that are truly indispensable or even good such as debts incurred for business capitalization purposes. What is more important is that debts are reduced to manageable levels.

Risk” pertains to protecting yourself and your family from life’s unexpected risks such as loss of job, total and permanent disability, and even death. The steps comprising this phase are setting up one’s emergency fund and insurance planning—both life and non-life. Although not usually done, I would also include here adequate asset protection planning.

Wealth” pertains to the accumulation thereof through long-term saving and investing. In other words, it is how to make your money work for you and not just you working for money. This is the phase where if successful, can spell the difference between being rich, just right, or poor. The primary reason we should be investing is because we will not always have the ability to generate income. Investing can be in the form of real estate, business, commodities, or the most popular class, paper assets such as stocks, bonds, money market instruments and pooled funds. Of course, we cannot bring our wealth with us when we pass on from this life, hence, included in this phase is estate planning or how to legally pass on your property and money to your loved ones when that time comes.

For now, we will focus on the first phase, which is the foundation of the financial planning process, and that is cashflow management. Contrary to popular belief, cashflow management is not only about being frugal when it comes to one’s expenses but about being wise. In behavioral economics, it is said that finance is only 10% skill and 90% behavior. This means that while we may possess all the necessary technical skills, all of that will be for naught if we cannot control ourselves and exercise prudence when it comes to spending our hard-earned money.

For effective cashflow management, categorize your expenses into “needs” and “wants,” the latter also being referred to as “discretionary expenses.” One of the biggest mistakes people make is rushing into financial decisions without considering what’s really important for them. As many people get caught up in the responsibilities of their daily lives, they often do not have time for reflection. The easiest way to identify wants is to actually start with needs. Needs can be further broken down into two broad categories: absolute or bare necessities and near necessities. Absolute necessities are those that are important for our basic survival, things like food, shelter and clothing. On the other hand, near necessities include things like reliable transportation, insurance coverage, utilities, telecommunications, and personal care expenses. While these last items are not necessary for survival, they are fairly important for us to function as responsible and effective members of society. Now that we know what needs are, it would be easy to define our wants. Now, everything else that do not fall into the category of needs are therefore classified as wants and could be cut out if necessary. To be more specific, wants are items that are only nice to have. They are not things that you need to survive. Although sometimes, needs turn into wants when you take your needs beyond the basics, i.e. if you buy a home that is much larger or a car that costs more than you can afford. Carefully go through your expenses and determine which are truly needs, and which are actually wants the order them. After determining your needs and wants, create a plan for living within your means. This is important to finding success in your personal finance.

To reach a certain place, the first thing you must know is where you are right now. You simply cannot plot your course without knowing your starting point. In order to know where you are financially, you have to determine your net worth. Your net worth is an important barometer of your financial health. It indicates your capacity to accomplish major financial goals to be discussed later. Just as all government officials are mandated to submit their Statement of Assets, Liabilities and Net Worth (SALN), everyone would do well to follow suit as this is an excellent tool for financial planning. To compute your net worth, you just have to follow this simple formula: Assets – Liabilities = Net Worth. Your assets consist of everything you own, both real and personal properties including cash in bank and cash on hand; while your liabilities consist of everything you owe such as debts and taxes. For financial planning purposes however, it is generally recommended that you exclude your family home when figuring out your financial assets. Include your home only if you expect to someday sell it or otherwise have it leased out to generate passive income.

Once you have determined where you are, the next preparatory step is to know where you want to go. In short, determine your goals. Your goals will vary depending on the life stage you are in; whether you are a student, single professional, married, married with children, empty nester, or retired. Accordingly, your financial goals may be one or more of the following: income continuation, starting a business, children’s education fund, health fund, buying a house or a car, getting married, a family vacation, retirement fund or estate creation and preservation. It is important to determine your goals as each of these goals will have a corresponding cost that you will need to prepare for. Not knowing where you are or where you are going will only lead you nowhere fast! It would just be like driving around aimlessly with no purpose in mind except to waste precious fuel. Failure to plan is a plan to fail.

Once you have plotted your course, it is now time to gather your resources for the journey, and this is where saving money comes into play. Most people however, if not everyone, try to save only what is left, if any, of their salary or income after paying all the bills and cost of living expenses, sometimes even including their leisure expenses. And this is exactly why they fail. Instead of using the formula Income – Expenses = Savings, we should change our mindset to Income – Savings = Expenses. Better yet, I’ll let you in on the secret formula to prosperity: Income – Tithes – Savings = Expenses. Specifically, the apportionment should be as follows: 100% (Income) – 10% (Tithes) – 20% (Savings) = 70% (Living Expenses). Now why do I include the tithe? It is because I believe that because God is the one who gives us the ability to produce wealth (Deuteronomy 8:18), then giving back the tithe is one of the best ways we can honor Him with our wealth. To be sure, God told the prophet Malachi to instruct His people to “Bring the full tithe into the storehouse, that there may be food in my house. And thereby put me to the test, says the LORD of hosts, if I will not open the flood windows of heaven for you and pour down for you a blessing until there is no more need” (3:10, ESV). In fact, this is the only exception to God’s law against putting Him to the test (Luke 4:12). This principle of saving is referred to a “Paying God and yourself first.” Nonetheless, if saving 20% is really difficult for you right now, you can start small with just 10% and increase it later on when your cashflow improves.

Saving is an essential part of the process because the funds accumulated as a result of which is where you will source the money needed for your emergency fund, paying off your loans, insurance premiums, and investments, in that particular order if not simultaneously. Without improving your cashflow and saving money, any financial planning activity shall be futile for lack of the ability to execute the same. The strategy to saving effectively is quite simple and is no secret at all: “Spend less than you earn,” or to put it in another way, “Live below your means.” It never fails. One can choose to be a saver or a big spender. The big spender follows the incorrect formula for saving. I know, it’s so much easier said than done; but with God’s grace, it is truly possible!

Some people tend to blame their financial shortcomings on not earning more income. Such people believe that if only they earned more, their financial—and personal—problems would melt away. The thing is, as Robert Kiyosaki puts it, “It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.” In short, it is all about increasing our financial I.Q. Remember, you cannot grow what you do not have. Regardless of your income or how you earn your income, you can make your money stretch further if you practice good financial habits and avoid mistakes. Effective and efficient cashflow management is essential to building wealth. In fact, the lower your income, the more important it is that you make the most of your income and savings because you don’t have the luxury of falling back on your next fat paycheck to bail you out. As aptly posited by Alvin Tabaňag, “A healthy amount of savings is the foundation on which you will build your personal wealth. Without any savings it is impossible for you to achieve financial security.”

There is so much more to learn about personal financial planning that this article can cover. Unfortunately, personal finance, for all its importance and practicality, is not generally taught in our schools. Yes, we have economics in high school and college, but the theories taught therein are usually either archaic or inapplicable in real life due to its extreme technicality. So, invest in yourself first. Read books, blogs and attend seminars of reputable finance professionals such as those mentioned above. The journey of a thousand miles begins with a single step. May the grace of our Lord be with you!

Advantages of Investing in Mutual Funds

When it comes to investing in the stock market, financial and investment advisers will always caution potential investors that before they place their hard-earned money therein, they should first be all-SET. This means that they should have the Size of funds, Expertise and Time. However, even though a potential stock market investor may not be all-SET, there is still an alternative paper asset that one can invest in — Mutual Funds. Below are the advantages of investing in mutual funds according to the Philippine Investment Funds Association (PIFA) and the Securities and Exchange Commission (SEC) along with my additional comments:

1. Professional Management

One of the main attractions of mutual funds is that it affords its investors, particularly the small ones, the services of full-time professional managers whose job is to analyze the various investment products available in the market and select those that would give the best possible returns to the fund and its shareholders.

2. Low Capital Requirement

Direct investments usually require substantial capital. The minimum investment amounts for Treasury Bills and Commercial paper, for instance, range from P100,000 to P1,000,000 depending on the bank or investment house you are dealing with. This also holds true for stock because while you may be able to buy one “lot” (shares are sold in board lots ranging from 10 shares to 1 million shares depending on the price at which these shares are traded) for as low as P1,000 or P5,000, you may not be able to buy the stock that you really want, especially the blue chip and growth stocks.

3. Diversification

There is a saying that goes, “Do not put all your eggs in one basket.” This adage is especially true in the world of investments which is full of uncertainties. In fact, even King Solomon, the wisest king who has ever lived, said, “But divide your investments among many places, for you do not know what risks might lie ahead (Ecclesiastes 11:2, NLT). There is no such thing as a “sure” thing. An important investment principle that requires holding several securities to reduce the risks associated with investing in individual securities is called diversification. When you invest in a mutual fund, you achieve instant diversification because the fund is required by law to be invested in a wide array of issues and/or securities.

4. Liquidity

Liquidity is the ability to readily convert investments into cash. Other investment products require you to find  buyer so that you can liquidate your investments. That is not the case with mutual fund shares because the fund itself stands ready to buy back these shares at the prevailing Net Asset Value Per Share. While the law provides that redemption proceeds must be given within seven (7) banking days from the date of the redemption request, most funds are able to pay the redemption proceeds within the next day. Mutual Funds are, therefore, considered very liquid investments.

5. Safety

Safety is a very important consideration for most investors. Mutual funds are highly regulated by the Securities and Exchange Commission under the Investment Company Act and its Implementing Rules and Regulations. Mutual funds are prohibited from investing in particular investment products and engaging in certain transactions. They also have to  submit regular reports to  the SEC as well as to their shareholders.

6. Potentially Higher Returns

Because a mutual fund is managed as a single portfolio, it is able to take advantage of certain economies of scale. For instance, with its millions of pesos (or other currency) under management, it can negotiate for lower stockbrokerage fees or higher interest rates on fixed-income instruments. In the end, however, it is still the investment company adviser who really makes the big difference when an individual is faced with this decision — “Will I make direct investments by myself or will I invest in a mutual fund?” Because very few individual investors can match the experience and skill of full-time professional fund managers, the investing public is well advised to invest in a mutual fund instead.

7. Convenience

Mutual funds are purchased directly through SEC-licensed Certified Investment Solicitors (CIS) only. These CIS are usually connected to banks, insurance companies, investment companies, or brokerage firms and normally provide personal, tailor-fit service. Some fund companies have even set up retail centers for investors. Many have payroll deduction plans and some funds, with proper authorization, will deduct and invest on a regular basis a specified amount from the shareholder’s bank account.

Funds offer a variety of services, including preparing monthly or quarterly account statements, automatically debiting additional investments from, or crediting redemption proceeds to, the investors’ bank account; or allowing transfers from one fund to another. Most major mutual fund companies offer extensive record-keeping services to help investors track their transactions and follow their funds’ performance via phone, text message, or the internet.

8. Transparency

Investment company advisers (such as Philam Asset Management, Inc.) provide investors with updated information pertaining to the fund. All material facts are disclosed to investors as required by the SEC.

9.  Flexibility

Investors are allowed to modify investment strategies over time by transferring or moving from one fund to another within a mutual fund family.

Some of the Things that a Professional Financial Advisor Does

Financial Planning:
• Cares more about you and your money than anyone who doesn’t share your last name
• Asks questions in order to understand your needs and objectives
• Helps you determine where you are at present
• Guides you to think about areas of your financial life you may not have considered
• Helps organize your financial situation
• Formalizes your goals and puts them in writing for you
• Helps you prioritize your financial opportunities
• Helps you determine realistic goals
• Studies possible alternatives that could meet your goals
• Prepares a financial plan and/or an investment policy statement for you
• Makes specific recommendations to help you meet your goals
• Implements those recommendations
• Suggests creative alternatives that you may not have considered
• Reviews and recommends life insurance policies to protect you
• Assists you in setting up a company retirement plan
• Assists in preparing an estate plan for you
• Persuades you to do the things you know you ought to do, even if you don’t feel like doing them

Investments:
• Prepares an asset allocation for you so you can achieve the best rate of return for a given level of risk tolerance
• Does due diligence on money managers and mutual fund managers in order to make appropriate recommendations
• Stays up to date on changes in the investment world
• Monitors your investments
• Reviews existing annuities
• Reviews your investments in your company PERA plans
• Reviews and revises portfolios as conditions change
• Guides you through difficult periods in the stock market by sharing historical perspective
• Works with you to improve your investment performance
• Can look inside your mutual funds to compare how many of their holdings duplicate each other
• Converts your investments to lifetime income
• Helps you evaluate the differences in risk levels between various fixed-income investments such as government bonds and corporate bonds.
• Provides research on stocks from both affiliated firm and third parties
• Holds and warehouses stocks, bonds and other securities
• Records and researches your cost basis on securities
• Provides you with unbiased stock research
• Provides you with personal stock analysis
• Provides you with a written sector-based evaluation of your portfolio
• Determines the risk level of your existing portfolio
• Helps you consolidate and simplify your investments
• Can provide you with technical fundamental and quantitative stock analysis
• Gives you strategies for trading options
• Provides you with executive services involving restricted stock and employer stock options
• Provides introductions to money managers
• Show you how to access your statement and other information online
• Shops top rates from financial institutions throughout the country
• Provides access to answers from a major investment firm

Taxes
• Suggests alternatives to lower your taxes
• Review your tax returns with an eye to possible savings in the future
• Stays up to date on tax law changes
• Helps you reduce your taxes
• Repositions investments to take full advantage of tax law provisions
• Works with your tax and legal advisors to help you meet your financial goals.

Person-to Person:
• Monitors changes in your life and family situation
• Proactively keeps in touch with you
• Remains only a telephone call away to answer financial questions for you
• Serves as a human glossary of financial terms such as beta, P/E ratio, and Sharpe ratio
• Makes sure that the he/she and the firm provide excellent service at all times
• Provides referrals to other professionals, such as accountants and attorneys
• Refers you to banking establishments for loan and trust alternatives
• Provides you with a chart showing the monthly income from all of your investments
• Suggests alternatives to increase your income during retirement
• Listens and provides feedback in a way that a magazine or newsletter writer does not
• Shares the experiences of dozens or hundreds of clients who have faced circumstances similar to yours
• Helps educate your children and grandchildren about investments and financial concepts
• Holds seminars to discuss significant and /or new financial concepts
• Helps with continuity of your family’s financial plan through generations
• Facilitates the transfer of investments from individual names to trust or from an owner through to beneficiaries
• Keeps you on track
• Identifies your savings shortfalls
• Develops and monitors a strategy for debt reduction
• Educates you on retirement issues
• Educates you on estate planning issues
• Educates you on college savings and financial aid options
• Is someone you can trust and get advice from in all of your financial matters
• Is a wise sounding board for ideas you are considering
• Is honest with you
• Saves you time

Words of Wisdom From Master Advisor Nick Murray

1. If you are still prospecting, no matter what else is wrong with your business, you will yet succeed. If you stop prospecting, in the absence of a steady flow of referrals/introductions, then no matter what else appears to be right with your business at the moment, you are ultimately going to fail.

2. “Rejection” does not hurt, other than to the extent we allow it to do so. The only way to hear “yes” is to risk hearing “no.”

3. Most people who invest most of their capital in fixed income investments as they go into retirement will run out of money well within their lifetimes, and will die destitute and dependent upon their children. Equities: life. Bonds: death-in-life.

4. Optimism is the only realism. It is the only world view that squares with the facts, and with the historical record.

5. Get a year’s living expenses in a money market fund as quickly as you can, even if you have live on coffee and rice while you’re saving toward this goal. This will allow you to turn down business that doesn’t feel 100% right to you. It will give you the strength to tell any prospect to go to the devil, and make it stick.

6. It is infinitely easier to turn a one-million dollar client into a two-million dollar client than it is to turn ten one-hundred thousand-dollar clients into two-hundred-thousand dollar clients.

7. Money is love. The wise advisor will always look for clients who wish to use their money as an expression of love.

8. Your price is only an issue to the extent that your value is in question.

9. Every year on your birthday, fire the client who has given you the most grief since your last birthday.

10. Never take part of an investment account. Win it all, or pass on it all. It’s not just the gaps, the overlaps and the lost fee efficiencies that make divided accounts a no-no: it’s that you’re getting sucked into a performance derby.

11. When we are telling prospects and clients exactly what they need to do in order to achieve their most deeply-held financial goals, it is not possible for them to counter with valid objections, because there are no valid objections.

12. The origin of all wealth is threefold: personal initiative, hard work, and thrift. Tell me the percentage of your income that you’re putting away, and I’ll tell you whether you’re going to achieve your financial goals.

13. The world does not end. It only seems to be ending. This time is never different.

14. Americans say they want safety and income. What they really want is all the income they can get, and the illusion of safety. More money has been lost in the quest for the chimerical combination of safety and high yield than in all the stock market crashes in history.

15. Stop trying to prove anything. You can’t prove the sun’s coming up tomorrow, nor that you or your client will be here to see it even if it does. A great advisor never accepts the burden of proof.

16. There is no such thing as a “standard” deviation. Reality always comes at us out of deep left field.

17. The only sane investment objective in retirement is an income that grows at a minimum of the same rates at which one’s cost of living is rising.

18. There is no statistical evidence fore the persistence of performance.

19. Disciplined diversification is a pact with heaven: I will never own enough of any one thing to make a killing in it; I will never own enough of any one thing to be able to be killed by it.

20. All investment “new eras” end in ruin, because all inventions follow the same arc, from miracle to commodity.

21. Never take your business problems home with you. That way you can never take them out on the people who love you.

22. Price and value are inversely correlated. When the price of any investment sector is rising, its value is declining; the converse is also true.

23. The most fascinating aspect of all financial crises is their essential sameness.

24. Life is too short to work with anyone you don’t like, and /or who doesn’t like you.

25. Get our of debt, and stay out of debt. This can be a very cyclical business. If you’re a genuinely high-quality advisor, you will lose accounts and AUM in a “new era” speculative orgy. Keep you nut as low as you possibly can.

26. What goes around comes around, even if it’s on a very long, elliptical orbit.

27. Inflation is always and everywhere a monetary phenomenon.

28. The iron law of the commodity cycle is: supply responds directly to price, even as demand responds inversely to it.

29. The advance is permanent. The declines are temporary. There have been twelve bear markets with a mean decline of 25% since the end of World War II. The first one started on May 29, 1946. that day, the S&P Index closed at 19.5. As I write, twelve ends-of-the-world later, it is 1400. Stocks are up seventy times over these six decades because earnings are up seventy times.

30. Almost all of life is in the Grateful Dead dong “Uncle John’s Band.” The rest is in “Box of Rain.”

31. The dominant determinant of the real long-term returns real people really get isn’t investment performance. It’s investor behavior.

32. Every Christmas, assemble your entire family and watch the A&E move The Crossing, about Washington’s attack across the Delaware on Christmas night, 1776. This, and not It’s a Wonderful Life, is the true American Christmas classic. Every April 13, assemble them all again, and watch Apollo 13.

33. Protectionism always raises consumer prices above where they would otherwise be; it also invariably destroys more jobs than it “saves.”

34. All investments are income investments. They are made for the production either of current income, or of future income, or of income for someone else. The only sane test of an investment’s long term income producing potential is its long term total return, not its current yield. By that one sane test, stocks are a far better income investment than bonds.

35. The computer in your cell phone is a million times smaller, a million times cheaper, and a thousand times more powerful than the mainframe computer used by E.F. Hutton & Company on the day I joined that firm, May 1, 1967. This is a billion fold increase in computing power per dollar. In the next quarter century, there will be another such billion fold increase, at which point technology will have essentially solved all our current problems: energy, the environment, poverty and disease. This is the exact worst moment in human history to turn pessimistic.

36. Freedom is never free.

37. No one who really understands baseball ever referred to the 1969 World Series champions as the Miracle Mets. They were anything but a miracle. Indeed, from the middle of the 1968 season on, they were well nigh inevitable.

38. There is no completely bad time to be prospecting, but the very best time to be prospecting is when the market is down 20%. Amateurs will have stopped calling their clients, and your timeless wisdom will never get a better hearing.

39. The only sure way to be trusted is to be single-mindedly, relentlessly trustworthy. The only way to be sure you’re always absolutely trustworthy is to tell the pure, unvarnished truth all the time, and let the chips fall where they may.

40. Stop asking for referrals. Ask for introductions.

41. And in the end, the love you take is equal to the love you make.

Investment 101

This time of year, many people think about freedom and what it means to them. We’d like to go one step further and ask that you consider your financial freedom. Imagine being financially free to live the life of your dreams and be in complete control of how you spend your time. Start today by asking yourself two simple questions:

Are you close to being financially free?

If not, do you have an action plan to get there?

If you didn’t answer an affirmative “YES” to either one of those questions, now is your time to take action. The reality is that you must have a plan if you want to achieve financial freedom. Without a plan you’ll likely never get to where you are going and could potentially waste a great deal of time and money in the process. The good news is as long as you make the decision to ACT TODAY you can begin taking steps towards financial freedom – and we can help!

Just gather at least 20 of your officemates, churchmates, classmates, friends, or relatives and we will come to you!

Investment 101

What is a VUL and Why is It a Good Investment?

I have read some blogs of certain financial experts advising people not to buy or invest in a VUL insurance because of the high charges that can eat up their account value (No. of units x NAVPU) and that people should instead buy a term insurance, which is significantly cheaper, and invest the difference in stocks, mutual funds, UITFs or ETFs. Other arguments against VULs is that it is only for those who are lazy to learn about investing themselves and that people who reach a ripe old age no longer have any young children or dependents to worry about when the call of death arrives.

While these seem like valid objections, however, there are some very important things about VUL insurance products that these writers have failed to consider. But before I proceed to address these issues, let me first define what a VUL is. VUL stands for Variable Unit-Linked/Variable Universal Life. According to Investopedia, a VUL is “A form of cash-value life insurance that offers both a death benefit and an investment feature. The premium amount for variable universal life insurance (VUL) is flexible and may be changed by the consumer as needed, though these changes can result in a change in the coverage amount. The investment feature usually includes sub-accounts  (pooled funds) which function very similar to mutual funds and can provide exposure to stocks and bonds. This exposure offers the possibility of an increased rate of return over a normal universal life or permanent insurance policy.” As Mr. Rienzie Biolena, RFP, puts it: “It is an investment and life insurance product in one. The difference between a VUL and other forms of life insurance is that part of the premiums is invested in pooled funds which, in time, are expected to grow in value.

Now, for my observations: First, you cannot make withdrawals from your term insurance because it does not have cash value unlike Whole Life and VULs which have cash/account value and can therefore also serve as your savings “account” in the case of the latter. Hence, the only way for an insured to enjoy his purchase is that if he or she dies during the term of the policy, which, in this case it is not really the insured who enjoys it but the beneficiaries. Second, according to Mr. Randell Tiongson, RFP:  “It is interesting to note that less than 20 percent of term insurance policies are still in force when the insured dies and, therefore, never pay a claim.” Third and most important of all, since the death benefits of a VUL, which include the amount invested in the pooled funds, is still classified as insurance, the proceeds thereof are excluded from the computation of gross income [Section 32(B)(1), National Internal Revenue Code of 1997] and gross estate [Section 85(E), Ibid] thereby exempting it in effect from taxation, provided, that the assignment of beneficiaries is irrevocable. Unfortunately, the same does not hold true for gains derived from investing in mutual funds, stocks, unit investment trust funds, or exchange traded funds, because in case of the death of the investor, such gains, if any, including the principal amount shall still form part of the gross estate and therefore subject to estate tax. And the worst part is, once the bank or financial institution finds out about the death of their depositor or investor, such funds are mandated by law to be frozen until payment of estate taxes is completed. That is why, as discussed in one of my previous blogs, life insurance, particularly VULs, is an indispensable tool in estate planning.

As a side note, there are VUL products, such as Philam Life’s Money Tree, that while providing minimal guaranteed life insurance coverage, has virtually the same rates of return as mutual fund investing. Maybe the writers criticizing VULs as a whole were not aware of the existence of VUL products such as the Money Tree or were greatly misinformed. As I conclude, remember that prior to investing, it is important to know your needs and goals before handing in your hard-earned money and diversify! As the wise teacher said: “Invest what you have in several different things. You don’t know what bad things might happen on earth.” (Ecclesiastes 11:2, ERV)

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!

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!