Chiawono's Three Rules (Part 2)

If you happen to arrive at this page without reading the first part, you can do it here.

Ok. So now that we have our Emergency Funds, what's next? Can we go and talk about investments? Well, read carefully, and you will notice that what I am going to share is called "the Chiawono's Three Rules before You Start Investing on Anything" and we have covered only the first rule so far. So here comes the second rule: zero bad debt.

Here's the thing: there are good debts and and there are bad debts. Let's talk about the differences some other time, but here we have several examples of bad debts:

1. If you don't pay full payment for your credit card bill, that's BAD debt. Especially if it's been going on for some time.

2. If you owe the credit card issuer more than you earn, that's BAD debt. In reality, since we have our regular spending, it's considered bad enough if your debt is more than one third of what you earn.

3. If you borrow money from pawn shops or loan sharks, that's BAD debt.

4. If you happen to have payday loan, that's BAD debt.

5. You get the idea. Every debt that has ridiculously high interest rate or has no collateral whatsoever can be considered bad debt. 

Editor's Note: For Indonesian readers: 'pawn shop' is 'pegadaian', 'loan shark' is 'renternir', and 'payday loan' is 'kasbon'.

So, if you happen to have bad debt(s), PAY IT OFF. NOW.  If you can't, then work hard and pay it off as soon as possible. Here's why:

1. Believe me, most of your bad debts will have MUCH higher interest rates (with a minimum of 2 to 3 times) than your normal investment return. So it's IMPOSSIBLE to pay off the interest of your debts using the interest or yield of your investments.

2. Compounding interest is the world's most powerful force (according to Albert Einstein). Most bad debts have these kinds of interest structure. So it's better to have the force on our side (when we're investing) rather than have the force against us (in our debts).

3. What if I put my money to a high yield investment? That's a bigger NO-NO. While the yield probably will won't be as high as the debt rates, you're putting yourself in a bigger risk of losing your capital. And then, you'll be in a deeper trouble.

4. But someone else is borrowing money from one place and invest in another place (or so you think you've heard)? Well, there are a lot of investors doing this stuff. It's called carry trade. But they're aware of the risks not to mention they are mostly much much much smarter than normal folks like me and you. So, don't do it. Seriously.

Now, probably you've noticed that i use a lot of capital letters in this second part. Personally, I can't help but try to emphasize that BAD debts are indeed BAD. Only when you're free of bad debts that you can start to build a good financial plan. And on the other hand, there are lots of good debts as well: house mortgages, student loans, a car loan (if you need one), etc. Feel free to take them after calculating your financial health. Remember, just like our body, a healthy loan can become unhealthy if not taken care of.

See you in the third part.

An Introduction: Chiawono's Three Rules (Part 1)

Many friends came to me for investment advices but most of them actually had no idea about what investment really meant. So I'm guessing that out there, there are actually people who needed these kinds of advices but due to the lack (or the abundance) of information, are unable to really discern what they should do.

In these kinds of situation, the salespersons from banks or investment managers or insurance companies are definitely not your number one friend (because they have their own interests and products) while financial planners are definitely not free. So I'm starting this blog in order to share some insights on investment for normal people like you and me.

So as an introduction to this blog, I'd like to share that I have what I call "the Chiawono's Three Rules before You Start Investing on Anything" that all of us really need to read and DO. And by 'all of us,' I really mean all. That includes first time investors as well as regular investors.

First of all, before you start thinking about portfolio or asset allocation or simply thinking about where will this part of my money go, you need to make your own Emergency Fund. Our daily needs are paid with our earnings. But things happen. Salary-men get fired, freelances have their low order cycles, entrepreneurs realize losses sometimes, and even children get allowance cuts. I know, this may sound a bit pessimistic, but believe me, in managing your personal financial, you need to prepare for the worst. In the instance that one of those things happen, we need to make sure life goes on. That's why everybody needs this Emergency Fund. So, if you don't already have your own Emergency Fund, make it a top priority and set aside a portion of your income for this purpose.

Before we go deeper, we have to separate the Emergency Fund from our investments. Emergency Fund should be idle and liquid while investments (we'll cover this later) should serve a purpose within a time frame and (therefore) not always liquid.

Now, how much money should we put into this Emergency Fund? Well, to really answer this question, we have to understand that everybody's situation and needs are different. To really get an exact amount that suits a certain someone, you will need to consult with a financial planner. And even after that, your situation might change. So here are a few guidelines for starting your Emergency Fund:
1. Some financial planners assume the amount the amount from the expenses, while some assume the amount from the earnings. I use the latter approach. In planning for Emergency Fund, use your current income (preferably monthly) as a benchmark.
2. Understand that every source of income has different risk level. For example, a graphic design freelancer is considered to have less job security risk than an in house graphic designer in an established company.
3. Think for the whole family, not only for yourself. If you have a wife and / or children, you'll definitely need more safety cushion when the situation where you need your Emergency Fund presents itself.
4. Always take time to evaluate your Emergency Fund periodically. Your income increases overtime and so does your expenses. It's silly to think that the Emergency Fund may stay the same.

To make it practical, this can be your minimum starting point:
1. If you are single and employed, you should prepare 3x - 6x of your monthly salary for the Emergency Fund.
2. If you are married without any child, you should prepare 6x - 9x of your combined monthly salary for the Emergency Fund.
3. If you are married with 1 child, you should prepare at least 9x - 12x of your combined monthly salary for the Emergency Fund.
4. If you are married with 2 or more children, you should prepare at least 12x of your combined monthly salary for the Emergency Fund.
5. If you live off your pension fund, you should prepare at least 12x of your monthly pension for the Emergency Fund.
6. If you are a freelancer, you should prepare at least 12x of your average monthly income for the Emergency Fund.

Some of you might think that the numbers above are quite big. Well, they are. But in my personal view, when you're bumping into a wall, it's better to have an airbag popping out from your front. So while you are allowed to think that airbag and Emergency Fund are optional, we dread for the time when we regret that we don't have them.

Well, what are the other 2 rules? Just stay around and expect them to be up as soon as possible.