Published: Saturday July 6, 2013 MYT 12:00:00 AM
Updated: Saturday July 6, 2013 MYT 7:49:44 AM
Losing big on small mistakes
Money and You: By Yap Ming Hui
Compounded errors can add up to quite a bit
THERE’S a famous proverb which goes like this, sikit-sikit, lama-lama jadi bukit. When it comes to the middle class and financial freedom, the only thing keeping them away from becoming financially free is a laundry list of seemingly small financial mistakes.
From my observation, the average middle-class Malaysian, those who make between RM10,000 and RM30,000 household income a month, makes mistakes that cost them between RM1.5mil to RM2.5mil over a period of 20 years. Can you afford such a loss?
The seeds of this financial disaster are planted years before their outcome. Further, the mistakes are often small and do not even look like mistakes at the time. So, many do not even realise that they are making them.
Even if they do understand the error of their ways, they are neither aware of its real impact on their overall financial position nor that it is eroding their chances of financial success. Worse, some take the mistakes lightly and are not vigilant when making these life-defining decisions.
When all these factors are combined, the result is simply a bombshell. If you fall prey to them, you are not going to achieve financial freedom, and you can certainly forget about becoming wealthy.
Thankfully, you can avoid falling into a financial black hole if you know what these simple mistakes are, the cost of making them and how to sidestep these pitfalls.
Mistake No. 1: Paying too much in insurance premiums
Many people either over-insure themselves or pay an excessive premium for insurance because they do not know how to optimise their money. For example, consider two insurance products for a person at age 35: term insurance for RM500,000 will cost RM1,625 per annum, whereas a whole life policy will cost RM14,225 per annum.
Remember that the idea is to buy insurance cover to protect our loved ones from financial hardship in case of an untoward event. We should go for the lowest possible premium and invest the difference between the two premiums to optimise our money.
If you buy term insurance instead of a whole life policy, you will have a saving of RM12,600 per annum to invest. At an 8% return on your investment over 20 years, you will gain RM576,600. On the other hand, with a whole life policy, assuming you receive the entire premium paid (RM14,225 x 20 years), you will have RM284,500. The loss is about RM292,100. Small mistake, big losses.
Mistake No. 2: Failing to increase savings when income rises
The writer C. Northcote Parkinson, who is famous for the so-called Parkinson’s Law that “work expands to fill the time available for its completion”, also said in his book, The Law and the Profits, that expenditures rise to meet income.
He added that “individual expenditure not only rises to meet income, but tends to surpass it, and probably always will.”
This is typical human behaviour. When an employee gets a raise, he decides that he can now afford a better lifestyle. He or she may drive a better car, get a better handbag or mobile phone or enjoy a better holiday. Instead of saving, the average person will spend the extra income.
However, a person who knows how to optimise his wealth would maintain his current lifestyle and increase his savings. Assuming that he saves RM1,000 per month and invests that amount, at an average rate of return of 8% per annum on his investment over 20 years, that would be RM589,020. Another small mistake that results in big losses.
Mistake No. 3: Not optimising the returns on savings
One other common error is to keep too much money in savings instead of investing it. Usually, this is due to fear of making losses or being too busy earning an income or attending to various needs. Say you put RM2,000 per month in a fixed deposit account for 20 years. At 3% interest p.a., FD will give you RM656,603. However, if you invest the amount, at an average rate of return of 8% p.a. on your investment, you would get RM1,178,040. You lose RM521,437. The outcome is even worse for those who put their money into a saving account, which gets only 1% to 2% p.a. Again, a small mistake that leads to big losses.
Mistake No. 4: Failing to revise the interest rate on your mortgage
Remember that the interest rate on mortgages fluctuates. Currently, it is about 2.5% below the Base Lending Rate (BLR) or 4.1% p.a. Some house buyers who are not mindful of the current rate may be paying a mortgage interest rate of BLR + 0% or 6.6% p.a. For a loan of RM500,000, at 4.1% you pay RM3,190 per month. In total, you pay RM765,672 over 20 years. Compare this with 6.6%, where you pay RM3,757 per month. In total, you pay RM901,766 instead. If your current mortgage interest rate is BLR+0 and you do not ask the bank to revise your loan to BLR-2.5%, you will end up paying an extra of RM136,094. Once again, a small mistake that costs you dearly.
If you take into account all four errors, the total losses is a whopping RM1,538,651. This does not include the investment losses made during the 20-year journey. They could be in the form of an abandoned property, frozen gold bullion investment, and unit trust or share market investment losses. Think about it: when a middle income earner makes unnecessary money mistakes, he would have accumulated at least RM1.5mil to RM2.5mil less wealth when he is 55, depending on the kind of mistakes he made.
This is why many middle-class people cannot reach their goal of becoming financially free. None of the four mistakes discussed here are in themselves disastrous. However, their combined and compounding effect rob the middle class of their financial freedom.
A final word: it does not matter whether the mistake you make is big or small. Every single mistake will impact on your goal of financial freedom.
If you seriously want to set yourself free from all your financial obligations, review and plug all possible leakages. At the very least, you can avoid making the mistakes mentioned above at all costs.
- YAP MING HUI (firstname.lastname@example.org) is a bestselling author, TV personality, columnist and coach on money optimisation. He heads Whitman Independent Advisors, a licensed independent financial advisory firm which has helped people to optimise their money holistically and achieve financial freedom since 2000.