Have you ever skydived before?
From what I hear from friends who've done it, skydiving is an exhilarating, once-in-a-lifetime experience. They talk about the excitement and anticipation you feel when you first board the place, not knowing what to expect. However, as the place takes off and slowly rises to 5,000, 10,000 and finally 15,000 feet, that same anticipation quickly turns to fear and trepidation.
As the plane levels off, your instructor tells you it's time to go. You gingerly approach the open door and the blood immediately drains from your face as you look at all that empty space below you. Suddenly, over the hum of the engine, you hear your instructor yell: "JUMP!" and before you know it, you're careening 200 kilometres per hour toward the ground screaming and wondering why you paid $300 to kill yourself.
But as you freefall, you suddenly realise that you no longer feel like you're dropping. In fact, it feels like you're flying… floating in the air even. But before you have the time to fully get a feel for things, your instructor pulls the cord. The parachute opens up and suddenly everything becomes calmer. You glide to the earth, taking in the scenery and enjoying the view all around you.
When you finally land, adrenaline is coursing through your veins and your face is beaming brighter than the midday sun. You tell yourself it was the best experience of your life and you can't wait to do it all over again.
Sounds fun, right? I'm sure it is — 100%.
Now imagine jumping off that plane and freefalling to 2,000 feet. It's now time to deploy your parachute. Your instructor pulls the cord and realises that the parachute isn't working! Your instructor is now looking alarmed. This has never happened to him before. He pulls the cord for the reserve chute and that fails to deploy as well. He's now in full on panic mode. Both of you have NO working parachute and will hit the ground in just 10 seconds.
What sort of emotions will you feel as you fall to your impending death knowing that both your parachutes have malfunctioned?
Shock, horror, fear. And probably the all-encompassing terror that nothing can save you when you finally hit the ground.
Your financial parachutes
We enjoy the experience of skydiving because we carry a parachute (with a reserve chute) every time we jump. We say it's the best experience of our lives! But the moment, you lose your parachute, the once-happy experience of freefalling through the air becomes a terrifying suicide jump.
We all know you need two parachutes when you skydive. Except this bad ass who jumped 25,000 feet without one. (Legend says the reason why he fell so fast to the ground was because he had balls of steel.)
Likewise, you also need two parachutes when you invest. Why? Simply because the stock market can be extremely unpredictable and volatile, especially in the short term. If the stock market goes into freefall, the parachutes are there so you're not forced to liquidate your stocks at the worst possible time.
What are the two parachutes must you have?
Parachute 1: Save
The first parachute you need is to have at least six months' worth of expenses in savings. For example, if your average household expenses are $5,000 a month, then you need to save at least:
$5,000 x 6 = $30,000
This essentially means if you're unable to work and unexpectedly lose your main source of income, you can cover your household expenses for at least the next six months while you get things back on track. (You can save up to 12 months if you're more conservative, in that case you have a one year buffer.)
You don't want to be caught in a situation where you need the money and you're forced to sell your investments at a loss because you didn't save enough for a rainy day.
Open two bank accounts
There's no secret to saving money: we simply need to spend less than we earn. But we can make the task easier by tracking how much we save.
If you only have one bank account, open another one. Preferably you should have one current account that's used to issue cheques, pay your bills, and manage your daily finances. And one savings account that's used for your… savings.
Unlike your current account where money flows in and out, money only flows into your savings account and stays there. If you have trouble sticking to your savings goal, set up a savings plan that automatically deposits a fixed sum from your current account into your savings account every month. And choose the option not to have an ATM or debit card to make it harder to withdraw any money from your savings account.
| ||Current account||Savings account|
|Purpose||Pay your bills and manage your daily finances||Meet your savings goal|
|Cash flow||In and out, transactional||Cash inflow|
|Access||Anytime||Money must first be transferred out to be used|
|Convenience||Chequebook, ATM, and debit cards for easy withdrawals||No facilities provided|
Why do we do this?
As opposed to lumping all your money in one bank account, it's much easier to keep track of your savings goal when you separate your money into two bank accounts – each with its own separate priorities.
Just as it's easier to lose weight when you have a weighing scale to keep track of your weight, it's easier to save money when you have a dedicated savings account to keep track of your savings goal. (Here's more information if you need to open a savings account in Singapore or Malaysia.)
Parachute 2: Get insured
Your second parachute is to make sure you're fully insured. Insurance acts like your reserve chute — you never hope to use it but, when you need to, you're glad it's there!
"Insurance is the only product you buy, which you hope never to use."
(I actually Googled this to find out if anyone made this quote before — no one. So I guess it's mine now?)
The reason why we need insurance is simple: disaster can strike us at any time. And we may not have enough savings to meet these major emergencies and our loss of income at the same time.
For example, if you (touch wood) suffer a heart attack and require open heart bypass surgery, the cost can rise as high as $45,000 in Singapore. Not to mention the costs of ongoing care, treatment, and medicine. If you're also unable to work long term and lose your main source of income, then this becomes a crisis not just for you, but for your loved ones as well.
So make sure you are adequately covered for critical illness, permanent disability, hospitalisation, and also death if you have a number of dependents. You should also consider mortgage insurance which will cover your home loan in case you're no longer able to meet your loan obligations, to ensure your family will continue to have a home to stay.
I can't give you advice on exactly what or how much to insure because it depends on each individual's personal needs and financial situation (I'll leave that to your insurance advisor), but get insured if you haven't already done so.
Term vs. whole life
Another common question is whether to get term or whole life insurance. What's the difference?
Term insurance is purely for protection – you pay a premium and the plan protects you against an unfortunate event for a fixed term (hence the name). If the event is triggered, you receive the sum assured. At the end of the term, you don't receive any cash back from all the premiums you've paid. The advantage is you pay a much lower premium for the sum assured. The disadvantage is your premiums may rise with age when you want to renew your policy.
Whole life insurance is for protection and savings – you pay a fixed premium and the plan protects you against an unfortunate event for your whole life. At the same time, the premiums are accumulated and earn interest just like your savings. If the event is triggered, you receive the sum assured or your accumulated cash value (whichever is higher). If the event isn't triggered, the advantage is you get to keep your accumulated cash value at the end. The disadvantage is you pay a much higher premium for the sum assured. And if you surrender your policy too early, you incur fees and may actually end up losing money on your policy.
Side note: There are also investment-linked insurance policies which we won't cover here simply because we believe in being in control of and managing our own investments. (This is an investment website after all.)
Here's a table to summarize:
| ||Term||Whole Life|
|Purpose||Protection||Protection and savings|
|Period||Fixed period (e.g. 25 years)||Entire life or up to 99|
|Premiums||Lower. Premiums may increase with age upon renewal.||Much higher. Fixed.|
|Payout||Lump sum upon event||Lump sum or accumulated cash value upon event, whichever is higher. Or accumulated cash value less fees upon surrender.|
So should you go with term or whole life insurance?
The answer is — it's really up to you and, again, it depends on your personal needs and financial situation. The main advantage of whole life insurance is the cash value you accumulate (assuming you don't surrender your policy early). The main advantage of term insurance is you pay a much lower premium for the sum assured. Because of this, you can insure yourself for much a larger sum at a reasonable cost.
For example, according to this Straits Times article, the annual premium of a term plan for an assured sum of $500,000 for a 45-year-old male non-smoker is $1,922 — compared to $14,320 for a whole life cover.
That's a big difference. So ask yourself if you want insurance to provide you with savings or protection.
Personally, I buy insurance for protection. I then take the difference I save in premiums and invest it. But this also means I better invest my money wisely from now until then since the trade-off is I will probably end up paying a higher premium if I want to renew my term policy in 25 years' time (when I'm 60) unlike a whole life policy where premiums are usually fixed and I am covered for life.
But this is my preference; your goals and needs might be different from mine, and what is suitable for me may or may not be the suitable for you. Remember, a combination of term and life insurance is also an option; they are not mutually exclusive.
The fifth perspective
As an investor, it's easy to get excited about the potential gains we might make from our stock investments. But when we get too carried away (or too greedy), we can forget to protect our downside.
Ideally, you should only invest the money you can afford not to use for the next 5-10 years. Simply because the stock market isn't a dull escalator ride to the top. Instead it can soar to the skies one moment and crash to the ground the next in the short term. And when the market is in freefall, we want to have our parachutes ready so we have peace of mind knowing we don't need to liquidate our stocks when it happens.