FINANCIAL literacy helps us properly approach our finances in the most effective way. It helps us focus on the correct areas to achieve our financial goals and objectives efficiently.
It is also important to understand that personal finance is not all about achieving a good credit score.
While having a good credit score can help you be more favourable to banks, make it easier to get the loan approved and qualify for better interest rates, we need to understand that a good credit score is a result of good cash flow management.
We need to focus on cash flow. That’s the most important component of personal finance. Cash flow is the money flowing in and out. This basic component should be well managed before we can go further into other areas of personal finances.
In order to achieve good cash flow, methods like budgeting and saving come in handy. Only with good cash flow can one start planning for the future.
Good cash flow enables us to start investing. The most common mistake is jumping into investments with bad cash flow. For example, if not done properly, you end up needing to withdraw a good investment at a loss due to liquidity issues.
Another common mistake is being too fixated on generating income when investing. Investing solely for income at an early stage may not be the best approach. In fact, when you choose a specific asset class or type of investment, you need to consider many factors, such as growth potential, regularity of returns, volatility risk and liquidity.
Investment choices
When investing, a general rule of thumb is to decide whether you want to prioritise capital growth or income generation.
Capital growth typically involves selecting assets with the highest growth potential but may involve trading off capital preservation for regular income. In contrast, income generation prioritises regular income and capital preservation and involves trading off the high-growth potential of a capital growth-type investment.
If you are thinking about investing, I recommend that those who are under the age of 40 prioritise capital growth. As you approach retirement, it is best to switch to income generation-type investments. This method allows you to generate a more significant income because you have spent your younger years aggressively growing your capital.
Income generation as an investment objective can be a trap for many investors. A reasonable rate of return is approximately 7% and any investment that can consistently produce this return over many years is considered high quality.
However, investors who focus on generating income without considering the actual percentage return may fall into the trap of seeking potentially shady or scam investments that promise high returns.
As a general rule, I recommend that individuals only consider income generation as an investment strategy when they are at least 40 years of age. By maintaining the correct expectations for your investments, you can avoid making such mistakes and achieve your financial goals in a more sustainable manner.
In conclusion, personal finance consists of many components such as cash flow management, asset management, risk management and distribution. It is essential to prioritise cash flow even before investing.
When investing, prioritise capital growth when you start working and then switch to income-generation-type investments when approaching retirement.
It is crucial to maintain realistic expectations of your investments and avoid falling into the trap of seeking potentially fraudulent investments that promise high returns. By following these principles, you can achieve much healthier finances in order to reach your financial goals as effectively and efficiently as possible. – May 7, 2023
Kimberly Law, CFP, IFP is the Co-Founder of Uno Advisers Sdn Bhd. She is also a licensed financial planner and a certified member of the Financial Planning Association of Malaysia.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
Main photo credit: iStock
