ASK Dr. NOET
‘Help! My financial plan failed me’
By Dr. Johnny Noet Ravalo
INQUIRER.net
First Posted 10:16:00 05/28/2008
(Part 11 of a series)
I followed the conventional advice and drew up a plan for my finances years ago. I have stuck to the plan well enough but I do not feel better off today because whatever savings we have doesn't seem enough to beat the higher food prices, higher tuition expenses, higher gas prices etc. etc. In fact, my honest feeling is that the saving habit has only made me forego a lot of things that my family could have enjoyed instead. That happiness would have been at least tangible but the reward of saving seems just a nice concept right now. What am I doing wrong? --- Patricia
Patricia, I hope that your financial plan was customized to your needs rather than some one-size-fits-all approach. Making sure personal circumstances are reflected in your financial plan makes the plan a livable strategy rather than a painful sacrifice of do's and dont's.
Remember that a financial plan is just a starting point. It helps in putting you in the proper mindset, but any plan cannot be effective if it is held completely insulated from changing conditions. Could it be that you feel let down by your financial plan because the details have not been updated to adapt to the changes with your family needs and in the financial market?
Our financial plans are much like our homes. Even though we try to weather-proof it, repairs come up every year. We may be lucky enough not to deal with a leak, a clog, a paint chip or a broken window hinge this year, but sooner or later changes are needed.
We can, of course, choose to do nothing. The problem is that a home will depreciate with unresolved repairs creating new and bigger problems. Doing nothing hurts us because we are choosing to miss out on opportunities. The longer we choose to do nothing and the more drastic the changes are, the more our financial plan becomes ill suited for our needs.
What opportunities are missed and how do these hurt us?
Until recently, global interest rates were generally low and were getting lower. A prudent financial adviser will suggest to his client that:
[a] he needs to set aside more periodically to be able to invest more or
[b] invest in higher-yield but higher-risk instruments or
[c] strongly consider fixed-income instruments for their capital gain upside or
[d] downsize the amount he wants to achieve upon retirement or
[e] some combination of all of the above.
By opting to do nothing, our financial plans will surely fall short of our targets because we will continue to reinvest at continually lower rates.
Inflation is another plan-altering factor, but it is a silent assassin. Officially, inflation numbers are reported after-the-fact (how the general price level moved over the past 12 months) but we live through the price increases contemporaneously.
This difference between “yesterday” (what is reported) and “today” (what we pay for) brings up another issue with our financial plans because interest rates are all about “tomorrow” (a promised reward in the future). This difference in timing is material to our financial plans because it alters the real value of our financial worth and our purchasing power.
We need to worry about matching yields with future inflation. Only when our effective investment yield is higher than inflation --- correctly timed --- are we moving ahead.
Already, the latest annual inflation is 8.3 percent, which means that if we did not invest in a 20-year fixed income bond in late March or early April last year, inflation just eroded the value of our financial returns over the past 12 months. Going for a 20-year bond will be difficult for most of us (because of the liquidity drain) but the hardest part of this is the fact that 12 months ago no one was talking about the possibility of an 8.0 percent inflation one year hence: oil was still well below $100 per barrel and there was no rice and food price spike envisioned back then.
Unfortunately, there is no quick-financial-fix to deal with higher inflation particularly those that are borne out of spikes in key commodities. We just have to monitor and re-balance our portfolios to better mitigate the erosion of inflation. By adapting our financial plan, surely we can still lose value. The difference is that doing nothing guarantees that loss while doing something raises that possibility.
Which brings me to this point: do talk to advisers who do these things professionally. Our saving and our future are too valuable to take a chance on hit-or-miss strategies.
(Have a question for Dr. Noet? Email personal_finance@inquirer.net.
(Noet Ravalo is a macro-financial economist by practice and profession. He was chief economist of the Bankers Association of the Philippines until 2002 and has since been doing consulting work. Since 1994, he has been asked to provide technical inputs to both the Senate and the House of Representatives on various economic and financial legislation, some of which will have big impact on Filipinos' personal finances.)
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