The rich say they don’t need it; poor say they can’t afford it
Question: I have been hearing about comprehensive financial plans being offered by financial planners. They say these contain detailed analyses of one’s personal finances as well as projections on how to achieve future goals. Are these plans really needed? Can’t I just DIY it?
Answer: Wealth management is something that everybody needs. The rich will say that they do not need it because they already have the wealth. But money can be more easily lost than earned. On the other hand, the poor say they do not have wealth to begin with. But both the mind and body have immense earning capacity, what we at Personal Finance Advisers Philippines (PFA) call human capital. And that human capital is something that can already be managed.
But what really is personal finance management?
When you graduated from college, all you had was your stock of knowledge. Let’s call that your equity. And since you most likely had not much else, we can say that the value of your stock of knowledge is also your total asset. At this point, your total assets equal your equity. Should you forget parts of what you know, both your total assets and equity will go down in value, never just one or the other.
But in life, people dream of owning more assets especially when they start their own families. One way to do this, since equity is limited, is to borrow. But loans must be used more to grow assets that also increase your earning potential. Borrowing to buy nonearning assets or just for pure consumption will not have a multiplier effect on your equity. If you do borrow, your total assets will now equal your total debts plus your equity, collectively forming what is known as your balance sheet or Statement of Assets, Liabilities and Net Worth (SALN).
Your earning assets (i.e. including your stock of knowledge) will help you generate gross revenues. Provided you manage your revenue-generating operations well, your expenses (e.g. food, shelter, clothing, transportation, etc.) should be in check and you will be able to produce savings, otherwise known as net income. In its entirety, the details behind your revenues less your operating expenses form your income statement.
Notice that even with your own personal finances, you can already come up with the basic financial statements of companies. And just like with any company, you have two options with your net income: either pay it out to yourself in the form of dividends that you can spend to your heart’s delight or plow it back to your equity.
When you do plow back your savings or net income to your equity, you can use them to further grow your earning assets and thus further grow your earnings or pay off your debts to reduce your interest expenses and improve your cash flow (i.e. by not having to repay more debt in the future).
So, what is clear is that in personal finance, as with corporate finance, to grow wealth, you will need to squeeze out as much net income from your gross revenues (i.e. increase your net income margin or net income divided by gross revenues), reinvest such net income in assets that are also earning (i.e. increase asset turnover or gross revenues divided by total assets) and borrow mostly to acquire more assets that are also earning assets (i.e. increase equity multiplier or total assets divided by equity).
Multiplying net income margin to equity multiplier to asset turnover is what is called the DuPont model in finance. At PFA, we translate this to Taglish as pala-save, pala-invest and pala-utang nang tama (regular saver, investor and prudent borrower).
However, personal finance management does not stop here. On the road to growing wealth, risk of loss beyond your control will be present. These could cause loss to property, major illnesses and even death. So, wouldn’t it be great if there were a large and stable company that would shore up whatever shortfall in wealth you want to leave behind to your family should you be taken early from this life?
That is why you need to add adequate insuring for perils against life, health and property to your personal finance management.
So, the complete personal finance management is pala-save, pala-utang nang tama, pala-seguro (get insurance) and pala-invest. This is what we call the PFA Diamond Model or the DuPont model on steroids.
And if we were to simplify the PFA Diamond Model, isn’t it pala-save cash management, pala-utang nang tama debt management, pala-seguro risk management and pala-invest wealth management? Therefore, the simpler representation of the PFA Diamond Model is what we call EnRich Cash, Debt, Risk & Wealth (or CD-RW) management.
Such analyses and more that are afforded by comprehensive financial plans cannot be had if you just DIY your personal finances.
Here’s to a prosperous New Year for you and your family.
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