One of the reasons I became a financial advisor is to let people know of the mistakes I made, hoping that they learn from and not repeat them. I didn’t begin right, and I found myself going back to zero in financial planning and start all over again.
Having a strong financial foundation is perhaps the most important part of this series.
How to build a strong financial foundation
Investing is good. It can be fun and exciting, especially when you are already doing it and you see the returns actualized. But it is also risky. And this is what financial foundation is about: how to manage the risks that investments, and life in general, throw your away.
It is important that each and every Pinoy old enough to have a bank account should have:
- Income protection
- Emergency fund
- Debt-free life
Income protection means your income continues even when you are sick, met an accident or die too soon. In short, you need to have sufficient insurance cover.
But we Pinoys tune out when the talk of insurance comes up. We don’t want to be reminded of our frailty and certainty of our passing, like it’s tempting fate to come around and haunt us.
And that’s just backward mentality. The right type of insurance and right amount of insurance cover actually buy you peace of mind, knowing that whatever happens your income will not stop. And your family and the people you love wouldn’t have to worry about finances during stressful and costly situations.
In some countries, having insurance for all employees is a business requirement. In the Philippines, providing a means in starting accounts in government-mandated benefits (SSS/PhilHealth/Pag-ibig) is the barest minimum, but they might not provide the necessary cover that you need.
So what should you do? You need insurance, whether you invest or not.
- Check your employer if it provides term insurance and HMO (health maintenance organization). If you have some form of cover, then you just to work out a permanent life (a policy that covers you until age 100), other types of policy like critical conditions and health care plan that continue after you retire or quit your current job.
- Talk to an advisor. She/He must be able to calculate your insurance needs. If she/he only recommends P1 million cover for all clients, regardless of situation and need, then be very afraid. You are talking to a salesperson, not an advisor.
- Ask your advisor the right type of insurance. There are several products that are available in the market today, and check which ones would address your need and that you can afford to pay.
- Get covered by buying the right insurance product that is appropriate to your situation.
Start an emergency fund
An emergency fund is money set aside for the rainy days. Whether you invest or not, you should start one. It is going tide you over life’s little bumps, such as unexpected expenses, minor illnesses and unemployment.
Why do you have to have an emergency fund together with insurance? Your emergency fund is what you can use when a pressing need arises. It should be parked in a bank account that discourages you to spend it impulsively but should be easy and accessible when you need it, like a passbook account.
Insurance is to protect you from loss of income during life’s big crises, such as a major illness. It should not be relied on all the time, especially that not all of your emergency situations are covered by the insurance company. And that’s where your emergency fund plays its role.
Your emergency fund is going to be a buffer between the wealth that you are building through investing and the need for ready cash during desperate times. It prevents you from making bad financial decisions, like pulling out your investments when the market is down and redeeming your shares at a loss, just because you need the money badly.
You can start small, and gradually increase the size of your rainy day fund.
How much should you set aside for rainy day fund?
If your job is stable and you are not planning to quit anytime soon, having at least three months worth of income is recommended. On the other hand, save at least half a year’s worth of income as emergency fund if you are self-employed or a contractual employee.
Get out of debt as soon as you can. Most, if not all, forms of debts have interests, which lessen your net worth. Besides, the longer that you delay paying them the bigger is your financial loss from late fees and other charges.
The reason that you have to pay your debts quickly is because they limit your ability to put money in other important things, such as getting insurance and starting a rainy day fund. They also put a limit to how much you save and invest.
Putting it all together
Wow, so many things you need to do! But don’t worry. This is where an advisor can really help you figure out your priorities and get you started. And once you have everything put in place, then it’s time to open your first investment account. On to the last part of the series.