Sunday, July 10, 2005

Managing one's finances 0 comments

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Let's take a step back from the stock market, and consider management of personal finances, for ultimately what do we invest in the stock market for, but to secure our financial future, and to attain financial independence as soon as possible? It therefore makes sense that we should not only think about how to allocate and make money from our assets (eg. investing), but also how to manage our liabilities.

I believe in keeping unnecessary personal liabilities to as low as possible. This allows one to have greater freedom in making decisions of all kind, and ultimately exercising better judgment. If one is heavily leveraged to keep up with the Lees and Tans, he is likely to limit himself towards making "high probability, average potential return" choices (eg. staying with your job) as opposed to "low probability, high potential return" bets (eg. exploring a promising business venture). Of course, sometimes the former might turn out to be the better decision, but my point is that judgment is impaired and one has to consider opportunity costs.

Some friends tell me that having such personal financial liabilities inculcates a sense of responsiblity which works ultimately to one's benefit. To me that is pure baloney. It is like saying that one does not commit a crime because it is against the law, when actually the right attitude to take is not to do it because it is wrong and immoral.

But don't get me wrong; I am not saying that one should not have personal liabilities. Taking the analogy of investing, I would admire a company that has the ability to maintain a high return on equity by taking on debt financing to complement equity financing. In the same way, we should consider our personal finance in the form of a balance sheet, and take on debt where we believe that it can spice up future personal growth. In short, a reason for taking on debt would be to invest in one's future growth. A good example, of course, would be further education. Extending the metaphor a bit further, we might follow certain rules such as maintaining a net positive working capital position (ie. current assets - current liabilities > 0); debt not to be larger than equity; and times interest coverage (ie. income/interest payments) to be 5 times or more, say.

By both considering the management of assets, through investing, and the management of personal liabilities, we can then have a comprehensive approach towards planning for our financial future.




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