March 25, 2007

What you should do with sudden cash inflow

Rather than splash it all on a new car or diamond ring, use it to give yourself greater financial security

By Lorna Tan, Finance Correspondent

BEING tempted to splurge is only natural when one is on the receiving end of a windfall.

Many Singaporeans now have to grapple with this tantalising temptation after a round of hefty salary increments and year-end bonuses, buoyed by a booming economy.

For instance, about 3,000 employees at the world's largest builder of offshore oil rigs, Keppel Fels, had a great start to the year when they received a whopping seven months' bonus.

And staff at banks should be getting news of their bonuses about now.

But before you rush out to make a down payment on a new car or buy that two-carat diamond ring, think about how you can use this extra cash for even greater long-term gains.

United Overseas Bank's (UOB) head of deposits, investments and insurance strategy, Mr Tay Han Chong, offers three broad strategies.

'Repay the past, indulge in the present and save for the future.'

UBS Global Asset Management says a key priority should be to pay off debts with high interest costs.

'Review your existing liabilities, ascertain the highest interest cost, match this against your potential investment returns and make the repayments accordingly,' said UBS' senior asset allocation and currency strategist, Ms Irene Goh.

For instance, if your debts are incurring high interest costs in excess of 10 per cent, it makes more sense to use your windfall to pay them off than to invest the cash in, say, high-yield bonds that may return just 6-8 per cent a year in the long term.

Ways to use the cash

Pay off credit card debts

FINANCIAL experts are unanimous when it comes to which debts almost invariably incur the highest interest costs.

'Focus on clearing off personal debts that are costly to maintain, for example, credit cards, as they charge as high as 24 per cent a year,' said Frontier Wealth Management director William Cai.

The trouble with making just the minimum payment on your credit card bill, instead of paying in full each month, is that interest is charged on the principal sum owed.

So if you have a $5,000 debt against your card for a year, you could pay $1,200 in interest alone.

Consumers saddled with heavy debt can negotiate with banks to convert credit card and personal loans charging interest of 16 per cent and above into term loans charging just 7-8 per cent a year.

'Even then, do try to have some cash savings as they will come in handy.

'Do not bother about investing till you have lowered your debt to a manageable level,' added Mr Cai.

Pay off mortgage or car loans

AS RATES for mortgage and car loans are lower than those for credit cards, there is an opportunity cost in paying off such loans.

'You need to weigh the pros and cons of doing so because if you have a sound investment strategy that can help you average a return (over the same period) that is higher than the interest rate on the loans, it may be more worthwhile to invest the money instead,' said ipac financial planning's Singapore vice-president, Mr Brian Goh.

Instead of paying off your mortgage or car loan, you might be better off using that same money to achieve potentially higher returns of over 7 per cent from investments such as equities.

For the more risk-averse, Mr Tay said it is reasonable to pay off part of a home loan to save on future interest expenses.

When you do so, however, he advises checking the terms of the loan to ensure that a partial repayment will not attract other costs, which could reduce the benefits of such a repayment.

Kick-start a savings plan

A WINDFALL presents a good opportunity to kick-start a savings and investment plan.

Many people prioritise their monthly spending in this order: The biggest item is likely to be the mortgage or rental, followed by car loan instalments, utility bills and food.

They then scrape the bottom of the barrel to cover the monthly minimum on their credit card bills.

Try a different approach to monthly budgeting: Pay yourself first. Putting aside just 10 per cent of your net pay as savings is a good start to accumulating wealth over time. This will force you to become more frugal and careful in your spending as the other bills must still be paid.

In fact, if you are fortunate enough to get a pay rise, putting away the increment each month will go a long way towards helping you achieve medium- or long-term goals

Kick-start an investment plan

UBS advises wannabe investors to map out their investment time horizon, determine a realistic timeframe versus liquidity needs and decide which asset class is most appropriate.

Once a holistic financial plan is in place, you will have a framework in which to make future financial decisions, which include knowing how best to optimise your windfall.

To understand the power of compounding interest, use the simple 'rule of 72' to calculate how long a sum will take to double, Mr Tay said.

If the investment return is, say, 10 per cent, then it would take slightly longer than seven years for an initial investment of $10,000 to double to $20,000. The number of years is calculated by dividing 72 by 10, that is, the rate of investment return.

Assess insurance needs

THERE is no time like the present to have a thorough audit to assess your insurance plans and cover.

If both areas are lacking, you could consider using part of the windfall to pay for the cost of any additional insurance coverage.

Easy traps to fall into

Stepping up monthly expenses

WHEN spending your windfall, try not to do so in ways that will increase your overall monthly expenditure.

Don't fall into the trap of making any new acquisitions that will be paid through instalments which, when added up, might exceed the original windfall - this would eat into other savings.

The fastest way to build your savings is to maintain your regular expenditure when your income rises.

Not managing cash flow, especially after a layoff

IF YOUR windfall came from a redundancy package and you're going through a career transition, the main concern is cash flow and debt management, Mr Goh added.

Regular expenses to keep in mind are premiums for insurance policies, club membership fees, mortgages, and credit card and other personal debts. You need to take stock of what these expenses are and what you can cut back on.

Once you have sorted out your cash flow, you might want to take out a fixed sum regularly, in place of a monthly salary, to cover these expenses while you take the next step in your career.

Reward yourself

YOU deserve it.

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