Monday, September 23, 2013

DIY Income Investor's Modified Income Pyramid

I honestly love the guy, and he probably doesn't know how much his advice helps me!

Anyway, so here is his Income Pyramid.

 Now that you've seen it, let's go through it.

Level 1: Solid Foundation
I think this is the most important step of them all. Don't invest money, if you have debt to pay off. Basically, live within your means. Don't even think about investing money if you have any outstanding loans to clear.

Sure, you don't make money paying off debt, but you save money paying off debt.

Why do I say that? Well, I think it's a given that regardless of what rate of returns you are getting on your investments, your debt is accumulating interest faster. So instead of working on becoming richer, let's work on not becoming poorer, aye?

Level 2: Easy Access Savings
Of course I have to agree with him when he says that your first level of income should be easy access savings.

These savings should be in a bank account which you can withdraw and deploy easily in case of any emergency or even just to pay your monthly bills and expenses. The money here shouldn't be locked up for any reason, and should be able to provide you enough buffer to definitely make it through the month, considering expenses.

He recommends 3-6 months of expenditure, which I clearly agree and support. If you don't have this amount of buffer time, in the event that you are really strapped for cash, you would have no choice but to liquidate your holdings. I believe that given enough buffer and you know that something bad is coming up, you would have enough time to make sure that the investments divested are ones that you would have done so anyway, and not a great investments that you should still hold on to. The time gives you the opportunity to make best of a bad situation.

Level 3: Fixed Rate Savings
Fixed Rate savings is an extra layer of quick cash that you can access if you really need to break the bank. The con is of course is you may not get the full rate that you were aiming for, but at least you now have cash!

Level 4: Easy Diversification
I'm going to cut him off here and say that ETFs are great and provide cheap, fast and easy diversification, but, in the context of me in Singapore, it may not be that appropriate.

The main aim and goal here is to pick a vehicle which gives you a cost-effective way to diversify to minimize risk. Rather than just sitting out and on your money, watching inflation erode away the value of your wealth, you would want to ensure that you wealth keep up with the times, and perhaps outperform it.

Given in the Singapore context, I think that the most diversified and simplest way to invest using ETFs would be say a split your portfolio to 50% MSCI World, 10% MSCI EM and 20% Local 1-3 Bonds and 20% Local Bonds.

Level 5: Bond Ladder Ownership
Now, considering that Singapore has no capital gains tax, I contest and doubt this part of the pyramid in this usefulness in Singapore. Perhaps to take a spin on this, it would be to directly own bonds, be it government bonds or corporate bonds. In this way, you're not affected by interest rate risk as long as you hold the bonds til their maturity. This creates confidence but having a definite knowledge of your cash flows. The only issues here is that there is substantial default risk, as well a experience is required to evaluate the bonds. As well as luck and timing!

Level 6: High Yield Dividend Shares
Lastly, we have direct investment into individual shares of companies. This requires the highest level of risk, knowledge and experience to execute correctly. There is no benefit of diversification, so there is plenty of downside risk. However, if done correctly, now only can you stand to benefit from constant handsome dividends, those dividends may increase, along with the share price of the securities.

I have removed Level 7 of his pyramid because I do not entirely agree with it's positioning. I think a bond ladder in Level 5 will do. Level 7 only becomes viable if interest rates have globally gone up very high and we're heading for a downturn soon, then we can use it to lock in long term favourable interest rates.

Anyway, that's all with my long wided rambling post. I'll add my own flavour and opinions, as well as suggestions and reasonings in another upcoming!

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