HAPPY New Year! It’s early enough to trust New Year resolutions we have made, have not yet been chucked out. Hopefully, a vestige of that first warm glow of optimism that generally begins to pervade us around Christmas and reaches a crescendo on New Year’s Eve is still with us. Regardless of how jaded you may have become by a long string of abandoned resolutions, never, ever give up on self-improvement.
Not when it comes to wealth accumulation, protection or distribution; and certainly not when it comes to other less tangible, but more important issues.
That was driven home by something I read in one of the awesome presents my wife Rachel gave me for Christmas. It was a weighty coffee table book entitled The Magic of M.C. Escher. The late Escher is, in my opinion, the greatest graphic artist who ever lived. The Dutchman’s mathematically precise works often portray beguiling, but impossible, situations such as men endlessly walking “up” four flights of stairs, arranged in a square, only to meet themselves again and again and again.
In a 1955 letter to his son Arthur, Escher wrote, “I believe that producing pictures, as I do, is almost solely a question of wanting so very, very much to do it well.”
We are all the same – you, Escher, and I!
You surely want to take very, very good care of your family; Escher’s passion and industry led him to create very, very impressive works of art; and I desire to take very, very good care of my clients.
I believe if you are serious about caring intelligently for your loved ones, you should mull over this explanation in McGill’s Life Insurance, published by the American College: “Life insurance is concerned with the economic value of a human life, which is derived from its earning capacity and the financial dependence of other lives on that earning capacity.”
As long as you have dependants whom you care for, you need life insurance at least until you grow rich enough to be self-insured. Thankfully, products exist in Malaysia to transfer the risk of economic loss from individuals to sterling companies such as AIA, Great Eastern, John Hancock, MAA and Prudential.
It was Sir Winston Churchill who said, “If I had my way I would write the word ‘INSURED’ over the door of every cottage and upon the blotting book of every public man: because I am convinced that, for sacrifices that are inconceivably small, families can be secured against catastrophes which otherwise would smash them up forever.”
In his book, Business Insurance – Million-Dollar Concepts, Lim Yuen Seong put it more succinctly, “Human capital is expensive and destructible. Protect it!”
In a later book cum manual, C@pture – The Handy Professional Aide for Financial Planners and Advisors, which Lim developed with Singaporean Ashokh Menon, this insurance planning process is advocated:
Step 1: Determine insurance objectives;
Step 2: Gather information;
Step 3: Analyse information;
Step 4: Develop insurance plan;
Step 5: Implement insurance plan; and
Step 6: Periodic reviews.
This six-step process found in that excellent book mirrors the Certified Financial Planner Board’s six-step financial planning process.
In my own practice, I use this algorithm (or recipe) to assess a client’s true life insurance coverage needs. But note it does not take into account future inflation.
Hypothetical ringgit amounts are included here to help make things clearer:
First, assess your family’s annual household expenses in your “absence”, say RM100,000.
Second, add in annual investment obligations for major goals that survive you, such as your children’s education funding and spouse’s retirement funding, say RM50,000.
The first two steps give an indication of annual budget requirements, in this case RM150,000.
Third, assume a fair capitalisation rate; I tend to use 5 per cent, so I multiply the calculated annual budget need by 20 (=1/0.05). Here that works out to RM3 million.
Fourth, add on a series of final expenses including your own burial costs, say RM30,000, which gives a total capital requirement of RM3.03 million.
Fifth, knock off actual existing savings and investments, excluding your own home, say RM730,000. That works out to RM2.3 million.
Sixth, knock off anticipated payouts from existing insurance policies, say RM1.5 million.
Seventh, the residual sum calculated is the amount a client is under-insured (if the sum is positive) or over-insured (if the amount is negative) by. In this case, the hypothetical client is RM800,000 under-insured.
If, like Escher, you aim to do very, very well in things that matter, please run a similar analysis on yourself. Then plug any gaps!
Next week, we’ll look at the lure of OPM – “other people’s money”, and consider the only situation in which it is safe to indulge in contra trading on the Kuala Lumpur Stock Exchange.
·Rajen Devadason is a certified financial planner and CEO of financial planning firm RD WealthCreation Sdn Bhd, which specialises in retirement planning for 30-to 45-year-olds. He invites feedback at firstname.lastname@example.org
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