The Balance Sheet (BS) represents the assets and liabilities you have accumulated in your life and they can have a significant impact on your income and expenses. I personally prefer the BS approach to the Profit & Loss (P&L) approach when dealing with Personal Finance. Working out your own BS first is how you take stock of your life i.e. exactly where you are at with your personal finance. This then shapes your P&L since it gives purpose to your income and motivation to reduce your expenses. Hence, the BS approach – using the BS to guide the decisions you make in your P&L – and this ultimately determines your net worth.
Once we worked out all of our assets and their percentage proportion, we use an asset allocation strategy to guide our investment decisions and manage our portfolios. Justin from Root of Good, a US Personal Finance & Investment blogger, has written 2 great posts here and here on asset allocation. It’s especially useful for us when managing the ETF portfolio!
We have actually extended this strategy to all of our assets. For us, our definition of an asset is any item of economic value that yields income. As such, we don’t consider the apartment we live in as an asset since we don’t derive any rental income from it. That being said, we do consider the mortgage as a liability since we will incur principal and interest payments.
Generally, we try to allocate target percentages to all of our assets and that’s how the 40% of monthly savings gets allocated. These target percentages can change over time as you enter different phases of your life and very much reflects the priorities and economic environment at that time.
This is our current target asset allocation:
Target Emergency Cash Funds – 10%
This refers to cash holdings that we have as a buffer in the event of job loss, medical emergency etc. It provides us with stability when the economy deteriorates and the investment portfolio takes a beating. The current environment is a good example of why having emergency funds is important since you are in a better position to manage potential unemployment and the resulting loss of salary income without having to liquidate the investment portfolio. Ideally, this should cover about 6 to 12 months of your entire monthly expense.
Target Spending Cash Funds – 5%
We hold a portion of our cash holdings as spending money. This is for big-ticket items like travel (flights, hotel etc), special occasion celebrations, renovation and last minute emergencies (fines, repairs etc).
Target Investment Cash Funds – 5%
These cash holdings are for taking advantage of dips and falls in the share markets. There is a Warchest component to this, which usually refers to cash held for investment in times of severe economic duress and bear markets. The Global Financial Crisis of 2007-2008 is a good example of when a Warchest would have been useful. We generally expend some of these funds every month to consistently grow our investment portfolio. The amount we use up can vary widely depending on the share market performance in that month (usually more in bad months and less in good months).
Target Share Portfolio – 25%
You can refer to our current share portfolio but this is the higher return & volatility equity component of our assets. The aim for the dividend yield on the share portfolio is 5%.
Target ETF Portfolio – 25%
You can refer to our current ETF portfolio but this is the lower return & volatility component of our assets. The aim for the dividend yield on the ETF portfolio is 3%.
Target Bond/Wholesale Life Insurance Portfolio – 10%
This is the bond component of our assets and tends to grow more slowly than the equity component. We think of it as a stabiliser for our investment portfolio to reduce the impact of the wild swings we can see in the equity component at times The aim for the interest yield on the Bond/Wholesale Life Insurance Portfolio is 2%.
Target Retirement Funds – 20%
Our CPF (Singapore) and Superannuation (Australia) constitutes this portion of our assets. They also act as a bond component of our assets but we can only access the funds upon retirement. Since the contributions to CPF are mandatory, the balances should grow as long as we are employed. Given that it is possible to make voluntary contributions to CPF, use the CPF-OA for housing, use the CPF-MA for medical costs, there is a level of control over the amounts in your CPF. In any case, the aim is to grow this component in tandem with the rest of our assets. The conventional wisdom is that you should not only rely on these retirement funds as an income source when you are retired but should have other assets and income sources. However, it is still important to grow these retirement funds over time especially when you can only take the long-term approach to this.
There you have it – our target asset allocation. At the end of every month, we allocate the 40% savings to the assets that are below the target over the next month to get the percentages more aligned. For example, from early Jan to mid Feb 2016, we used up quite a bit of our investment cash funds to purchase shares and ETFs. Hence, a significant portion of our 40% savings for Feb 2016 will go into topping up the investment cash funds. The key is to increase your entire asset base by consistently pushing as much savings into it as possible.
We try to grow our assets in proportion because it facilitates the transition between different phases of our lives. Our needs and wants can change over time and we try to reflect that in our target asset allocation. We use it as a guide to prioritise our focus on various aspects of our lives and it has helped to get us to where we are.