If you have read this far, you would have picked up some ideas on how to form a simple financial road map. The purpose of a road map is to help you reach a destination. In personal finance, your destinations are your financial goals – what exactly do you wish to achieve? Stating your goals clearly is the first step in designing a financial road map. Answering two questions will make your goals clear: (a) how much money do you need and (b) when do you need it?
Let’s illustrate the art of designing a road map with a little case study. Assume you just started working with very little money in your bank account. A prudent goal is to build a reserve or rainy day fund to meet unexpected expenses like losing your job and other urgent cash calls. The rule for thumb is to have at least 3 months’ salary in your reserve fund (more if the economy is gloomy). So, if your starting salary is $3,000, you should have at least $9,000 in your reserve account. If you save $1,000 a month, you will have your rainy day fund in less than a year. That is a good first step.
What about other goals? For illustration, assume you plan get hitched and settle down in 5 years’ time in a new HDB flat. As HDB takes 2 to 3 years to build flats, you plan to apply for your flat in 3 year’s time. Let’s say you and your future spouse are looking for a flat in a mature estate that cost around $500,000. That is a lot of money for a twenty-something!
Suppose also that you plan to buy a new car in 3 years. The car is expected to cost $120,000 including the dreaded Certificate of Entitlement (COE). Owning a car adds another big ticket item to your wish list.
I assume that like most people, you will be getting a loan for your car and flat. Your road map for each goal should include how much you wish to borrow, whether you are comfortable with the loan repayments, and how to accumulate sufficient savings for the down-payments (the portion not financed by loans). Therefore, to design a realistic road map, you need to be familiar with the rules governing housing and car loans.
Let’s begin with the HDB flat. If you are borrowing from HDB, the maximum housing loan amount is 90% of the purchase price ($450,000 in my example). You can borrow for a maximum period of 25 years or up to age 65 whichever loan period is shorter. The interest rate for a HDB loan is 2.6% per annum (the formula is 0.1% + the CPF Ordinary Account interest rate). The loan (principal and interest) is repaid by monthly installments.
The maximum loan amount for a new car is 70% of the car price inclusive of COE, and the maximum loan period is 7 years. The interest rate varies between banks, so you should shop around for best rates. Like housing loans, car loans are serviced by monthly installments. HDB and banks will be able to work out the exact monthly loan installments for you. You can also calculate these using time value of money formulas (see below).
Before we run through the math, a quick recap of your goals:
Goal #1 – to save up $9,000 for rainy day fund. Timeline: 9 months.
Goal #2 – have $50,000 of CPFOA savings (you and your spouse’s). Timeline: 5 years.
Goal #3 – to save $36,000 (30% of the car price of $120,000) for down-payment. Timeline: 3 years.
And here are the road maps for each goal:
For Goal #1 – save $1,000 a month as suggested
For Goal #2 – stay working over the next 5 years as CPF is an employment-based savings scheme.
To figure out whether you and your future spouse will achieve Goal #2, we need to make some assumptions. For simplicity, I assume that you and your spouse earns gross salary of $3,000 a month throughout the 5-year period (sorry, no promotions for both of you), that CPFOA contribution is 23% of each person’s gross salary (up to a salary limit of $6,000 as per CPF Board rules), and that the CPFOA interest rate is 2.5% throughout.
Given the above assumptions, it is easy to show that your combined CPFOA account will have more than $80,000 in 5 years, so Goal #2 is more than achievable.
Now for Goal #3. The goal is to have $36,000 in cash to purchase your car in 3 year’s time. The road map is to determine how much to save each month to accumulate this amount and whether this is feasible. For this, I will assume a savings account interest rate of 1% per annum (monthly compounding).
Assuming you start saving now, the amount you need to save is $985.49 per month. This is 20.5 % of your combined take-home salary of $4,800 (80% of $6,000 since 20% of gross salary goes into your CPF accounts). Whether this saving rate is feasible given your other expenditure needs is something you will have to work out through a household budget.