EXPERT ADVICE>FINANCIAL PLANNER

By Henry Ong, RFP®

Tax-Advantaged Investments

The more infamous four-letter words in our vocabulary are those that cannot be uttered in front of children. But there are also four-letter words and acronyms that deserve to be mentioned especially in front of children. Yet, they are commonly disregarded when it comes to personal finance. The first two are CTRP and PERA.

CTRP stands for the Comprehensive Tax Reform Package that was put into law and incorporated in the 1997 Tax Code. PERA on the other hand stands for the Personal Equity Retirement Account, a recently enacted law, implementing rules and regulations of which are currently being drafted.

Under Section 24(B)(1) of the National Internal Revenue Code of 1997 “A final tax at the rate of twenty percent (20%) is hereby imposed upon the amount of interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements;…Provided, further, That interest income from long term deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments evidenced by the certificates in such form prescribed by the Bangko Sentral ng Pilipinas (BSP) shall be exempt from the tax imposed under this Subsection: Provided, finally, That should the holder of the certificate pre-terminate the deposit or investment before the fifth (5th) year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investment certificate based on the remaining maturity thereof:

Four (4) years to less than five (5) years — 5%

Three (3) years to less than four (4) years — 12%; and

Less than three (3) years — 20%”

This exemption is reiterated in Section 25(A)(2) of the 1997 Tax Code. Section 25(FF) of the same Tax Code defines long term deposit or investment as “…certificate of time deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments with a maturity period of not less than five (5) years, the form of which shall be prescribed by the Bangko Sentral ng Pilipinas (BSP) and issued by banks only (not by non-bank financial intermediaries and finance companies) to individuals in denominations of Ten thousand pesos (P10,000) and other denominations may be prescribed by the BSP.”

Together with provisions in the Manual of Regulations for Banks of the BSP, the above tax exemption is taken to apply to individuals investing in bank deposits or security issuances that are at least five years in tenor and are held by the investments for the same amount of time. The tax exemption also applies to bond issues of non-banks provided the investments are coursed through individual trust or investment management accounts that are held for at least five years.  There are certain nuances to this tax exemption and as such, it is best to consult a financial adviser, like a Registered Financial Planner, or your favorite banker.

On the other hand, PERA, or the Personal Equity and Retirement Account Act of 2008, seeks to provide the following salient benefits, among others, to individuals setting aside money for their own retirement:

1. tax credit of 5% based on all contributions to an individual’s PERA provided that the maximum contribution per individual per year is Php100,000 provided further that if the individual is an OFW, the maximum contribution per year is P200,000;
2. tax exemption on investment income-related taxes; and
3. tax exemption on withdrawals from the PERA upon retirement.

A cursory look at both laws shows that while what is exempted under the CTRP is the tax on interest income, PERA extends tax exemption on all investment income plus gives a tax credit of 5% per year. Clearly, for the average investor who does not have much funds and who is not out to do active trading, PERA is more advantageous. Nonetheless, this should not stop an individual from using both to his advantage as PERA has limits on the tax-exempt investments per year.

So what is the third four-letter word? It is nothing but SAVE. Regardless of the tax exemption, such a benefit will never be enjoyed if we don’t start saving. So save now and periodically, come hell or high water, so that you will have enough to invest and become not only financially free but also tax free.

Cheers to the Pinoy!

[PULL QUOTE]

“Regardless of the tax exemption, such a benefit will never be enjoyed if we don’t start saving.”

[PROFILE]

Henry Ong, RFP is the founder of the Philippine chapter of the Registered Financial Planner Institute of USA. He is also the President of the Association of Registered Financial Planners of the Philippines (ARFPP), the premiere professional body of practicing financial planners in the country. For more information about RFP Philippines, visit www.rfp-philippines.com.

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EXPERT ADVICE>RFP MONEY MAKEOVER

Cash Rich, Investment Poor

By Roland Ramos, RFP

Ron and Che Lopez, a young and dynamic couple based in Davao City, established a network of product distribution in the area of Davao City and Socsargen with two of their college buddies. Currently, Ron is the vice president for operations and is handling the different manpower and marketing aspects of the entire operation. Che, on the other hand, is vice president for finance and is handling the accounting department of their company.

Since starting their company eight years ago, they have steadily grown their operations from distributing two products to 15 product lines this year. Though small in size, the company has provided enough steady income for the couple over the past years.

Ron, as vice president for operations, is receiving a monthly salary of P80,000 per month. Che, as vice president for finance, is also receiving P80,000 per month. On top of their basic salary, a regular share in the profit is given by the company to its shareholders in the amount of P80,000 per shareholder per month. Ron and Che, therefore, are receiving a monthly profit share of P160,000 a month for the past three years. This monthly profit sharing has been agreed upon by the shareholders when the company incurred a substantial surplus on its day to day operations three years ago. This, however, is an all-in package for each shareholder inclusive already of their 13th month pay, medical and hospital benefits, and other bonuses.

The couple has invested in several guaranteed instruments and is expecting to receive several cash maturities in the next 14 years amounting to P3,169,657.50. Their four children are expected to take up their college in either Cebu City or Manila.

The couple has several life insurance policies with two reputable insurance companies with an aggregate amount of P15,800,000 and is looking at the adequacy of their respective coverage. They have not started saving up for their retirement except for a minimal time deposit of P1,000,000 and $10,000.

Aside from these, Ron has two golf club shares – a class A share at Apo Golf and Country Club and another at Fairways and Bluewater in Boracay with a total market value of P650,000. The couple lives in a small subdivision and owns the house and lot with a market value of P3,200,000. Ron drives a Toyota Land Cruiser and Che a one-year-old Fortuner with an amortization of P20,000 a month for the next four  years.

Their stake in their distribution company has a book value of P8,000,000, which is the bulk of their total assets. A look at their net worth statement (see Table 1: Statement of Assets and Liabilities) shows they don’t have a lot of liquid assets – just P2,000,000.

Table 1: Statement of Assets and Liabilities

However, their current cash flow shows a different story. With annual income of P3,840,000 and annual expenses of P2,843,675, they have net positive cash flow of P996,325 or around P83,000 a month. In other words, they are cash rich but investment poor. They have two cars that depreciate in value, a house and lot they live in (and not for investment), and golf shares that are not exactly liquid. As for their equity in their distribution company, that is of enormous value, but they can’t (and probably won’t) just sell their equity in their business. So the only investible assets they have are their cash and time deposits. In the meantime, they have financial goals that require long term investing.

Saving for the future

The Lopezes are blessed with four children, namely Paula (second year high school), Annika (grade six), Adam (grade three), and Sergio (kindergarten). They are two or three years apart and are currently studying in one of the private schools in Davao City.

Though the couple has already made substantial investments in the previous years in guaranteed instruments amounting to P3,169,657.50, with yearly releases from 2008 to 2022, the tuition projections for all four children clearly indicates the need for further preparation. Assuming tuition rate increases of 10% a year, they would need P9,912,200.99, resulting in a P6,742,543.49 shortfall.

They don’t have several years to build their educational fund, since all four children are already in school. They definitely have to set aside money from their annual income for this purpose, amounting to P200,000 in the next 14 years. In addition, they need to transfer their time deposit of P1,000,000 pesos to a reputable mutual fund which needs to have an average annual return of 15%, so it is highly recommended that the funds be invested in an equity fund. This strategy will ensure funds are always available for tuition.

The Lopez couple has also purchased several life insurance policies in the previous years. The policies are a mixture of participating, variable, and medical coverage with a total of P15,800,000.

Although the amount is already substantial, computing for their protection needs show that both Ron and Che, since they earn exactly the same amount, also have the same total protection requirement of P17,285,271.75 (sum of their immediate needs, educational fund needs, and income replacement needs). Double that equals P34,570,543.50. With existing coverage of P15,800,000, they’re short by P18,770,543.50. To meet that, we recommend additional variable insurance coverage by that amount, with annual premiums of P272,739.00. Again, that would come from their annual cash flow.

One other major goal of the couple is to be able to have enough funds when they retire. They both agreed on retiring 23 years from now. They therefore should have the needed funds to have a comfortable retirement. They decided that having a monthly retirement income of P120,000 (current value) is sufficient for their needs and both expect to live up to 80 years old.

An illustration follows:

Table 2: Retirement Plan

To cope with inflation and set up enough retirement funds, the couple should regularly invest in another equity fund that has the capacity to yield 15% per annum. From year 1 to 15 (2008 to 2022), they should invest P228,000 a year, which should grow to P12,475,584 in 15 years. Note that starting on the 16th year, they would have finished funding for the educational fund requirement for their children thereby having enough surplus to accelerate the growth of their retirement fund. So they can use the P200,000 they have been setting aside for education to their retirement fund. By the 24^th year, or in 2031, they can accumulate P52,149,552, assuming their mutual fund averages 15% a year. Also recommended is the shifting of their dollar time deposit to a dollar bond fund instrument that has a capacity to earn 7% per year. So putting $9,500 to work for the next 24 years, they can build their savings to $48,187 or P3,614,025 (assuming the dollar is worth P75 by then). Add their withdrawable funds from their new and existing life insurance policies, they can meet (even exceed) their retirement fund of P84,036,889.80.

Table 3: Summary of Investments for Retirement

Setting aside P200,000 a year for the educational fund, P272,739 a year for additional premiums, and P228,000 a year for retirement certainly will take a toll on their cash flow, but that should still give them a positive balance. What’s important is they maximize their present earning capacity while they’re still young and healthy. By moving more of their annual income to appreciating and future income-generating assets, they will be better able to meet their financial goals.

SAVVY INVESTOR>GLOBAL INVESTMENTS

Keeping Up With Inflation in a Freefall Market
Using “With Profit Funds” of the United Kingdom as a time deposit alternative
By Doby Atilano

We have learned through this crisis not to overexpose one’s savings in the stock market, mutual funds or any instrument that has a price and swings up and down. We have seen that those who are least affected have only exposed 10% of their income yearly to volatile instruments in order to reduce risk and maximize returns in the long term.

These clever ones who apply the dollar cost averaging strategy are probably the individuals who have panicked less during these times as they still have a considerable amount of liquidity to average out bargain prices during the crises.

However, most believers of the dollar cost averaging strategy still question how to maximize the rest of their disposable income or savings. In freefalling markets, most resort to cash and bite the losses of inflation. During these times, a 3-4% loss from inflation on cash is good enough.

Is cash really king? Another alternative that beats inflation even during these times and is widely used by United Kingdom pension companies and retirees is the “With Profit Fund.” The objective of the With Profit Fund is to provide smooth and steady returns by withholding most of the profits during good times in order to have enough cash in reserve to compensate for the losses during down markets.

Just like any other country, most of the pensioners’ assets in the United Kingdom are held in a fund that has a significant amount of global equities. The only difference is the “smoothing strategy,” a method the British life companies use to smoothen returns.

A fact is that 60% of the UK pension industry is invested in With Profit Funds. What has set this fund apart is the way it manages itself. Shown below are the distinct characteristics between a regular global mutual fund and the way a With Profit Fund manages itself.

Chart A: Regular Global Mutual Fund

As seen in the graph, a regular mutual fund may fluctuate depending on the current economic situation. The chart above shows a regular global equity fund.

Chart B: With Profit Fund

A With Profit Fund on the other hand smoothens the volatility by withholding the profits during good times such as from 1995 until 2000 (as seen on chart B) and by putting it in a reserve box.

For example, if the fund profits, say, 30% in a year, the fund will only give out 4% to its investors through a small price appreciation of its NAV (net asset value). Subsequently, they store the 26% remaining profit in a reserve box in order to keep the returns consistent by injecting funds from the reserve to the system during tough times such as the present economic condition. This sounds like a very simple concept. However, most companies who have applied the same investment smoothing strategy often fail because they lack enough cash in their reserve box to provide for losses especially when the bear market lasts for a long period of time.

In fact, previous studies have shown that the fund must have at least 50 billion Sterling pounds. This is one of the key requirements to make the smoothing work properly. Having said that, it is not surprising why only two massive companies have been successfully making With Profit Funds work for more than a hundred years. These two companies are the UK-based Aviva and Prudential.

Though many have tried the system and failed simply because they lack the financial muscle to smoothen the line of return during extended periods of losses, these two companies remain to actively manage the two most resilient and robust With Profit Funds available in the market.

In addition, according to OECD 2006 data, the With Profit Fund market has reached US$1.8 trillion. This means that the With Profits Market is as big as the GDP (gross domestic product) of Spain, Switzerland, and Belgium combined; it can also be compared to the GDP of France at US$1.9 trillion. Moreover, most of the pensioners’ money in the UK are invested in the With Profit Fund market. In fact, recent OECD data shows that more than 60% of long-term savings in the UK is held in With Profit Funds.

Long term performance
Bloomberg figures also show that the 7-year return of a typical With Profit Fund beats the returns of a regular equity index. However, in the longer term such as 10 years to 20 years, equities may beat the With Profit Fund. Although it may not match returns from the stock market in the long term, the With Profit Fund will provide stress free-volatility for the investor.

A With Profit Fund provides returns in two ways. The first way is through the regular bonus which is declared at the beginning of the year. During bad market conditions such as the present, the regular bonus from the With Profit Fund can go as low as 4% per year. In addition, a withdrawal bonus known as a “final bonus” may be paid out to the investor every time he or she withdraws. The final bonus will depend on the amount or the size of the reserves of the With Profit Fund. Over its 100 plus years history, the With Profit Fund has averaged 6-8% return on its investors if the regular bonus and the final bonus are effectively added together. Furthermore, if the market moves up and the reserve is enough, investors will be enjoying a nice bonus upon withdrawing their money.

To sum up, With Profit Funds have a good balance of risk, returns, and liquidity. Although With Profit Funds are not as profitable as equities or stock funds in the long run, it still provides a nice and stable return that is just able to beat a 4% inflation rate. Risk is reduced by the “smoothing out” through simply taking some profits from good times in order to keep the consistent low returns steady even in bearish markets. We have also seen some evidence that the With Profit Market is a US$1.8 trillion market comparable to the GDP of France. The sheer size of the With Profit Market allows efficient smoothing that has been tried and tested by two companies for hundreds of years.

PROFILE

Doby Atilano is a registered financial planner and founder of the Global Investors Center, a pioneering education facility specializing in global portfolio management. Bringing together representatives from Fortune 500’s top fund management companies abroad as trainers, this facility is keen on educating the general public in independently choosing the right investment opportunities abroad.

The seminars convened within the Global Investor’s Center will help impart proper investment knowledge to its students, giving them the opportunity to maximize their investment portfolios in a global scale. Seminar dates are the following: “Investing Profitably in Specialized Wine Funds” (May 16), “Mastering Global Mutual Funds Selection” (May 25), and “Investment 101 for Newlyweds: Building for Your Future” (July 25).

Other upcoming seminar topics include “Forex Trading: The Basics in Currency Trading” and “International Investment Strategies for Your Retirement: How to Retire Rich with Global Funds.” To learn more about the Global Investors Center, call tel. nos. 994-7424 or 328-8858, e-mail inquiry@gicphil.com, or visit their Web site at www.gicphil.com.

SMART SPENDER>CONSUMER HELP DESK

Outsmarting Investment Scams
Victimized by Ponzi schemes? Lost money on pre-need plans? Learn how to protect yourself from being a scam victim
By Sherwin Chan, RFP

“I got zero!”

Unlike the toothpaste commercial, there is a woeful sighing that comes with that statement. This lament comes from investment scam victims.

Greed is a powerful incentive for individuals who take unmitigated risks with their money. Based from old news reports, victims of Performance Investment Products Corp. (PIPC) plunked in a consolidated amount of $250 million. On the other hand, unsuspecting “investors” devoted $51 million to Royal Manchester Five Trading Corp.

What drives individuals into bilking other people’s money?

Jordan Belfort, author of “The Wolf of Wall Street” and a convicted investment scam artist himself has this to say, “We did some outrageous behavior, some illegal stuff, but everyone was doing it… a lot of people turned a blind eye to what was going on. We were all making money.”

Crooks are not limited anymore to petty thieves that thrive on dark alleys and shabby corners. They now wear corporate suits and sell you stories about solid investments with good returns.

Need for greed
Sometime in 2007, a person went up to this author and inquired about a possible investment with the Rural Bank of Parañaque. The bank’s officer had been wooing him about a “double your money in 5 years” scheme and his efforts were starting to bear fruit. Naturally, he began asking this author whether he should dive into it or not.

In hindsight, an ounce of pretension was worth a pound of manure.

During our discussion, this person showed me printouts of the bank officer’s PowerPoint presentation. It was a sales presentation with little details about where the money would be invested. More than that, the clincher was this statement made by the bank officer – “If you’re still unsure, just invest up to P250,000 only. Anyway, if the investment goes wrong, you are protected by the PDIC.”

A unique sales pitch if you came into the meeting unprepared. But if you’ve heard the trite phrase “Start with the end in mind” then you would understand that this investment was doomed from the start.

Knowledge is power
A little knowledge of basic investment principles like the rule of 72 would help most of us. This principle simply states that you divide the interest rate by 72 to know the length of time it takes to double your money. For our Rural Bank of Parañaque example, that interest rate is somewhere between 13% to 15% p.a.

With this in mind, start thinking of what sort of investments the bank will make to guarantee you an interest rate like that. Remember 2007? Telltale signs of the faltering global economy were already there. If the economy is doing badly, how can one bank have the ability to still generate investments that kind of return?

Nowadays, it really pays to be well informed about what is happening around us. News travels fast but oftentimes our ignorance still persists. A convenient solution to that is to use the Internet to do a background check.

Searching through the Internet for resource, this author came across a post last June 2007 in an online forum called Pinoy Money Talk regarding irregularities with Banco Parañaque. At that time, the Legacy Financial Group wasn’t hogging the headlines yet. However, the fact that a financial institution’s reputation is stained with controversy should make would be investors think twice.

Then again, an organization like the Legacy Group would have been difficult to assess at the beginning. With so many branches and so many depositors, people had the perception that there was nothing wrong. But now that the truth has come out, it appears that they actually offered products like the “double your money in five years” and even “double your money in three years” deposit mentioned above as well as a slew of other “too good to be true” schemes.

Handling scams
In most cases, your easy solution is to compare what the established and well-known banks and financial institutions are offering. Chances are that if they aren’t offering similar products, there is something fishy going on. You should be extra careful with your dealings with investment solicitors.

So what do you do when you are confronted with a possible scam? Our Securities and Exchange Commission (SEC) proposes a set of questions you must ask to protect you and your money.

1. Name of the person and the company making the offer
2. Address of both the person and the company
3. Phone number, particularly the landline
4. SEC registration

Bear in mind though that having an SEC company registration does not grant it the authority to sell investment instruments, such as securities, bonds, commercial papers, or similar financial instruments. Only investment houses and financing companies with QB (quasi-banking) license and with SEC registered securities may offer to sell the same to more than 19 investors. And only SEC registered persons (brokers/dealers/sales people) may offer or sell SEC registered securities to the public.

A case in point is Royal Manchester Five Trading Corp. If you didn’t know already, you can check on the veracity of a corporation’s registration license over at the SEC Web site (www.sec.gov.ph). That site carries a preamble that tells you that a name listed there as a registered corporation does not mean they are authorized to sell investment products. Try looking up Royal Manchester Five in its search facility. It is there, but as we all know by now, they were not authorized to sell investment instruments.

If you find irregularities after carefully mulling all of the items, then it’s time to call the SEC–CED (Compliance Monitoring and Enforcement Department) at 724-7650 or 727-2267.

Investing tips
The moribund investing climate we are in today certainly discourages retail investors. The stock market, unit investment trust funds, and mutual funds have lost on average 50% from their highs in 2007. It also doesn’t help that big US banks buckled under the pressure of the subprime meltdown.

Investor confidence needs to be restored before paper asset prices begin to recover. However, lately we’ve seen that most stock market indices have started regaining lost ground due to policies set forth by governments worldwide. If this is the start of a long awaited recovery remains to be seen.

Just always remember that a high rate of return simply means a higher degree of risk. Given that logic, an exorbitant rate of return means that there is also an unbelievable level of risk. Also remember that oft-quoted line, “Don’t invest what you can’t afford to lose.”

If you find it hard to trust banks and investment houses then why not trust in yourself? Your money and talents could be the powerful ingredients for a successful path to entrepreneurship. After all, if you can’t trust other people to do the investing for you, do it yourself.

Sherwin Chan is a Registered Financial Planner. He maintains a weekly personal finance blog at guerillainvesting.blogspot.com. For comments or questions, you may email guerillainvesting@yahoo.com.