Cash Rich, Investment Poor

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

Item	Amount (in Php)
AssetsCashPeso time deposit Dollar time deposit ($10,000 / P50) Cars Less: Depreciation Residence Golf shares Company equity Total Assets	500,0001,000,000 500,000 3,900,000 (2,730,000) 3,200,000 650,000 8,000,000 16,580,000
LiabilitiesCar amortization	960,000
Net Worth	15,620,000

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

Retirement Details	Ron	Che
AgeDesired Retirement AgeYears Before Retirement Life Expectancy Years After Retirement	396223 80 18	376023 80 20
Desired Retirement IncomeInflation Rate	120,000.005%	1,440,000.005%
Desired amount upon Retirement onY23FV= PV (120,000), inflation rate (5%), nper (23) Lumpsum Needed for Retirement Years	368,582.85	4,422,994.2084,036,889.80

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

Sources	Amount
Value of peso investment for retirement at mutual fund company	52,149,552.00
Value of dollar investment for retirement at mutual fund company (assumption $1=P75)	3,614,025.00
Withdrawable funds of new life insurance policy of Ron at age 62 (partial)	3,000,000.00
Withdrawable funds of new life insurance policy of Che at age 60 (partial)	15,000,000.00
Total withdrawable funds, guaranteed cash values of life insurance policies of Ron and Che for previous life insurance coverage totaling P15,800,000	12,500,000.00
Total	86,263,577.00
Amount needed for their retirement planning	84,036,889.80
Excess/ (Shortfall)	2,226,687.20

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.