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Showing posts with label investment. Show all posts
Showing posts with label investment. Show all posts

On Finance: The Path to Financial Freedom and Financial Independence

This post is an adapted version of an article on economics and finance I wrote recently, dedicated to two of my former economics students, WL & YC, who participated in the National Economics and Financial Management Quiz 2013 organised by the Economics Department at the National University of Singapore (NUS). Currently, the National Economics and Financial Management Challenge 2014 is on - good luck to all economics students participating and all the best! 

The Path to Financial Freedom and Financial Independence 

Recently, I was asked interesting questions about the path to financial freedom (how to achieve financial independence), and it is one of the economics and finance topics that interests me, so here's my sharing on steps to financial freedom. 

None of these ideas in this discussion constitute professional financial advice, and all ideas here should be considered principles, concepts, and ideas. I'm not a financial adviser. Take note further that while the steps may be simple, implementing them takes discipline and effort. The principles might be easy but the implementation and execution of these principles are much harder. Nonetheless, this finance article might be of great use to economics students who want to think through financial issues or who would like to learn about good ideas that I have collated via my experiences and would love to share with you. 

Here are some simple steps to financial freedom and independence you should seriously consider. 

(1) First, think through and plan your financial goals and objectives. 

First, the most important thing about financial freedom is about goal setting and objectives. You must think about your life and what you want out of life. What does financial freedom really mean, to you, personally? If you want a luxurious life full of fast cars and fanciful toys, then clearly the passive income you need from investments would be much larger and harder to achieve compared to someone who wants a simple life with occasional luxuries.

Clearly there are many myriad possibilities - so plan first your financial goals and objectives. 

(2) Second, think about "Why".

Why? It should be clear that different people have different goals and objectives, but the idea is to make sure you know why you are doing what you are doing. "Why" is often more important than "what", since it means that you will be motivated, inspired, and able to achieve what you want.

Personally, I want to have the freedom and time to pursue the many hobbies I have, and so having the financial means to do so without worrying about my paycheck is a strong incentive. 

(3) Third, always spend less than you earn. 

This is important: you have to spend less than you earn. Simple: keep your spending lower than your earnings and always live beneath your means. 

(4) Fourth, earn additional income to augment your main source of income. 

In fact, if need be, take up extra jobs or work harder in your current job to gain additional income. 

(5) Fifth, grow your money through sound investments. 

With money you save from spending less than you earn, invest the money. The idea is simple - don't let money accumulate under your bed and certainly do not have all your money only in your savings account; invest and grow your wealth. 

(6) Sixth, gain and grow your passive income. 

On this note, many suggest gaining passive income, for instance, through investment in stocks for dividends, and bonds for interest, and, for the more conservative amongst us, placing money into long term bank fixed deposits to gain interest might be a good idea. In short, invest your money. 

(7) Seventh, manage your debts.

Make sure you pay off your debts. Many people say, however, don't borrow; try not to get into debts at all; and debts are bad. One famous saying I usually tell my students is that Shakespeare says, "Neither a borrower nor lender be." On the other hand, I would say instead that it really depends on what your debt is about. If you borrow money to spend on consumption, such as borrowing for a new TV set, then that might not be a good idea. Try to pay those in full, because interest has this nasty habit of expanding and expanding. You always end up paying much more than you expect due to "effective interest rates".

If, however, you borrow money to spend on assets, such as a house (which is an asset as it can be rented out, or sold for capital gains) or to spend on machinery for your business if you are an entrepreneur, it is rather different from borrowing for consumption.

I would say, in my opinion, try to reduce "bad debt" and try to pay off "good debts". If you can pay for things in full, it would be better - but in my view if you have to borrow, try to borrow for the right reasons. 

(8) Eight, keep track of your incomes and expenditures.

Personally, I keep records of how much I spend and how much I earn, and this accounting keeps me disciplined. Make sure you know how much you spend, and how much you earn, and this will make sure you have the knowledge to cut in the right places. 

(9) Ninth, and this should be pure common sense, always spend within your allocated budget - have discipline!

Set a budget and spend within the budget. 

(10) Tenth, you could learn about dynamic asset allocation.

One of the recent National Economics and Financial Management Challenge 2014 FaceBook post questions in the competition was about comparing dollar cost averaging and asset allocation.

One of the financial ideas that is definitely useful here is dynamic asset allocation. You could allocate your resources across various classes of assets, like stocks, cash, bond, REITs, and insurance, as this diversification of investments helps you ensure that you build up your wealth while reducing company-specific and other associated risks drastically.

(11) Finally, there is also a need to eventually build up an emergency fund. 

Once you do the above steps in your journey to financial freedom, build up an emergency fund for a rainy day just in case you need the funds quickly. Many people say that an emergency fund should be 3 to 6 months of your income.Do this last because paying off existing debts and investing for long term dividend and capital gains should be your main priorities.  

Hope these economics and finance ideas on financial freedom help you think through carefully about your own journey to financial freedom. Do think through the ideas and concepts carefully and reflect on what you have learnt from them, and see which finance ideas are applicable to your own particular context and situation, and which ones will be important to you in future. Thanks for reading and cheers!

JC Economics Essays - This simple finance article is my personal sharing about the path to financial freedom and financial independence. Thank you for reading my sharing on economics and finance ideas and knowledge, and hopefully it is helpful for economics students competing in the National Economics and Financial Management Challenge 2014, NUS, Singapore. Thanks for reading and cheers. 

(a) Explain why low inflation is an important macroeconomic aim of the Singapore government. [8]



(a) Explain why low inflation is an important macroeconomic aim of the Singapore government. [8]

Inflation is defined as a sustained and persistent increase in the general price level. There are different possible causes of inflation, such as demand-pull or cost-push inflation. According to economists, a generally low inflation rate of 2 to 3% is optimal for an economy; however, hyperinflation results in adverse internal and external effects on an economy. Therefore, price stability is considered one of the important, major macroeconomic aims of any government, and Singapore is not an exception.

Internal Effects

There are adverse internal effects on an economy due to inflation. First, there could be an increase in “menu costs” as businesses would have to change price lists on their menus and catalogues often when inflation occurs, therefore incurring high transaction costs. Inflation could also result in “shoe-leather costs”, for instance, when firms frequently move money in and out of financial institutions to get the highest possible returns. Hence, high transaction costs could be an internal problem generated by inflation.

Secondly, inflation could also lead to a redistribution of income. Fixed income earners would suffer as the real value of their income would decrease due to inflation. For instance, pensioners or people on fixed wages would suffer due to inflation as their incomes would be able to buy less goods and services. Variable income earners, such as insurance agents or property agents, might not suffer that much because their incomes could increase due to inflation. Simultaneously, inflation would reduce the real value of debt. Hence, debtors would gain while creditors would lose in terms of purchasing power. The amount of the debt repaid by the borrower would have a smaller purchasing power due to inflation. Hence, a redistribution of income in favour of variable wage earners and debtors would occur.

Third, inflation damages investment. This is because the real value of savings will fall and people might be inclined to consume and spend instead of saving. This fall in savings would reduce the amount of funds available for investment, hence increasing borrowing costs (interest rates would rise as a result). Inflation also creates uncertainty as it is difficult for businesses to predict costs and revenues, profits, and losses. This would lead to a fall in investment, which would limit the future economic growth of the economy as well as the productive capacity of the country.

External Effects

When it comes to the foreign sector, inflation also has adverse effects. Inflation could negatively affect the competitiveness of a country’s exports. With higher inflation, a country’s exports would become relatively more expensive compared to goods from other countries. Assuming that the demand for Singapore’s exports is price-elastic, this would mean a larger than proportionate fall in the quantity demanded of exports when Singapore’s exports are priced higher relative to other countries due to the effects of inflation. Furthermore, with a higher relative rate of inflation as compared to other countries, this would mean that domestically-produced goods are relatively more expensive as compared to imports. Consumers would then switch from locally-produced goods to purchasing imports instead, assuming these are close substitutes. Therefore, import expenditure would also increase.

The Balance of Payments (BOP) would therefore be affected. For a small and open economy like Singapore, which depends on exports to drive economic growth, inflation could greatly worsen the country’s current account and thus worsen the BOP, assuming the capital/financial account remains unchanged. As a small economy with no natural resources, Singapore is dependent on imports of raw materials. Therefore, this makes Singapore susceptible to imported inflation, where the rising prices of such imports would lead to a higher cost of production, hence leading to a spiral of higher prices. Due to the high import content of Singapore’s exports, this could lead to a higher price of Singapore’s exports, hence adversely affecting export competitiveness.

Conclusion

In conclusion, the higher the rate of inflation, the greater the adverse effects on the country, be it internal or external effects. There are many different policies that the Singapore government can potentially use to curb inflation, such as fiscal policy, monetary policy, and supply-side policies.


JC Economics Essays: Tutor's Comments - This is part (a) of a two part Economics examination question set by an Economics tutor who was one of my classmates at NIE (National Institute of Education), where we did the PGDE (Postgrad Diploma in Education) for Economics. She kindly allowed me to modify her essay to fit this post. However, despite the fact this Economics essay was written by an Economics tutor, under simulated examination conditions, the question still remains: how can I improve on this work? Now, try a little more "feeling-based" or even "emotion-based" questions - what do I feel is correct about this Economics paper? what do I feel is right about this paper? is it just right in length? does it address the question? and so on. You can get a right gut feel about an Economics paper if you have reviewed many related Economics questions and gotten a feel of what a correct answer will or should look like. On my Economics site here, I have many other related questions - do explore them and see the comments that I have given to my students, other fellow Economics tutors, and to professional Economics paper writers. Thanks for reading and cheers! 

(b) Discuss what influence the rate of interest might have on the level of investment in an economy [15]


(b) Discuss what influence the rate of interest might have on the level of investment in an economy [15]

This paper discusses the influence the rate of interest might have on the level of investment in an economy. Investment refers to a process of accumulating capital, where goods are used in the production of other goods. There are two types of investment, the first being fixed capital such as machineries, plants and equipment, and second type of investments includes inventories such as raw materials and unsold goods. The cost of borrowing money or the cost of credit is important for businesses that depend on borrowed capital. The decision to invest depends on the expected returns on investment (MEI) and cost of investment (i/r). Investments will be profitable as long as MEI is more than interest rate. Hence the rate of interest definitely has an impact on investment, although there are some limitations and other factors that need to be considered in this paper.

There exists an inverse relationship between interest rates and investments. If the rate of interest decreases, then investment will increase, ceteris peribus. Projects with lower expected returns will now appear profitable and so more investments will occur. When interest rates are at 4%, projects with returns of 2% and below appears unprofitable I*, and will not be undertaken. If it falls to 2%, these projects will now become profitable, thus investments increase.

THINK: Insert theoretical diagram. What economics diagram do you think this will be?

Also, when rates of interest falls, people may save less but can consume more. This may increase production and employment and national income in the economy. Producers that need to meet higher consumption will invest more.

The extent of increase in the level of investment due to a fall in interest rates depend on the responsiveness of investment decisions to interest rate changes which in turn depends on economic conditions, business confidence and source of investment. Keynes suggested the interest elasticity of demand for capital goods – during a recession – businesses are pessimistic, and even decreases in interest rates may fail to stimulate investments.

Interest rates alone are also insufficient to influence the level of investment, but the expected yield is also crucial in determining investments. The expected returns are important in that a fall in interest rates that is accompanied by a fall in expected returns may not result in greater investment. Even without any increases in interest rates, if the MEI curve shifts up, there will be more investment at each interest rate than before. The increase in expected returns could result from either a fall in the cost of capital goods, increased efficiency of machines due to technological advancement or favourable changes in government policy such as decreases in profit taxes or any increase in business confidence.

Expected yield may end up being more important in certain circumstances – for example in Singapore, where investment is largely foreign. Most investments take place when businesses are optimistic about the profitability of their projects. The reduction in corporate tax for example, will increase the expected yield of business projects and encourage greater investment expenditures.

Therefore, the rate of interest is only one of many factors that affect the level of investment in an economy. Its impact depends on the responsiveness of the investment to interest rates. If the elasticity of investments to interest rates is elastic than an increase in interest rates will lead to more than proportionate increase in investments and vice versa.

JC Economics Essays - Economics Tutor's Comment: This economics paper could be improved. However, this is quite a good approach, although many relevant real life, real world examples are lacking and more details could be further added. This economics paper is quite strong in theory and the candidate clearly knows her work. Although it was written under model "A" level examination conditions, still think - how could this economics paper be further improved and made better? How could the conclusion be made more argumentative, more evaluative, more considered and better nuanced? Remember that an evaluative conclusion that gives a susbstantiated, justified, and nuanced opinion can score high, good marks. Suggested possible exam grade: 11.5 / 15.  

(a) Discuss the likely causes of a rise in consumer spending in Singapore [10]


(a) Discuss the likely causes of a rise in consumer spending in Singapore [10]

This paper discusses the likely causes of a rise in consumer spending in Singapore. Consumption refers to the planned spending on consumer goods and consists of both autonomous and induced consumption. There are several factors that can cause a rise in consumer spending in Singapore.

Firstly, induced consumption could be due to national income changes. Singapore may experience high economic growth rates in recent years which led to the growing affluence of Singaporeans. This rise in national income translates into an increase in purchasing power which would mean that households would be able to spend more on consumer goods and services. Eventually, there will be a rise in consumption indicated by a shift of the curve. However, the extent of the rise in consumption depends on the value of the MPC and whether the rise in national income is permanent.

Apart from this, autonomous consumption also increases. This could be done to firstly, consumers expectations. Strong economic forecasts and stability in both internal and external environment would lead to an optimistic outlook on the economy. Therefore, there will be strong consumer confidence as people tend to save less for rainy days and expect future increase in income, leading to a rise in consumption. However, the extent of the rise depends on how optimistic consumers are judging from the outlook and whether this outlook is a temporary or permanent phenomena.

Secondly, consumption increase may be due to government policies or disposable income rise. A fall in income tax rates (which reduces the reliance on direct taxes) and the increase in transfer payments in recent years have led to an increase in the disposable income. Households are likely to down more due to the increase in purchasing power. However, the extent of increase in consumption depends on the propensity to consume and other factors - for example, a rise in GST from 5% to 7%

Lastly, interest rates and credit availability also affect consumption. Lower cost of borrowing and loosening of credit facilities as seen by growing varieties of credit cards available in the market and the aggressive advertising tactics that follow show an encouragement on the bank's part to consume. It is now cheaper and easier to borrow in order to purchase consumer durables and there is a reduced incentive to save due to lower returns, therefore leading to a rise in consumption.

The extent of the rise, however, depends on the interest elasticity of consumption, the economic outlook and availability of past savings.

JC Economics Essays - Economics Tutor's Comment: This response is quite a good attempt at answering the economics question posed, especially during examination conditions. Fair work, and a good effort, given that this was done under "A" level Economics examination conditions. However, there are some possible areas of improvement - putting yourself into the shoes of an Economics tutor or examiner, what would you do to improve this economics paper, other than drawing in the correct Economics diagram and then explaining it carefully? What other economics details should have brought into this paper in order to improve it? Thanks for reading and cheers. Suggested grade: 8/10. 

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