Personal Financial Planning (Preview)

PERSONAL

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Published by Scola Books

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Perpustakaan Negara Malaysia

Nga,PERSONALJoyce

FINANCIAL PLANNING : A Comprehensive Guide to Personal Financial Planning in Malaysia

ISBN 978-967-5492-76-1

1. Finance, Personal.

2. Consumer credit.

3. Saving and investment.

4. Wealth--Religious aspects--Islam.

I. 332.024Title.

Disclaimer

Any products, brands or company names featured in questions and examples are for illustrative purposes only and may not be their actual representation. They do not constitute nor imply an endorsement by the publisher.

All information in this publication is correct at the time of printing and may be subject to changes.

Cover image: zhu difeng/Shutterstock.com Image used under license from Shutterstock.com

Answers to questions can be found on the Sunway University Press website.

ForewordContentsbytheMalaysian

Financial Planning Council

Praise for Personal Financial Planning

Chapter 1 Introduction to Personal Financial Planning

1.0 What is Financial Planning?

1.1 The Importance of Financial Planning

1.2 The Financial Planning Process

1.3 Setting Financial Goals Using the SMART Model

1.4 The Financial Planning Regulatory Environment

1.5 The Role of the Financial Planner The Financial Planner’s Code of Ethics

1.7 Methods of Remuneration for Financial Planners

Application Exercises

Chapter 2 Managing Your Personal Finances

2.0 Basics of Money Management Introduction to Cash Flow Management The Personal Budget and Cash Flow Statement The Net Worth Personal Financial Ratios Other Factors to Consider in Interpreting Personal Financial Statements and Ratios The Concept of Time Value of Common Applications of Time Value of Money

Chapter 3 Managing Consumer Credit

3.0 The Characteristics of Types

3.3 Buying a Car 72

3.4 Car Loans in Malaysia 74

3.5 Assessment of Consumer Creditworthiness 80

3.6 Managing Debts 86

Summary 91

References 91

Application Exercises 93 Case Study 96

Chapter 4 Tax Planning 98

4.0 Introduction to Tax Planning 98

4.1 Basic Rules of Taxation in Malaysia 99

4.2 Tax Computation Basics 106

4.3 Employment Income 108

4.4 Business Income 120

4.5 Other Income 124

4.6 Donations and Gifts 126

4.7 Tax Relief for Individuals 127

4.8 Tax Rebates 127

4.9 Joint Assessment 127

4.10 Real Property Gains Tax (RPGT) 134

Summary 135 References 136

Application Exercises 137

Case Study 140

Chapter 5 Investments in Bonds and Shares 142

5.0 Introduction to Investment Planning 142

5.1 Factors That Determine an Individual’s Risk Profile 143

5.2 Types of Investment and Risk Profile 147

5.3 Investment in Bonds 148

5.4 Risks of Investments in Bonds 155

5.5 Investment in Shares 158

5.6 Common Reasons for Investment in Shares 160

5.7 Classification of Share Investments in Malaysia 161

5.8 Pre-Investment Considerations for Share Investors 169

5.9 Risks of Investing in Shares 171

5.10 Valuation of Share Investments 174

5.11 Measuring Share Investment Returns 183

5.12 Factors That can Impact Share Prices 187

5.13 Methods of Share Investing 193

5.14 Behavioural Aspects of Share Investments 197

Summary 201

References 202 Application Exercises 203 Case Study 206

Chapter 6 Investment in Unit Trusts 208

6.0 Introduction to Unit Trusts 208

6.1 Major Characteristics of Investment Funds 210

6.2 Classification of Unit Trust Funds in Malaysia 212

6.3 Methods of Investing in Unit Trusts 215

6.4 Benefits of Investing in Unit Trusts 218

6.5 Disadvantages of Investing in Unit Trusts 220

6.6 Costs of Unit Trust Investments 221

6.7 Common Unit Trust Measurement Metrics 223

6.8 Risks of Investing in Unit Trusts 231

6.9 Importance of the Unit Trust Scheme Prospectus 234

6.10 Role of the Unit Trust Consultant 237

Summary 238 References 239 Application Exercises 239 Case Study 242

Chapter 7 Investment in Real Estate 244

7.0 Introduction to Real Estate Investment 244

7.1 Common Reasons for Property Investment in Malaysia 247

7.2 Factors Affecting Value of Property in Malaysia 249

7.3 Current and Previous House Payment Schemes in Malaysia 259

7.4 Types of Housing Loans 264

7.5 Mortgage Loan Refinancing 269

7.6 Other Costs Associated with Buying a House 273

7.7 Risks of Investment in Property 277

7.8 Taxes on Property Investments 278

7.9 Buying Versus Renting a Property 281

7.10 Real Estate Investment Trusts (REITs) 284

Summary 288 References 289 Application Exercises 291 Case Study 294

Chapter 8 Life, Medical and Takaful Insurance 295

8.0 Introduction 295

8.1 Concepts of Life and Medical Insurance Contracts 297

8.2 Assessing an Individual’s Life Insurance Needs 299

8.3 Types of Life Insurance Policies in Malaysia 306

8.4 Medical and Health Insurance 315

8.5 Takaful Insurance 323

Summary 326 References 327

Application Exercises 328 Case Study 331

Chapter 9 General Insurance 333

9.0 Introduction 333

9.1 Insurance Regulations in Malaysia 335

9.2 Financial Services Act 2013 and Key Provisions Related to the Insurance Contract 337

9.3 Risk Management Function and Insurance Planning 340

9.4 Underwriting Functions 342

9.5 The Claims Function 346

9.6 Personal Insurance Coverage in Malaysia 351

9.7 Insurance Marketing and Distribution 364

Summary 369 References 370

Application Exercises 370 Case Study 373

Chapter 10 374

10.0 Introduction 374

10.1 Estate Planning Terminology 375

10.2 Concepts of Ownership Rights in Malaysia 376

10.3 Wills and Estate Planning 379

10.4 Non-Muslim Wills in Malaysia 385

10.5 Grants of Representation and the Probate Process 394

10.6 Inheritance (Family Provision) Act 1971 403

10.7 Trusts in Estate Planning 407

10.8 Types of Trusts 409

10.9 Nominations 414

10.10 Estate Planning for Muslims 417

10.11 Estate Planning Methods During a Muslim’s Lifetime 419

10.12 Estate Planning Methods for Muslims Upon Death 422

10.13 Power of Attorney 431

Summary 433

References 435

Application Exercises 435 Case Study 438

Chapter 11 Retirement Planning 440

11.0 Introduction 440

11.1 Debunking False Beliefs About Retirement 442

11.2 Issues Concerning Retirement Planning in Malaysia 446

11.3 Investment for Retirement 452

11.4 Categories of Retirement Benefit Schemes in Malaysia 461

11.5 Major Retirement Schemes in Malaysia 463

11.6 Major Steps in Retirement Planning 470

11.7 Determining Retirement Income Needs 471

11.8 Determining the Required Retirement Income 474

11.9 Determining Available Retirement Income Funding Streams 478

11.10 Retirement Funding Gap 482

11.11 Retirement Planning Risks and Obstacles 484

Summary 486

References 487

Application Exercises 489 Case Study 492

Chapter 12 Overview of Islamic Wealth Management 496

12.0 Overview of Malaysia’s Islamic Wealth Management Framework 496

12.1 Basic Concepts of Islam and Shariah Law 498 12.2 Concept of Wealth in Islam 499

12.3 Wealth Purification 501

12.4 Basics of Islamic Finance Instrument Contracts 510

12.5 Wealth Protection 518

12.6 Wealth Distribution 521

12.7 The Issues and Challenges in Islamic Wealth Management 529

Summary 531

References 532

Application Exercises 533 Case Study 536

Further Reading 537 Index 548

Foreword by the Malaysian Financial Planning Council

I would like to congratulate Dr Joyce Nga and Scola Books for publishing Personal Financial Planning: A Comprehensive Guide to Personal Financial Planning in Malaysia. They have identified this essential need in society, especially as the Covid-19 pandemic has made individuals and businesses focus more on having higher saving thresholds. No matter the season or financial climate, businesses and individuals must remain defensively positioned with their personal finances. In order to attain this, the 6-Step financial planning process as highlighted in page 4 of this book should be used as a guiding force in the attainment of a state of financial well-being.

In Chapter 2, the book highlights the need for an individual to have passive income streams in their personal financial quest. Importantly, from my view in money management, one must be able to optimise their current savings to improve their financial state. Thus, the importance of understanding financial ratios, time value of money and future value, all of which and many more concepts are covered in detail in this book.

Further chapters in this book highlight debt and tax management, investments, as well as estate planning, among other important subjects. It provides readers with a holistic view of all necessary personal financial knowledge. The book also highlights the right financial professionals to seek advice from, to help minimise the risk of getting bad advice.

On behalf of the Malaysian Financial Planning Council (MFPC), I find this wellplanned and produced book an essential reading material that will appeal to Malaysians of all walks of life.

MFPC is supportive of the efforts by Scola Books and look forward to future cooperation to further our mission of financial planning human capital development.

Dr Desmond Chong Adjunct Professor, Deputy President, Chairman Certification & CPD Board (CCB) Malaysian Financial Planning Council

Foreword

It is not how much money you earn, but how you manage it and what you do with it in your lifetime that determines how well you will live your life. Dr Joyce Nga has successfully turned this very serious yet important subject into one that is easy to read and understand with relevant examples and case studies in her book.

As you go through each topic, you will gain insight into what is important and how each aspect of your personal finance links to one another. Dr Joyce has successfully compiled 240 hours of technical financial planning lessons into this precise and concise book.

So how should it be used? It can be an introductory reference material for those who wish to embark on the journey into the financial planning profession. Alternatively, for the general reader who wants to try to DIY the basics of their personal finances, this book will help get you started. However, a word of caution for those who are not so numerically inclined: you may want to consult a Licensed Financial Planner instead as they can help you crunch the numbers and analyse your financial situation so that you can understand where you stand financially, and how to proceed from there to achieve your financial life goals.

I also hope this book will inspire readers to consider pursuing a career in the financial planning profession, as it is a sunrise industry. With an estimated 60% of Malaysia’s population potentially requiring some form of financial planning and advice, we definitely need to grow the current pool of Licensed Financial Planners. I certainly applaud the efforts of Dr Joyce Nga for her contribution towards better financial literacy for youths through this book.

Linnet Lee CFP CERT TM, IFP® Chief Executive Officer Financial Planning Association of Malaysia

Praise for Personal Financial Planning

This book offers comprehensive guidance with a down-to-earth approach to personal financial planning in Malaysia. This is an important text that is filled with illustrative examples and case studies that reflect real-life situations.

Dr Joyce Nga has managed to bring together all the important concepts to present a holistic coverage of personal financial planning that not only includes investing in shares, unit trusts, properties, and other ways of wealth building, but also looks at credit and tax obligations, everyday spending and budgeting, protecting the family with suitable insurance policies, as well as retirement planning and estate planning. These are all inter-connected facets of personal financial planning.

Most interestingly, this book also covers Islamic wealth management, according to Islamic perspectives and principles, while also discussing the differences between conventional and Islamic wealth management.

This book is a significant resource for both students and lecturers studying personal financial planning as it includes exercises and practical cases. I would also say that this is the book of choice for the average Malaysian looking for a quality read on personal financial planning, as this book is tailored for the Malaysian context.

Siti Aminah Mainal Senior UniversitiLecturerTeknologi MARA, Puncak Alam Campus

Acknowledgements

Firstly, I would like to thank Almighty God for the guidance and wisdom in enabling the smooth completion of this book despite the many challenges encountered along the way. I would also like to thank my family for their love, understanding and support throughout this project.

I extend my appreciation to Professor Mohamed Ariff Syed Mohamed, Distinguished Professor and Head of the Department of Economics and Finance, Sunway University Business School for the space given to me to research and reflect on the contents of this book as well as my colleagues at Sunway University Business School for their moral support. I also acknowledge and am grateful for the contributions from my colleagues at the Centre for Commercial Law and Justice, Professor Cheah You Sum for Chapter 9 , and Sri Bala Murugan Gogula Nathan for Chapter 10 , as well as Nasaruddin Zainal for his general contributions, especially regarding takaful insurance in Chapter 8.

I would like to thank Dr Desmond Chong, Deputy President of the Malaysian Financial Planning Council for his continual support and encouragement to this project, as well as the Malaysian Financial Planning Council for the endorsement of the book. I would also like to thank Ms Linnet Lee from the Financial Planning Association of Malaysia for writing the foreword and Puan Siti Aminah Mainal of UiTM for supporting the book.

This book will not have been possible without the help of editorial and administrative support of the Scola Books team, especially Ms Carol Wong, Ms Hani Hazman, Mr Nicholas Hoe, as well as all the others who have worked diligently behind the scenes to bring this book to fruition. Many thanks also to the reviewers of this book who have contributed their time and effort in enhancing the contents of the book.

Last but not least, I would like to dedicate this book to the readers and students of this text and Malaysian youths in general with the hope that it would motivate and add value to them in their journey towards achieving financial freedom.

Introduction to Personal Financial Planning

LEARNING OUTCOMES

At the end of this chapter, you should be able to:

• Describe the importance • Apply the SMART

• Describe the financial • Describe the roles

1.0 What is Financial Planning?

Do you realise that even in ordinary commonplace situations in life, the things that you do may affect your limited financial resources? For example, it may seem obvious that if you need to drive to an important meeting in the early morning, you will need to decide on the best time to start and the shortest or fastest route to take. If you wake up late, you may miss an important opportunity to close a sales deal and lose out on potential income. If you do not plan your commute well, you may end up taking a longer route or be stuck in traffic, incurring more fuel costs and possibly greater car maintenance costs as well.

In life, time and financial resources are limited. As the sayings go, ‘Everything involves money’ and ‘Time is money’. Some people say that they would only start financial planning when they have more income. When they do have more income, however, their personal and social lifestyle preferences may have changed. The fact is that if we do not have proper financial planning, we may end up spending more than we should even if we have a higher level of income. This would leave us with greater expenses and possibly very little savings. In this respect, many people find managing money a real challenge in life.

By failing to prepare, you are preparing to fail.

Benjamin Franklin

Personal financial planning is the process of developing strategies in managing our financial affairs to have enough resources for emergencies, to accumulate wealth over time, and to achieve our personal life goals. Personal financial planning provides direction and meaning to our financial decisions.

As individuals, we are unique. We differ in our background, education level, stage in life, personal commitments and situations, and values and belief systems. These differences influence our risk profiles and financial needs. As such, no two financial plans are the same and financial plans must be reviewed from time to time as personal life circumstances change (e.g., from singlehood to being married, getting divorced, additions to the family, death in the family, etc.).

Personal financial planning is a lifelong process that assists us with achieving financial freedom. This process can be broken down into many components such as budgeting and monitoring net worth, debt management, tax planning, investment planning, insurance planning, estate planning, and retirement planning, all of

The Importance of Financial Planning

The main objective of personal financial planning is to ensure freedom from financial worries knowing that our short-, medium-, and long-term financial needs have been provided for. Personal financial planning is important for the

There is a saying that goes, ‘Money does not grow on trees’, which means wealth does not happen overnight. Wealth is a function of effort in saving and investing, interest rates, and time. We may say that we will wait until we win the lottery before we start to invest, but this may happen too late or not at all.

To have more consistent and effective wealth accumulation for the future, we need to be disciplined in managing our current income and expenses (including taxes). We need to develop the habit of finding practical and creative ways to save and invest money. Every little bit counts!

• It increases our net worth

The topic of net worth will be discussed in Chapter 2. Conceptually, net worth is a measure of what we own (assets) minus what we owe (liabilities). We can increase our assets by saving up and making wise investments (e.g., in shares, unit trusts, property, etc.). Making wise investments is beneficial because the returns may be greater than the inflation rate and stable passive income can be

generated (e.g., income from dividends, interest, and/or rentals does not rely on our active employment). We will explore investment planning further in Chapters 5, 6, and 7.

There are no guarantees, however, in investing. Even ‘good’ investments may suffer losses at times. That is why we should start investing early to give our investments sufficient time to grow and to increase our likelihood of having sufficient funds for retirement.

• It improves debt management

High debts will have a negative impact on our net worth. As such, learning how to properly manage our current debts and avoiding excessive debts (financial distress) are important. There are many implications of improper debt management, such as being blacklisted for future loans, property being repossessed (e.g., cars, equipment, etc.), and in the worst-case scenario, declaring bankruptcy. We will discuss debt management further in Chapter 3.

• It enhances personal risk management

There are many uncertainties and risks in life that could hinder our financial plans: death of the household’s breadwinner; temporary or permanent disability; critical illnesses, health problems, and high medical costs; loss of property due to disaster; etc. Any of these could be a major setback to us if we are not adequately protected by proper insurance coverage. Life insurance provides some financial reprieve to the dependants (beneficiaries) of the deceased, whereas general insurance enables the replacement or restoration of assets so that life can continue with as little disruption as possible. These aspects will be covered in Chapters 8 and 9.

• It helps with distribution of wealth

There is a saying that goes, ‘Nothing is certain in life besides death and taxes’. We do not know exactly how long we will live and without proper estate planning, our intended beneficiaries will not inherit our assets automatically upon our passing. Instead, they will need to go through a very tedious legal process that could take years. In the interim, our assets will be frozen (i.e., cannot be distributed, transferred, and/or sold). Under Malaysian law, a person can make a will if the person is above 18 years of age and is of sound mind. With a will, the probate legal process is shorter and there would be a smoother transition and distribution of assets to beneficiaries. We will look at estate planning in Chapter 10.

• It improves our relationships with others

Debts, quarrels over property, and other money problems are common stressors, potentially leading to estrangement in a family, divorce, loss of friendship, and

Step 2: Set your financial goals

Financial goals are influenced by our beliefs, values, attitude towards money, and social factors. We may want many things in life but due to our limited resources, we may not be able to achieve all at the same time. We will discuss the SMART model in goal setting in Section 1.3.

Financial goals can be short-, medium-, or long-term, and it is important that we prioritise our financial goals based on our needs. According to renowned psychologist Abraham Maslow, human needs can be classified into basic needs, psychological needs, and self-fulfilment needs (Figure 1.2). When we start out in life, we focus on ensuring that our basic needs—food, water, shelter/housing, transport, basic clothing—are met. Once those needs are met, we strive towards fulfilling our psychological needs such as achieving a sense of belonging/love and accomplishment. From a financial planning perspective, fulfilling these needs incurs expenses related to dating, marriage, household/family, raising children (including providing for their education), and lifestyle choices (e.g., fine dining, branded clothing, luxury cars, etc.). As we advance further in life, we look for purpose and meaning in life and will strive to achieve self-fulfilment needs or self-actualisation. We may go on religious pilgrimages, seek creative activities that we enjoy (e.g., composing music, writing poetry, etc.), and/or engage in activities that benefit others (e.g., volunteerism, charity) to leave behind a meaningful legacy.

status and recognition)

Belongingness and love needs (Close relationships with family and friends)

Safety needs

(Personal security, both in terms of physical safety as well as other aspects such as financial security and health)

Physiological needs

(Basic needs including food, shelter and clothing to keep warm, and rest)

Figure 1.2 Maslow’s hierarchy of needs Psychological

Step 3: Identify and evaluate your courses of action

There are many different ways to achieve our financial goals and the following example illustrates the different courses of action we could take if our goal was to buy a

Adamcar.wants

Example 1.1

to buy a new car and needs to pay an initial deposit of RM6,000 and monthly hire purchase instalments of RM1,050 for five years. His current monthly net income is RM2,800 and his average monthly living expenses are RM1,500. He also likes travelling and plans to put aside RM12,000 per year for trips. Adam has a lot to consider before buying the car, and there

Buy the car and make no changes to his current lifestyle choices

If Adam chooses to do this, he would have monthly savings of only RM250 (RM2,800 – RM1,500 – RM1,050 = RM250), which is insufficient for his travelling plans. More importantly, he may not have

Buy the car and find ways to increase his financial resources

Adam could pursue a part-time and/or freelance job in addition to his current job for additional income. However, he might have less time for leisure activities and feel stressed managing multiple jobs.

Adam might accept the fact that buying a new car is too costly and could instead opt for a cheaper, secondhand car. Assuming that the monthly instalment of the secondhand car is RM500 for two years, he would have reduced his expected monthly car instalments by RM550 (RM1,050 – RM500 = RM550). If he also decides to reduce his living expenses by RM500 per month, he could have savings of RM1,300 (RM2,800 – RM1,000 – RM500 = RM1,300) per month and RM15,600 per year. Adam could afford a car and go travelling with some savings left over.

All personal decisions involve trade-offs and opportunity costs. Figure 1.3 shows some of the trade-offs in personal financial planning.

Current Opportunity costs

• Personal Time Effort Health

• Retirement savings

• Buying a house

• Children’s education

• Investment plans

• Financial Liquidity Security Future Likelihood of achieving financial goals

Source: Adapted from Kapoor,

There are also many uncertainties and risks that need to be considered when evaluating alternatives. Some of these areas of uncertainty are tabulated in Table 1.1.

Area of uncertainty

Personal earnings/income

Longevity

Personal circumstances and life events

Inflation increasing living

Interest rate in borrowing costs if the interest is based on variable interest rates

• Reinvestment of mature investments at lower rates resulting in lower interest income

• Unstable investment returns

• Debt management planning

Figure 1.3 Trade-offs in personal financial planning

Table 1.1 Areas of uncertainty

Step 4: Develop your financial plan

We may have many financial goals and in developing our financial plan, we need to list down and prioritise these goals as well as our courses of action towards achieving the overall plan. It is important for financial plans to adopt a life-cycle approach so that a more holistic view of how each financial goal contributes

Example 1.2

Elizabeth, aged 27, has been working for five years and is currently a Senior Business Development Executive. Her monthly net income is RM4,300 and she receives an average two-month bonus each year. Her average monthly expenses are approximately RM1,500 and she currently has RM5,000 in her savings and fixed deposit accounts. Her short-term financial goal is to have six months’ worth of living expenses, or RM9,000, in savings for

Elizabeth drives a secondhand car that has a current market value of RM5,000. Another of her financial goals is to buy a new Perodua Myvi 1.5L Automatic, which was priced at RM54,090 at the beginning of 2019. She would have to pay a 10% down payment and take a five-year hire purchase loan with prevailing interest rate at 3.2% per year and inflation rate at 3%. Thus, the monthly hire purchase instalment would be RM969 (this calculation will be discussed in Chapter 3). To achieve both her financial goals of buying the new car and having more in savings, she is committed to saving 10% of her

Elizabeth’s longer-term goal is to have RM1 million (excluding her Employees Provident Fund) in savings for her retirement at the age of 60. To achieve this goal, she plans to make regular investments starting in 2020, when she is 28 years old. Table 1.2 summarises Elizabeth’s overall financial plan.

From Table 1.2, Elizabeth’s first priority is to build up her emergency fund equivalent to six months’ worth of living expenses, which would be RM9,000 (RM1,500 × 6 = RM9,000). This is reasonably conservative given that the amount does not include expenses related to the new car that she intends to buy. She currently has RM5,000 in her savings and fixed deposit accounts and if she commits to saving RM430 per month (10% × RM4,300 = RM430), she would have RM4,300 after 10 months and hence, achieve her short-term financial goal.