Application Exercises

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 car.

Example 1.1

Adam wants 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 are several courses of action he could take:

(a) 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 enough savings for emergencies.

(b) 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.

(c) Consider alternatives to a new car

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

• Financial ♦ Liquidity ♦ Security

Future

Likelihood of achieving financial goals • Retirement savings • Buying a house • Children’s education • Investment plans

Source: Adapted from Kapoor, Dlabay, Hughes, & Hart (2017)

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 Brief characteristics

Personal earnings/income Risk of retrenchment due to bad economy or jobs being replaced by new technology

Longevity Risk of outliving one’s retirement savings

Personal circumstances and life events • Total permanent disablement • Death of household’s breadwinner • Damage to property due to fire and/or theft Insurance planning

Inflation

Interest rate Risk of reduced purchasing power due to increasing cost of living

• Increase 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 • Investment planning

Financial plan

Emergency savings

• Investment planning • Retirement planning

Investment planning Figure 1.3 Trade-offs in personal financial planning

Table 1.1 Areas of uncertainty