Wednesday, November 30, 2016

Hierarchy of Financial Needs

Most readers would probably have come across Maslow's famous hierarchy of needs: a pretty neat explanation of how humans should view our existence in terms of our needs. Abraham Maslow, an Amercan psychologist, created this hierarchy as he was trying to understand human nature. 

The hierarchy of needs is usually produced in a pyramid like the one shown below. The theory goes like this: humans have needs and we need to fulfill our basic needs before we can advance to the next level. For example, the most basic needs like food, water, shelter have to be fulfilled before we can think about health, starting a family, owning a property etc. As we move up the hierarchy, we need friendship and connections, develop self esteem and finally achieve what we are supposed to achieve - self actualization. In short, reaching our potential in life.

Maslow's hierarchy of needs

As civilization progressed, most developed countries today, including Singapore, have moved up the pyramid and a lot of individuals do have opportunities to achieve self actualization. Maslow postulated that only 1% of humans would actually succeed. Well, that's probably not far from the truth given that a few hundred million people still live in poverty, in war torn territories, fearing for their lives, wondering if they could eat the next meal. Let's pray for them. However, in developed countries, the population of people who can self-actualize would be much higher, including most readers here.

In the world of personal finance, we can modify the pyramid to map our financial needs following more or less the same rules as the original Maslow pyramid. In this new hierarchy of financial needs, we also need to fulfill the lower levels before we advance upwards. The lowest level corresponds to the very basic and important needs. In life, obviously we need food and water before we talk about other needs. In finance, it's the same reasoning, we should fulfill fundamental needs first. However there would be minor differences as we delve further. 

At the most fundamental level, we first need to build our foundation before anything else. This foundation incorporates, most importantly, stable income which is salary, or for entrepreneurs, cashflow from their core business. Once we have achieved that, we should own our homes or for some countries, make sure that the salary takes care of the rent (unfortunately Singapore might fall into this culture some day as it gets too expensive to own our homes). And as the old adage goes, we also need savings for the rainy days. As a rule of thumb, we should have cash savings of around 12 months of expenses to cater for emergency needs. Since this website started out talking about investment, we often neglect these bread and butter issues. Investment actually comes after we have our foundations built! The following pyramid gives a sense of how the financial needs are ranked.

Hierarchy of Financial Needs

The second level is security, or protection. This is where we make sure we are protected by buying insurance and strive to have more incremental savings (beyond 12 months of expenses) if we can. We also then try to supplement our cashflow by investing these savings, thereby receiving dividends if we buy stocks, or bond coupons if we have bonds. Needless to say, one of the best security is having a second property that gives good rental income. The goal here is that the dividends, coupons, rent received from stocks, bonds, property here would cover expenses some day. It is worth mentioning that salary, by and large, will always be the main source of income. Rich Dad Poor Dad did the world a major dis-service by introducing the concept of passive income. It's a lie. Passive income cannot replace salary or an entrepreneur's main source of cashflow. Even if we reach aforementioned scenario where our dividends, coupons and rent can cover all our expenses, we should still work if we are employable. Of course, we then have the freedom to choose jobs that we find meaningful and hence can truly enjoy.

Insurance is a topic that deserves more scrutiny, but perhaps in another post. The whole industry is made complicated by agents as most of them mis-inform and mis-guide their customers. While it is important to have insurance, it's more important to buy the right ones with the right amount of money! A rule of thumb could be using 5-10% of the overall income to buy the correct insurance (usually term insurance) for good protection. Insurance is ultimately a cost paid to gain protection from adverse events and agents like to use emotional blackmailing to make people pay more than they should. We need to exercise common sense and rationality extremely well when dealing with insurance agents.

At the growth level, the focus for this website, we are actually talking about investing like the great investors - Warren Buffett, David Einhorn, Ray Dalio etc. We think hard and try to pick stocks well - stocks that compound growth and becomes multi-baggers over time. Or we take advantage of rare arbitrage opportunities to compound wealth. Hopefully we beat the markets when we measure ourselves across decades and make really good money. By right, this level should only be attempted when we have fulfilled the lower levels. But we do need stable income from dividends and bonds (at the security level). So, in a sense, there are overlaps. We need a few good stocks to supplement our income at the security level, yet the same capital would help catapult our growth. It's also worth noting that the growth level takes on higher risks to achieve higher returns. 

The highest level, arbitrary termed wealth maximization is about maximizing returns, which means we engage in the highest risks investments which can pay out big amounts, usually by utilizing a small percentage of our net worth (say maybe only 3-5% of our total net worth). For instance, buying long dated options or bio-tech stocks or for high net worth individuals investing in venture capital and the likes. This is a stage where we are prepared to lose the whole amount, but since it's limited to a small percentage of the portfolio, it doesn't really change things. But we have the opportunity to hit the jackpot i.e. like finding the next Facebook or Alibaba. Again, as with Maslow's needs, perhaps only 1% of the global population would reach this stage. 

Over the years, many experts had also reviewed Maslow's original hierarchy and it was proposed that changes should be made to reflect how the world had evolved since Maslow's days. So the new hierarchy looks something like this:

Haha! Yes more fundamental than anything else, today we need WiFi! It comes before the need to eat, sleep and having a shelter. Okay, just kidding. The new hierarchy actually adds to the highest level which is termed self-transcendence or simply transcendence. Later in his life, Maslow and others believed that perhaps self-actualization was not the ultimate goal in life. It was to self-actualize and use that ability to help others. In Maslow's own words:

Self Transcendence - seeks to further a cause beyond the self and to experience a communion beyond the boundaries of the self through peak experience

In our hierarchy of financial needs, perhaps there is a similar transcendence. What is our purpose of accumulating so much wealth when most of our financial needs would probably be finite? Most billionaires have come to this conclusion. They would never finish spending their billions and it might not be such a good idea to simply give it to their sons and daughters, as it kills their motivation to work hard. Hence people like Warren Buffett and Bill Gates actually pledged to give away more than 80% of their wealth to further progress the human race. This is very noble and perhaps an inspiration for us as well. No matter where we are at the hierarchy, we can always transcend and give away whatever we can afford to those who need it more.

Financial Transcendence - giving away what we can afford to help others

Thursday, November 17, 2016

Vietnam Property: 5 Bagger! - Part 2

This is the continuation of the previous post on Vietnam Property.

We have established the following in the last post:

1. Vietnam has a huge and hungry population and is on the growth trajectory to be a developed country. GDP will continue grow at high single digit and property prices at a multiple of that over time. It might be the last Asian Tiger in our lifetimes.

2. The development of the Ho Chi Minh City (HCMC), mirrors the development of Shanghai. With the east of the city growing much faster: the analogy of Pudong and Puxi vs HCMC's District 2 and District 1. At current $2,000 psm, we can expect prices to see $10,000 psm in the future when HCMC becomes like Shanghai or Bangkok.

One big secular trend behind this is also the urbanization of Vietnam. As a country develops, its population moves from the rural farmlands to urban cities. Urbanization ratio over time climbs over 50% to reach 60-70% eventually. Vietnam today is at 34%. As we already know, Vietnam has a population of 94 million of which only a mere 8 million lives in HCMC (another 7.5m in Hanoi). As the country urbanizes we can expect HCMC population to explode. Most big cities in the world houses 15-20 million people when we include the sub-urban population, HCMC should see its population increase at least 50% over the next 5-10 years. 

Big Picture: HCMC City 

This is a major point because it debunks the over-supply argument. Most amateur investors would point to the enormous number of property development in the two big cities and say that over supply would come and prices would collapse. But when we think about how 5 million or even 10 million people would eventually find homes in HCMC, or for that matter Hanoi, over supply would never be an issue over a long enough time frame. Besides we are investing in the Central Business District or CBD, the core of the city where land will be limited. It is too easy to paint a bear story without seeing the big picture. 

Today, Vietnam is at an inflexion point. It's GDP per capita has almost doubled from $1,300 in 2010 to $2,200 today (chart below) and is likely to hit the all important $3,000 in a few years where the demand for cars, properties and modern goods takes off. The Vietnamese government relaxed regulations and allowed foreigners to own properties in 2015 and started to privatize many state own enterprises in 2016. These are all important milestones for growth. We can pretty much say that Vietnam is all out to transform from a developing to a developed country. 

Vietnam GDP per capita

If history is any guide, Vietnam would continue to grow its GDP at a high single digit, not unlike China in the 1990s and 2000s and its GDP per capita would reach $10,000 to 15,000 in time. The same chart above shows how it has grown steadily over the years but still at a low $1,300 which is lower than Indonesia, South East Asia's largest economy at $3,500 GDP per capita and Philippines, another rising star at $2,800 GDP per capita. The difference is that Vietnam is going to be another manufacturing hub, from shoes, to white goods to electronics. The formula that has proven to work as we saw how South Korea, Taiwan and needless to say China transformed their economies that way.

Coupled with the reasons hitherto, Vietnam stands to prosper and Ho Chi Minh City, being the commercial centre, stands to benefit the most. There is an estimated five or six new condominium developments coming on-stream in the next 1-2 years that are targeting foreigners. The HCMC property market is finally recovering after its huge decline as it was dragged down by the Global Financial Crisis (GFC). The Singapore developers already has some successes with a few earlier project launches, building on Singapore's brand name and property development prowess. One of the prominent project in District 2 called The Nassim launched by the Jardine Group targeting the luxury segment had done really well (more than 90% sold) and is set to redefine HCMC's luxury segment with potential for astronomical price increase.

The Nassim

The cherry on the cake is the affordability as a result of the low quantum of these projects. The Nassim, is going for c.$200,000-400,000 per unit and for the less luxurious projects, a state-of-the-art 90 square metre condominium can be bought for c.$150,000 - a quantum that can't even buy a 2 litre car in Singapore. Such is the irony of life. This is the function of Vietnam still being a frontier market and perhaps a reflection that everything in Singapore is really too expensive.

Well, if the story is so good, why isn't everything sold out?

As described before, there's always risk. Nothing is certain in investing and the future, though painted here as rosy and prosperous, is always but "one of the probably futures". The future is a set of probabilities. There isn't just one but many possible futures. When pundits predict one future and it turns out to be correct, more often than not, it's just luck. The true expert, points out all the possible futures and assign accurate probabilities, knowing that one of them would come true and how to bet in a win-win manner. The high probability future of Vietnam is that it succeeds as another Asian tiger and we get our 5 bagger. There is always another chance that it would falter. The government reforms could fail and the Vietnamese Dong collapses again and the story is pushed out for another decade. Or infighting in the Communist party resulting in some power struggle and the politics is thrown into disarray. If these futures pan out, unfortunately, the money put in would see substantial losses. The author would attribute a 10-20% chance of this happening. But still, the risk reward profile is highly favourable. It's 5 bagger vs losing say 30% of the capital. More likely than not though, investors won't lose their pants. There is always a buyer to sell to if the price is low enough.

The other major concern for investors at this juncture is actually financing. Because the Vietnamese economy only started to open up, there is actually no means of financing. There is no such thing as a mortgage in Vietnam today. The mortgage market is non-existent and the banks don't know how to do it. This is the state of affairs in frontier economies. However over time we can expect the Vietnamese banks to introduce mortgages and future investors would have it easier. Without mortgage or financing means, investors must put in 100% of the cash needed and be subjected to full currency risk. The Vietnamese Dong is ultimately an emerging market currency, the exchange rate is volatile and the bid-ask spread is very wide. These are the costs to investing. Although if the story pans out as we have discussed, then such trivial should be overlooked. Why think about a 3% spread or a 10% currency depreciation when the return is going to be 500%?

The other risk is the possibility of intermittent rental income.

As alluded to in the previous paragraphs, Vietnam is only starting to open up very recently. There is no concept of mortgage yet. Global manufacturing firms only started to setup shop 1-2 years ago. The rental market is only for expats working with the global firms. Most Vietnamese people are still living in villages and couldn't afford rental. The rich and famous Vietnamese are actually fellow investors in these luxury properties and they are not about to rent. They just buy properties when they need to stay in the city. Hence while the rental yield is touted to be a good 6-8%, actual rental would be a function of how good the property agents are, whether they can secure good tenants working for MNCs. The rental market is thus highly competitive given the new capacity for these luxury condos coming in the next 1-2 years.

Nevertheless, if the main scenario pans out, then the return should be in the tune of a few hundred percent and missing one or two years of rental yield of 6-8% shouldn't move the needle too much. To reiterate, this is a five bagger story. Vietnamese properties in Ho Chi Minh today sells at $2000 psm but should reach $10,000 psm which is closer to what global cities like Shanghai, Taipei and Bangkok is selling at. Such opportunities don't come often. 

Seize the day!

Read from the first post! This author owns a property in HCMC.