China Expat Finance

Expats in China are an over-scheduled group – but they’re savvy enough to understand the importance of building and maintaining sensible financial plans. You get the phone calls all the time – but what do these salesmen mean when they talk about Financial Planning? Just as your company needs a business plan to help it grow effectively and manage budgets, your household also needs a plan to set and reach your financial goals. The big ones are retirement, education funding, and major purchases like real estate.

Everyone needs a plan – but for China expats the stakes are even higher. Laws and regulations here can be contradictory or unclear, your length of stay is flexible, and it’s hard to know who to trust. If you’re like a lot of over worked expats, your response is to push financial planning to the bottom of a very long list of things to do. Natural – but unwise. The fact that the landscape is so strange and difficult makes it even more important for you to develop a simple but effective strategy for managing your future.

ChinaExpatFinance.com understands the realities of your hectic existence, so we are publishing a 10-part series on Financial Planning for the Time-Challenged - the nt2p financial plan.

Part I introduces the concept of financial planning and introduces you to some basic terminology and strategies.

What is the purpose of a Financial Plan?
Collecting and tracking the data you’ll need.
Goals of a comprehensive financial plan.

Part II gets down to business with specific tools, analysis and techniques that help you build a simple but sensible plan of action.

Tools, On-line Resources and General Strategy 
Calculating your own Net Asset Position
Obligations and Expenses:  Calculating your spending.
Cash Flows into Assets — Meeting your goals over the long term.  

Part III finishes up with some thoughts about how to maintain and adjust your plan as your situation or priorities change. 

           Determining your own investment style
           Diversification and Spreading Risk
           6 month checkups:  A different kind of ABC

We hope you find the information valuable, and look forward to working with you to meet your financial goals.

 

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An effective financial plan guides you to formulate specific goals for your future, and then builds a map for turning those goals into a reality. To be effective, a financial plan must determine your net asset position, cash flow, known obligations and personal goals. It will then determine what steps need to be taken to meet those goals and obligations. It is an ongoing, iterative process – and you may find that some of your goals are simply not feasible.

What does this mean to the China expat? Two things. The importance of planning goes up when your situation is uncertain and dynamic. Too many fast-living expats who find the time to track every new club or restaurant in town can’t bring themselves to plot out their own financial path. The second bell ringing for expats in Shanghai is that your income-expense ratio is probably more favorable now than it ever was (or may be again). Lots of you are being paid western salaries while paying local expenses (some of the time). The NY stockbroker earning US $200,000 may be spending 75% of that on taxes, housing and expenses. The gap between your income and expenses – or your EXCESS cash flow – is likely to be much higher as an expat.

Financial planning is about goal setting – so let’s get the process started with a big one. What will your retirement be like? When will it start? Where will you be? Who will be included? How long will it last? Many people respond by saying – “Who knows? I have never thought about it.” Starting to think about that kind of big question is what financial planning is really about.

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China expats doing financial planning for the first time may be shocked and appalled by how little basic household information they can actually lay hands on. How much is your 401k worth? What is the equity in your home? What is your outstanding credit card & short term debt? You’ll also notice some uncomfortably LARGE questions emerge. What do I want out of life? Will I do this job forever? How many children do I want? Can I provide for my family?

Financial Planning Tip: Ignore the vision-quest stuff and focus on things you can control. If you take care of the details, the big stuff works itself out.

China expats: Make those trips home count. You’ll need accurate records concerning bank accounts, investments, taxes, deeds, valuations, etc. While this is true for everyone, most people aren’t this far from the storage unit. Make a list of all the accounts and contacts you’ll need. Originals can stay safe at home (usually) but it’s always a good idea to have a responsible ‘go-to guy’ who can access your important documents at any time.

Smart expats will always have a few pieces of official mail (i.e.: utility bill) to verify their home address. It’s also a great idea to look into multicurrency bank accounts and credit cards.

If your first stages of planning aren’t raising a lot of tough questions then you are doing something wrong. This is part of the process. Data collection and good record keeping (and no – ‘it’s on my hard-drive somewhere’ doesn’t count as record keeping) will be ongoing concerns, but you are ready to go to the next step and start building a real plan.

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I’ve worked with many China expat managers who confided that they simply had no idea what the point of financial planning was. They didn’t doubt the importance of having a plan – they just couldn’t envision the goals or limits of a comprehensive financial plan. Put another way - how do you know when you’re finished? What constitutes an effective financial plan?What is the goal of a financial plan for the ex-pat in China? Simply put, you are matching income and spending, setting both short and long term goals and identifying your major expenses and obligations.

 FINALLY, a financial strategy should help you develop a long-term savings plan that will enable you to reach goals that you wouldn’t be able to achieve in the short-term (like building up the US$ 1.5 – 3 million nest egg that the typical expat is going to need to live the retirement life-style you have in mind for yourself and your family).What does this mean to the China expat? With your flexible lengths of stay, relatively high income, lower expenses and preferred tax position (almost everyone can get SOME kind of tax benefit for living abroad – even Americans). This gives you more options – but also tends to make goal-setting a little more difficult. A client recently laughed at me when I asked where she wanted to retire in 25 years. “I’m not even sure what country I’ll be living in after April – how do you expect me to know where I’m going to retire?”Still, every adult should be able to answer some basic questions about their financial status.If the answer is ‘I have no idea’, then the exercise was a success – you now know what you have to do to.

Nt2p Activity.   Put numbers on the following -

Assets

• Home equity
• Savings accounts
• Investment funds
• Retirement funds

Liability & Debts

• Monthly expenses
• Projected expenses, obligations or investments (i.e.: education for the children).

Net Asset Position (some people use the cruder term, ‘net worth’)Projected income for the next 3 yearsYear of retirementAnnual cost of retirement (post-retirement income)

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At the end of the day, financial planning is really about converting cash-flows into assets and assets into cash-flows.    Put another way – a good financial plan shows you how to build a big enough bank to draw down for your major obligations – including housing, education and retirement.   It’s really about knowing what you’ve got,  knowing what you’ll need and knowing how you’re going to bridge the gap between what you will need and what you’ve got now.   Your allies in the financial planning process are time, compound interest, tax planning and good investment choices.  Your enemies are inflation, interest payments, taxes, improper planning, and poor investment choices.

What does this mean for the China expat?  2 things.  First – you are probably in perfect position to start turning cash-flow (income) into assets.  You’ve got excess income, investment opportunities and time on your side.  BUT – there is a tendency on the part of  China expats to let the opportunity slip through their fingers and put their financial planning on hiatus until they leave China.  If you know for a fact that you’ll back home in 6 months or less, then that’s probably sensible.   If, however, there’s even a chance that you’ll be here for longer then you need to find people to advise you on investment options and tax planning (probably different people).    

The financial planning process starts by developing a strategy.  For most of us, that means identifying our biggest KNOWN obligations.  We then figure out how much we have to put away every month to meet them. 

Whether you are a hands-on financial decision-maker who needs an advisor to help execute your own plans, or you are a delegator who needs to feel comfortable that someone competent is taking charge, it is still your responsibility to do the research and play a supervisory role in the financial planning process. 

Some great websites for general finance knowledge:  

Motley Fool  (www.MotleyFool.com)
MarketWatch Personal Finance (http://www.marketwatch.com )
Money (http://money.cnn.com)

Specific tools:

ChinaFinancialPlanning.com (www.chinafinancialplanning.com)

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Net Asset Position, known more crudely as Net Worth, is one of the first analyses you will perform when developing your financial plan. Accuracy is important, but it is not crucial for you to account for every penny. The exercise is much more valuable to help you determine your starting position for the long journey ahead.

Most of you will probably need to build an NAP of around US$1.5 – 2.5 million to retire in the style you are accustomed to. If you are sending 2 children to private university then go ahead and tack on another US$350,000 for eight years of undergrad. The sums are considerable, but don’t be too alarmed just yet – we’ll discuss how to reach your goals relatively painless in the next few sections.

Many China expats drop the ball here because they either don’t know how to get started or can’t get their hands on all the necessary data. Don’t worry if your first attempts are incomplete and inaccurate. Net Asset Position analysis is supposed to be a process – not a number.

The key is to approach NAP as a 2-step process.

First, make a list of all your assets and all your liabilities. No numbers or accounts yet. Just make as complete a list of what you own and what you owe.

THEN go back and try to put numbers on everything.In the case of real estate you want to focus on your equity — which is anticipated sales price less outstanding mortgage balance. You may have to estimate or even guess about the value of a house or building – that’s ok, but err on the conservative side or current estimates. Don’t make the mistake of including the entire resale value of your home – unless you own 100% of it free and clear.

When listing your assets consider segregating the list into different classes of liquidity. Cash and ‘near cash’ (bank accounts, stocks, bonds and other assets that can be converted into cash quickly and reliably). At the opposite extreme are savings & pension plans that cannot be touched until you are 65 and real estate that may take months to sell and convert to cash. This is very important for the next couple of steps – analyzing your goal systems and matching cash-flow to obligations.

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Now that you have an idea about your net asset position and your goals are a little clearer, its time to put some more numbers into our model. We are now talking about Obligations.To you, it’s a dream wedding, a child’s education or the retirement you’ve always dreamed of. To the financial planning, it’s an obligation that must be prepared for. We will identify and calculate each major expense you will have to meet in each phase of your financial future.

3 Phases of Your Financial Life 

We will divide up the rest of your life into Short, Medium and Long Term phases. Short term is right now to 3 years out. This is the time to rebalance your financial structure (i.e.: get rid of credit card debt) and build up a cash reserve. There’s not much a financial plan can do for you in this short a time frame. Medium term is 4 – 9 years into the future. We’ll have some time to build up assets for this period, but the most important thing to do now is to identify and quantify as many big expenses as possible for this high-spending period. Long term is 10 years out, and this is where financial planning really operates most effectively.We separate the categories with a bold, solid line. Don’t let expenses bleed over if you can avoid it. 8 years of college tuition don’t come due on the first day of school. You may have 5 years of tuition in the medium term and only 3 in the long term. It’s important to get a clear picture of when your cash is flowing out.

Calculate, Segregate, Allocate

Now our job is put numbers on the obligations and see just how frightening the numbers are going to be. Don’t make a list of every insignificant spend, and don’t count things twice. If travel is a big part of your life, you are better off figuring out what it costs you on a monthly basis and then adding it to expenses. The same goes with mortgage payments – they are expenses that reduce excess income, not financial events that get accounted for annually.

No phantom obligations!

Try to focus on ACTUAL, QUANTIFIABLE expenses. If you dream of maybe someday kind of going back to school for your masters degree or know that you want to drive a Rolls Royce someday, you shouldn’t rush to allocate resources to these vague notions before you are truly ready. They are too easy to wipe off the balance sheet and ‘free up’ cash that was never really there in the first place.

Cash Reserve: Your first and last obligation

You should always have a cash reserve equal to 6 months of expenses – or 20% of your portfolio (whichever is larger). For some of you that may seem like a lot right now, but others may notice that their cash position is a bit larger than it should be. It’s important to hold enough cash so that you can take care of short term obligations – no matter how large they may be – without wrecking your carefully built financial structure. That’s why people anticipating a wedding or a tuition bill are advised to keep enough cash available.

China Ex-pats:  Lots of managers and entrepreneurs come for 6 months and stay for 5 years. That’s exciting, and probably has a lot of great stories. Just make sure that one of those stories isn’t about having a 5-year hole in your planning.  Complex or simple – have a good sense about what kinds of obligations are waiting for you. 

Next step: You don’t need a crystal ball to anticipate the big spends in your life. Right now, private college in the US is $40,000 (or so) per kid per year. 2 diplomas = $320,000. Painful, but simple. Retirement housing may be a long way off, but you can ballpark the kind of home and the kind of environment you would opt for if you had the choice. Calculating retirement income is a little trickier, but you can easily match numbers to your dreams by checking at an online retirement planning tool.  One good one is on the Essential Finance site at www.essential-finance.com .  

 Next: Cash flow and compounding. Meeting those obligations.

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 Cash flow into Assets. 

Some of us are starting our plan from a high net asset position.  You’ve got lots of money and maybe some property.  Others are looking at their obligations looming out in front of them in shock and horror.  Relax.  It’s ok.

The key here is to decide on our EXCESS – the gap between what we earn and what we spend.  That will give us a feel for the amount of money that we can use to invest and plan with.  Calculating your earnings is pretty straight-forward, but figuring expenses is tricky and subjective.  We strongly recommend you use a budget calculator to drill down to the real details.      Be honest, and test your assumptions by tracking your spending. 

Areas of greatest self-delusion:

 Men:   Restaurants, bars, Tongren Lu
 Women:  Restaurants, personal maintenance
 Couples:  Travel, restaurants, home, children

This is where you reach down deep into the honesty well and learn some horrible things about yourself.  Yes, those are the choices you made.  Now write them down on a piece of paper (or enter them into the program) and get ready.

Match Obligations with Cash Flow
The next step is to take that excess and match it up against your obligations.  Remember our 3 Year short-term phase?  The minimum amount will be 6 months of expenses for our emergency fund – and now we know exactly what that amount should be!  See how big that obligation looks now?  What else is in the short-term category?  All of that gets added up and compared to 3 years of your excess.  Get the picture?  We’re seeing if your entire excess of earnings over expenses will cover your basic financial needs in the next three years. 

How did you do?  
If your short term obligations can be disposed of with 50% of your accumulated excess, then congratulations.  You are ready to move on to some serious financial planning.   If your 3 years of excess just barely cover your obligations (including that emergency fund), then you are still in decent shape.  Just take a look at trimming the expenses and freeing up a little more cash to invest towards your future. 

If your 3 years of excess don’t cover your short-term obligations then you have a potential problem on your hands.   Twenty-something’s just starting out don’t have to worry.  Forty-something’s who earn lots but don’t know where the money goes had better hear the alarm clock ringing.  It’s time to wake up.

Are you earning enough? 
How do you know if you’re earning enough?  One quick test is to see if you could be earning more.  If people are offering you higher paying jobs, then it’s a very valid question.  Otherwise, we go to the second test.  How are you doing compared to your friends?  If you’re in the middle of a pretty average sample set, then yes – you are earning enough. 

Are you spending too much? 
Here’s the tough one.  As we’ll see in a moment, you can enjoy now or enjoy later – but not both.  Every dollar you drink now is one dollar you’ll have to earn later.

Are you unsure where the money is going?  Deal with this now.  Spending too much on restaurants and clubs is bad enough when you KNOW that’s what you’re doing.  Some people grossly underestimate their spending when the booze is flowing and the music is blasting.  Keep a daily tally if you have to, but get a clear understanding about where every penny is going.

What do I do with the excess cash flow?

Allocate your excess
Our task now is to allocate our excess cash to short and long term goals.  We want to dispatch our short term spending obligations and emergency fund as quickly as possible and then focus our energies on long-term asset accumulation.  Hopefully you’ll be starting out with a split somewhere in the neighborhood of 35% short term, 65% mid & long term allocation of your excess cash flow.

Why do financial planners tell you to get started early?
Imagine 3 people saving US$1,000 per month, every month (assume 9% return, no inflation)

 The 50 year old saves for 10 years and ends up with $ 193,514
 The 40 year old saves for 20 years and ends up with $ 667,887
 The 30 year old saves for 30 years and ends up with $ 1,830,743

 See for yourself at Essential Finance’s tools & calculator section. 

Next:  Understanding your own investment style 

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Investing methods, strategies and styles.

So now we have a good sense of where we want to go and what our resources are.  The question before us is how we are going to use those resources – our monthly excess cash-flow – to reach our long term financial goals.

Whether you know it or not, you have an investment style.  It all comes down to your attitude towards risk and your need for returns.  Picking an investment vehicle is a lot like choosing a car.  Some of us are Ferraris, some are Volvos and others are Volkswagen Santanas.  

Ferraris are bitchin’ fast and cool to drive – but expensive, high maintenance and more than a little dangerous to operate.  Take your eyes off the road for even a moment, and you can end up having a lot of problems.  The financial equivalent is managing your own portfolio – picking your own stocks, trading in and out based on your own research and investment ideas.  You may even opt to try your hand at emerging markets day trading, options, futures and derivatives. 

Volvos are where lots of people want to put their families.  Volvos are expensive to buy but relatively cheap to maintain.  They are safe, high-service and steady.  If one of them has a problem there is an army of dedicated staffers waiting to make sure your day gets better.  In the world of finance, this would be an investor who trusts his assets to a dedicated fund manager – or who follows a professional’s portfolio recommendations.  This type of investor likes full service from a team of experts – and is willing to pay the price in terms of fees, charges AND is content to delegate day-to-day decision-making authority.

Volkswagen Santanas are a fine form of transport – but they’re neither high-status nor high performance.   Still – it’s the best that many people can afford.  An inexpensive vehicle can take you far and serve you well, but you have to be careful about maintenance and understand its limitations.  The investing equivalent is someone who saves what they can at the end of each month, but doesn’t yet have the financial wherewithal to hire experts – or trade the more exotic instruments that he’d like to.  The main goal of this type of investor is to trade up to a more satisfying option. 

What kind of investor are you?

To figure out what kind of investor you are, consider how you would react to the following news.  You log onto your account and find that your investments have just suffered a 7% loss over the last 2 days. 

Do you shrug it off and get back to your day?    (High tolerance for risk.)
Does it bother you a bit, but you remain confident that your long-term plan is still sound? (Moderate tolerance for risk)
Or
Are you devastated by the loss and decide to reassess your plans and find a safer option – even if it means settling for a lower projected rate of return and sacrificing some of your medium term goals?  (Low tolerance for risk)

Remember that risk and return are inextricably linked to one another – and to the time horizon that you are planning for.  A 25 year old can afford to take chances because the sums involved probably aren’t huge and he has another 40 years to let market forces make him whole again in the event of a loss.  A 55 year old with mortgages, tuition and a looming retirement, on the other hand, is probably going to much more risk averse and should have his investment advisors choose accordingly. 

But what if you feel like a Ferrari personality stuck in a Volvo lifestyle?  Lot’s of us like to drive fast every once in a while – which is why there are clubs, tracks and rental agencies that specialize in indulging our need for speed every once in a while.  Likewise, the household investor who likes to dabble in day-trading or exotic structured products can devote 5 or 10% of his assets (or whatever else he can afford to lose) into a separate account and trade away.  It sure beats the alternative of trying to stuff your wife, kids, and pets into a sexy sports car.

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 Mom would say “don’t put all of your eggs in one basket”, but odds are that she wasn’t a portfolio manager.  They are more likely to talk about diversifying a portfolio among non-correlated investment targets to reduce non-systemic risk and limit the likelihood of downward revaluations and negative capital gains.  In other words, don’t put all of your eggs in one basket.  

 There are different types of risk that you can control through diversification.  The traditional goal of spreading risk was to avoid getting caught in an industry-wide downdraft.  Imagine that you decided to invest in 5 different Dot Com stocks in 1999.  Would you have shielded yourself from the ensuing loss that was just around the corner?  Not likely.  Even though you have spread your risk around to 5 different targets, they are all CORRELATED, or move in the same way.  In finance, we are always looking for the mythical “red ink manufacturer” whose business picks up just as everyone else’s begins to fall through the floor.   The problem is that we haven’t really found one yet.  Some people like gold (the metal) as a proxy for red (the ink), but that usually involves buying-in a year before you knew you needed the hedge.  

Some experts look at balancing cyclicals against consumer staples, high growth with high income, and high betas with low betas.  A few old-school investors even try to diversify between different classes of assets – such as equity, bonds, real estate and commodities. For the last decade or so, investors have had the opportunity to diversify their portfolios geographically – and that has proven to be a winning strategy for many, many people. 

Do different economies behave differently, or are they fundamentally linked (correlated)?  Great question.   If you have a definitive answer then there are more than a few central bankers, corporate treasurers and portfolio managers who would love to have a sit-down with you.  There was a time when we would answer that different countries are definitely non-correlated, and maybe even contra-cyclical.  Those days seem to be behind us.  Lately the only debate is between the global crash people and the contagion people. 

Global crash people also tend to believe in the global boom – they think that the whole world is so closely linked that every economy (or economic sector) moves in lockstep around the world.  It may not happen everywhere at the same time, but these guys believe that economic assets are basically fungible, or readily exchangeable.  Real estate in Business Center X is 5 times as expensive as the real estate in BC Y.  If BC X drops by 20%, then BC Y will come under pressure as global investors start to see it as relatively pricey.  Everything eventually works itself to equilibrium at a slightly lower level, consolidates for a while, and then starts booming again - more or less in unison.

‘Contagion people’ sound like a dangerous cult, but they are really just believers in the notion that economic downturns spread like dominos.  A slowdown in the US economy doesn’t directly affect other economies, but rather creates a series of events that may or may not cause problems for them.  If unemployment in the US goes up and people are worried about losing their jobs, then they buy less stuff.  Demand slows and inventories build up – causing retailers and wholesalers to cut back on orders to suppliers overseas.  Factories in Guangzhou and parts suppliers in Fujian see their orders drop – and may even go out of business.  Suddenly there’s unemployment, downward pressure on wages, business shut-downs – and the long lines at Carrefour and the Mercedes dealership disappear.  
 
Interesting stuff – but dangerous.  Diversification is a great concept – but the problem is that it forces you to engage in far-off places that aren’t particularly well researched.  You’ve got 3 choices.  First, you can engage in ‘passive diversification’, where you invest in a range of assets and then just leave it all in place – come hell or high water.  If you can’t stomach the idea of other people managing your money, this isn’t a terrible option.  You may, however, be better off with choice #2 – professional fund management.  In this scenario you are turning your investments over to a dedicated manager who picks stocks or mutual funds for a living.  You can expect to pay for the privilege, but the returns are usually better than what you could score on your own.   Both are better than your third option – trading stocks and funds that you don’t understand in markets you know nothing about.  Option 3 sounds ludicrous – but people you know are doing it even as we speak. 

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