I am writing this blog while waiting for the next batch of training participants at a company that provides generous support for its employees.
Apart from free housing in the employees’ village, employees do not pay a single centavo for electricity or water. Employees shell out only Php600 a year for each child’s elementary education as supervised by one of the top schools in Metro Manila. They also get free transportation to and from the company’s plant site. Even their recreation is provided for via tennis and badminton courts, an Olympic-sized swimming pool and a club house at the employee village.
So why was I still hired to provide personal finance training for the employees of this company? Apparently, the host of benefits lulled the employees to a false sense of financial stability. With not much by way of financial challenges, many of the employees resorted to loading up on consumer durables like household appliances. And many times, the purchases of consumer items were done through the aid of debt, up to the point of borrowing as much as 10% per month on add-on-rate from private lenders, commonly known as “utang sa tao.” Some went overboard and even pawned their payroll ATMs with lenders.
The financial situation of this company’s employees is not uncommon. Overconfidence combined with convenience in spending (as private lenders readily lend just with the pawning of ATMs and with no other evidence of repayment capability) have led people to wallow in debt. My solution is to D.R.E.A.M.
“D” stands for direction. There must be a conscious effort to get out of debt. One way to encourage this direction is to see how much savings can be had over several years if payments to (expensive) debts were not being made.
“R” stands for refinancing. Since debt from private lenders is expensive, securing refinancing from more formal sources like banks and credit card companies would be ideal. A 10% add-on-rate is equivalent to 88% in effective interest p.a. A credit card debt can go as low as 0.59% add-on-rate or effectively 13% p.a. The lower interest rate also affords a much lower cash outflow.
“E” stands for expel. Once the debt has been fully refinanced, a person should expel his credit card by cutting it up. If he does not, this new source of (cheaper) debt can also lead to a false sense of wealth.
“A” stands for automate. Automatic debit arrangements should be set up not only to pay the refinanced debt. And to make this auto debit arrangement more acceptable, a person must condition himself to think that he is not saving a portion of his income. Instead, he should think positively by framing the auto debt as making him live on the complimentary percentage of his income. Behavioural scientists have shown that putting a positive spin makes the person see the auto debit as a foregone gain rather than an outright loss (when he saves a portion of his income).
“M” stands for magnify. If a person can afford it, he should have an amount equal to his previous debt amortization debited monthly. Any debit amounts in excess of the new and lower debt amortization should be credited to an investment account. And once the refinanced debt has been fully paid, all of the periodic debits should be invested.