We spend a lot of time helping clients to understand the financial path they’re on, what their destination might be, and what options are available to make the most out of their journey. As a general rule and regardless of a person’s financial position, the younger you are when you start to engage with your finances, the better positioned you’ll be in your later years, with improved quality of life along the way.
But - the irony is that we often don’t realise this until we’ve lived (perhaps too much) and learned (perhaps too slowly). As a result, it’s not uncommon for clients to ask us how they can help themselves, their children and their grandchildren learn to develop a healthier relationship with money.
The important thing to remember is that it’s never too late to take control and there are some simple rules that will serve to help you and your family build a strong financial foundation:
1. Know where you stand
Before considering your options, look at your assets, liabilities, income and expenses to identify realistic goals and objectives.
If you are looking to invest some of your savings, your investment timeframe is equally as important. For example, the last place you would put your money is into the stock market if you’re saving to buy a house within the next two years, as a short-term adverse market movement could play havoc with your savings progress.
2. Keeping up with the Jones’s
Don’t do it. Unless you’re Bill Gates, there’s always someone wealthier just around the corner. Or, more importantly…
3. Know your limits
For the first time in history, the average Australian mortgage has reached $500,000. If interest rates rise by 1% on a loan of this size with a 25-year term and a current rate of 4.5%, the monthly repayments increase by ~$290.
Having a margin of safety between your repayments and your excess cash flow is critical.
4. Speaking of debt…
It is normal to consider any debt as ‘bad’, but some types of debt can lead to opportunities:
- Good debt – tax deductible investment debt (if it is appropriate to you) – refer to rules 1-3. Borrowing to invest can magnify returns (and losses);
- Core debt – such as mortgages and student loans – necessary for most of us (once again, refer to rules 1-3).
However, there is also Bad debt (consumer debts). In a world of instant gratification through credit card consumption, the appreciation of enjoying the fruits of our labour is disappearing.
Taking on debt to fund personal expenses is the kind of behaviour that only serves to line the pockets of bankers, and it ultimately increases the costs of the items purchased through interest repayments, often significantly.
If there’s an item you really want to buy, take the old-fashioned route and save for it. If you’re planning a holiday but need to take out a personal loan for it, then you should seriously consider if you can actually afford the holiday.
Alternatively, if you’re considering investing some money and have non-deductible debt (e.g. a car loan, credit card, etc.), generally you may want to consider repaying your debts first.
For example, if your marginal tax rate is 37% including Medicare (taxable income between $87,000 and $180,000) and your annual credit card interest rate is 10%, the return on an investment required for the investment to be more favourable than repaying the debt is 16% (where your return is 100% taxable).
This can be calculated with the following formula:
(1 - Marginal Tax Rate)
In this scenario, arguably this level of investment return is extremely difficult to achieve without taking on considerable investment risks, as opposed to taking a risk-free debt repayment approach.
5. The absolute best investment
Yourself. Your ability to earn income will always be your highest-yielding asset.
6. Income protection
Income protection is essential to protecting your capacity to earn income and provide financial security to your family. It’s generally fully tax-deductible and can protect you up until your retirement.
For most of us, our largest assets are our homes and superannuation. Rarely would anyone consider having an uninsured home and yet we often leave our greatest asset uninsured - our ability to earn an income.
7. Emergency account
Have liquid funds ready for an emergency. A general rule is to have three months of essential living expenses banked. For people who don’t receive a regular income, as much as 12 months should be considered.
Of course, cash buffers at these levels aren’t realistically attainable for everyone, but having some funds available in an emergency could be the difference of either having to choose between financial security and medical treatment (for example), or having the financial freedom for both.
ometimes separating expenses and savings through different accounts for bills and lifestyle can help preserve funds for when they are really needed.
8. The benefit of superannuation and compounding returns
Full tax deductions on concessional contributions as well as compounding returns in a concessionally taxed environment make superannuation the ultimate (legal) tax haven.
When used effectively, superannuation can supercharge your long-term accumulation of wealth. However, we would normally suggest using a combination of different wealth creation strategies through both superannuation and in your personal name (or through other tax structures where appropriate).
9. Get the basics right and be prepared for anything
- Health insurance - ensure you have health insurance in place once reaching age 31 or if your salary exceeds $90,000 (singles) or $180,000 (couples) to avoid lifetime loadings and the Medicare levy surcharge (and also to get the best health treatment of your choice). Take a couple hours out of an afternoon to review your policy to ensure you’re getting good value for money compared to what else is available in the market
- Comprehensive general insurances – car and home
- Only use a credit card if you can fully repay it every month within the interest-free period
- Where discounts apply to paying bills annually, try to do so rather than paying monthly (e.g. an 8% loading can apply to life insurances paid monthly instead of annually)
- Don’t be passive on bills – pay on time or set up direct debits
- Get the best rates on debts (and other bills) - don’t be afraid to shop around as a 1% rate saving could mean thousands of dollars saved in the long run. The banks rely on the apathy of customers towards their loans, so when you start asking questions, they’ll often jump through hoops to keep you on their books, given it can cost banks substantially more to obtain new business
- Prepare for fixed costs – insurance premiums, utility bills and car registration will show up at the same time every year. When we know a bill is coming we shouldn’t experience bill shock. Put away some money each week into a dedicated expenses account to prepare for these costs as they arise.
These nine simple rules to take financial control of your situation will ultimately have a considerable impact on your personal wealth creation and lifestyle spending options in the years to come.
The information in this document reflects our understanding of existing legislation, proposed legislation, rulings, etc., as at the date of issue. In some cases, the information has been provided to us by third parties. While it is believed the information is accurate and reliable, this is not guaranteed in any way. The information is not, nor is it intended to be, comprehensive or a substitute for professional advice on specific circumstances.
The financial product advice or information in this document is of general nature only and has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision on the basis of the advice above, a prospective investor needs to consider, with or without the assistance of a professional adviser, whether the advice is appropriate in the light of their particular investment needs, objectives and financial circumstances.