Australia, Personal Finance - Written by Chris Wright on Monday, September 20, 2010 8:20 - 0 Comments
Sun Herald: Give yourself a financial makeover
AFR Investor, Sun Herald/Sunday Age, September 2010
Time for some spring cleaning. Not of the house – your finances. Many of us think from time to time that we ought to take stock and take a long hard look at our money, our bills, our lifestyle, our plans for retirement, but few of us really take the time to do it. But the effort is well worth making.
In this article we offer 10 ways to perform a financial makeover: to work out what’s right and wrong about your financial position, and to decide what to do about it.
- Take stock.
“If you don’t know what you don’t know, how can you fix it?” says Julie Berry, chair of the Financial Planning Association and a certified financial planner. Working out how to give yourself a financial makeover first requires you to know exactly what you’ve got today. “It’s very hard to plan for the future if you don’t know what you’re doing now,” says Nick Callil at Towers Watson.
Knowing what you’ve got doesn’t just mean your bank balance or your latest super statement: it’s the precise level of your mortgage, your shares, your commitments. “We try to encourage clients when they are taking stock not only to look at dollar value but factor in things like their earning potential for future income, or the health of the family,” says Darren Johns, an independent financial adviser at Align Financial. “It’s not too difficult to draw up a family balance sheet.”
2. Stress test yourself.
Banks do it. Why shouldn’t you? Many people found during the financial crisis that they were over-geared, or stuck in investments that they couldn’t get out of when they needed to. Let that be a wake-up call. Regulators require banks to imagine various scenarios, and to work out how they would fare if those scenarios happen. It’s good discipline: if you’ve got an investment property, what happens if you suddenly find yourself without a tenant for three months, or the existing tenant stops paying the rent? Would you still be able to meet the mortgage payments? What happens if interest rates raise 3% over the next few years? And if you think you’d be able to sell an existing investment to meet a shortfall, have you checked the circumstances in which you can sell out? If you don’t like any of the answers you find, do something about it.
Related to this is diversification. People who had everything in shares had a rude shock during the financial crisis, though mercifully they’ve got most of it back again since. What would happen to you if the ASX took a 30% nosedive? And given that bonds, property and other asset classes usually don’t behave in the same way as shares, do you need to have a rethink about your portfolio?
It’s pretty obvious, but few people do it properly. “A lot of people come in and have no idea they should have done a budget,” says Berry. “But budgeting is a big missing link. It’s the key to everything.” But it doesn’t have to be complicated. “Don’t make it hard. It’s not about a huge Excel spreadsheet. It might be as simple as keeping a notebook: if you know the fixed costs you have to pay but at the end of the week are wondering where all your money went, keep a note of it as you spend.” For those who do prefer a more complicated and detailed approach, there are many computer programs available to help you, including some online that are free.
Johns prefers to talk of a spending plan than a budget. “Budgeting tends to have restrictive or cannot-do connotations,” he says. “People think of it as something they have to stick to. But it’s not that people can’t spend money in their retirement. It’s more about understanding where it’s gone – not questioning it, just understanding it – so you can live like you want to live.” He, too, keeps it simple: a column for ‘what’, a column for ‘how much’, a column for ‘by when’. “If you want to take the kids to Disneyland, what will it cost you and when do you want to do it? Once you’ve written it down you’re more likely to stick to a plan.”
4. Know what your goals are
This relates to Johns’ point on planning. Know what you want to do, then you’ll have a better chance of working out how to afford it.
“Everything starts with establishing goals,” says Paul Moran of Paul Moran Financial Planning. When he sits down with clients he speaks in terms of seven goals: short term, which are specific things people plan to do in the next three years, such as holidays or buying a car; medium term, over four to 10 years, such as saving for a house deposit or paying off debt; long-term, which is 10 years or longer, like mortgage repayment, education costs or a holiday home; insurance goals, in which the client identifies what level of protection they would want if they died or were injured; retirement goals, around the type of income people want in retirement and when they want it to start; estate planning; and cashflow, which involves looking at your income today and where it goes. “We always have two meetings with clients,” he says, “one to tell them what the goals are that they have to discover, then a second meeting to talk about it. As a planner I know what the characteristics of the goals are but I can’t tell a client what those goals should be. It’s the single most important part of the process.”
Clearly retirement is a key goal. “When would I like to retire?” asks Callil. “What would I like to have to spend in my retirement? How much would I need in order to be able to achieve that? Those are big questions and there’s another whole series of steps to achieving what you want for them, but the key to it is assessing where you are now and what retirement means to you.”
5. Pay down the credit card.
Obviously if you don’t have any money available this isn’t an option, but if you have any free cash squirreled away somewhere, there are few smarter things you can do than paying off the card. The interest rate on a credit card is higher than you could ever expect to gain on any investment you might make yourself. The logic speaks for itself. “But it is surprising the number of people we see who do carry forward credit card debt each month and don’t make a decision to pay it off,” says Johns.
6. Know the difference between good and bad debt.
“Consolidating debt is always a good place to start,” says Berry; for one thing, it can get rid of those horrible credit card repayments. It’s also much more manageable. “If you consolidate into a debt where you know what your repayment is and you’ve got a defined term on it, it makes life easier,” Berry says, and it also brings some money back in because the repayments are probably going to be lower than they were before (particularly if you’ve cleared a credit card).
However, not all debt needs to be paid off urgently, and some has advantages because it is tax deductible. If you can afford to pay down some but not all debt, do the investment-related debt last. “You can rank your debt from really bad debt to really good debt,” says Johns. “Personal loans and credit card debt might be first, then car loans, home loans, investment loans – not many people know which order they should be paying it off in.”
Moran adds: “Always work from the highest interest rate backwards. There’s little point making repayments on a mortgage at 7% when you’re paying 19% on your credit card.”
7. Take retirement savings seriously
Australians are generally extremely well informed about retirement savings: there is mandated superannuation, people have a reasonably strong understanding of super funds and investment generally, and are well read on their income options post-retirement. Still, some patterns emerge. “People tend to underestimate what it costs them to live,” says Johns. “But, inversely, they overestimate what dollar figure they might need to sustain a lifestyle for 30 years.”
Although daunting, it is arguably easier than ever to work out what people need from retirement savings. “There are tools individuals can use to project where they might be up to at the date they are thinking of retiring,” says Callil. “If you’re 40 you can jump online to a super fund calculator and get a handle on the amount of money you need and how much you need to put in to save it. Savings vehicles can do so much, but for a lot of people it’s not just relying on markets to do the work for them but putting the money in. There is an under-emphasis on savings, on adding to the pool.”
People have greater control than ever before over their superannuation since the introduction of super choice, but moving your money around to chase the best recent returns may not be the answer. “The idea of chasing the best fund is fraught with danger, because no-one can know what the best fund is going to be,” says Moran. “All they can do is know what was the best fund in the past. And there’s reasonable evidence that what was the best fund in the past is certainly not the best fund in the future. What they should be looking at is, does the fund offer them the investment choices they want, the insurance options, and are the fees reasonable?”
Many believe that self-managed super funds are the way to go. “There are large numbers of people with significant amounts of money saved who are voting with their feet and setting up their own plan,” says Callil. “That’s driven by a combination of wanting to have control, and perhaps member not having had faith in the fund they were in to do a good job for them.” For some people, they are a wonderful way to take control of their savings. But they are a huge commitment and require expertise and, invariably, good advice. Do not take this lightly.
Many people who started earning well before compulsory super came in feel they have missed the boat: that there is barely any point in saving for retirement now because the amount they save is going to be negligible compared to what they need. Not so. “Don’t panic, it’s never too late to start,” says Berry, who suggests people make the best use of what they’ve got and consider their entitlements through Centrelink for what else they need.
Additionally, the nature of retirement has changed for people: more and more chose to phase themselves into it, reducing the hours or the stress of their job but still earning enough to get by so that retirement savings are not depleted. This is another important option to think through.
8. Look for the easy tricks and have a haggle
Some quite lucrative financial techniques are straightforward but little used. Darren Johns highlights putting the savings in the account of the partner on the lower tax bracket as an example. Moran suggests another: knowing what insurance you get through your superannuation. “People sometimes have more insurance than they think because they’re ignoring their super.”
Also, be aware that as a consumer you have power. “In my experience, banks are more willing than they have ever been to have a negotiation on the current rate on a home loan facility,” says Johns. “If a bank is contacted and told a client is looking to move or refinance, they are more willing than ever to offer a lower rate.”
9. Think about estate planning
If you have plenty of money, have you thought about where it goes when you die? “Are there people in a family group – perhaps a second family – that might challenge where the assets go? Have you got that sorted out?” asks Berry.
Moran makes an interesting point. “The three significant assets people tend to own at death frequently do not form part of the estate, and aren’t part of the will.” These are the family home, which if jointly owned passes automatically to the surviving partner and does not form part of the estate; superannuation, which is always paid to a specific nominated beneficiary, again bypassing the will; and insurance, where again a specific beneficiary is nominated. “People who think that because they’ve got a will they’ll be OK, may not be dealing with the bulk of their actual assets,” he says.
10. Educate the kids
Make sure your children are financially literate – that way they won’t have to give themselves a financial makeover late in their own lives because they’ll have got things right from the start. The FPA publishes a Dollarsmart book, available for free on its web site, that helps to educate teenagers on money. “Because money comes out of the wall these days, kids have a very different view of it than we did when we were younger,” says Berry. “We try to show them you can’t have champagne on a beer budget.” Ensure they understand the value of money from an early age.
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