A good time to stress test your finances?
As covid continues to hog the headlines, we're finally seeing some bright lights at the end of the tunnel of the last 18 months. While the delta variant is a dark cloud, the vaccination programme is having a real impact and our world is starting to open up again. Imagine, we can start thinking about going on a foreign holiday again!
The outlook in relation to the economy is a little less certain. As governments around the world start to implement plans to recover from the economic turmoil of the pandemic, this brings uncertainty for businesses and individuals. They face a future without the pandemic financial supports, and also potential taxation increases in the future to pay for it all.
With this uncertainty on the horizon, now is a good time to have a very clear picture in relation to your personal finances. We believe it makes a lot of sense to stress test the key elements of your financial profile. You will have some experience already of stress testing, as banks carry this out as a matter of course when offering a loan. After all, they want to ensure that they will get their money back! They consider scenarios such as your ability to repay in the event of interest rates increasing.
So where do you start when it comes to stress testing your finances? The best place maybe to consider the risks you are exposed to, and the likelihood of them coming to pass. Here are a few areas to think about.
Your income
This is probably the most obvious one. What are the risks to your income should the economy take a downturn? What will this mean for your business or for the company that you work for? Will it withstand a downturn relatively easily, or instead will there be immediate pressure to reduce headcount or salary levels that could impact your personal finances?
Once you are clear on the level of risk to your income, it then makes sense to consider ways to mitigate or reduce this risk. You might consider ways to broaden or diversify your income. This might involve developing potential new income streams on a part time basis. Diversification of your income is very good protection against an economic downturn. Another way to manage this risk is by working hard to build up your emergency fund, so that you have immediate access to cash should the worst come to pass.
Of course if you are retired and reliant on your Approved Retirement Fund (ARF) for income, the return on your investment is an important risk to be considered and managed. We suggest that you talk to your wealth management consultant to ensure your investment strategy is aligned with your personal appetite for risk and also your capacity to take risk.
Understand your spending
Having clarity about how much you spend and where you spend it every month is an important element of stress testing your finances. Many people spend freely because they simply have spare resources and don't pay too much attention to the impact on their overall finances. They see unused cash in their bank account as a target to be spent! Unfortunately, if times get tough, it can be very hard to change these practices.
Have a household budget and stick to it. Understand the money you spend in the different areas of your life - running your household, paying for holidays, entertainment, big purchases and keeping money aside for emergencies.
Manage debt very carefully as part of your spending. Ensure you are paying off your credit card bill in full every month. Even though base interest rates maybe at 0% currently, credit card interest rates remain in the 15% to 20% p.a. range. While never a good idea at any time, an outstanding credit card bill could become a significant challenge should your income be impacted in any way.
Where possible, steer clear too of avoidable debt when it comes to more significant purchases such as expensive holidays or new cars. If possible, save in advance for these. Borrowing for these may seem fine at the time and well within your means, but it makes sense to consider any repayments in scenarios of a reduced income or if interest rates increased.
Review your benefits and insurances
Sometimes unfortunately ill-health just pays an unwelcome visit. How would you deal with this? Does your employee benefits package support you in this scenario, and if not, have you got sufficient specified illness cover and income protection in place? Maybe now is a good time to have these reviewed.
Stress testing your finances is about ensuring you’ll be ok no matter what the future brings. Do it now, and build your confidence and capability to deal with whatever uncertainty might come to pass.