How do you allocate your financial resources?
World Financial Planning day took place on the 6th of October this year, with the aim of increasing financial literacy worldwide and helping people understand the value of financial planning. Also in October, Budget 2022 has been announced, which is essentially the State’s attempt to allocate the country’s resources in a useful and sustainable manner. The decisions made in the budget are to a large degree outside of our personal control. However, when it comes to how we manage our personal finances, we have a great deal more control over the decisions we make, as we seek a balance between spending on our lifestyle today and planning for our future.
At Invesco, we are frequently approached by clients seeking a WealthPlan to assist with their finances. Normally, once we’ve taken the time to listen to their needs, what they really want is someone to assist them with becoming more structured in how they manage their financial affairs.
So let’s take a look at some of the key steps we can take in order to provide structure, and how we can efficiently allocate our personal resources in a useful and sustainable manner in order to meet our financial objectives.
Before we begin, I will mention that this is a conservative approach, aimed at reducing the potential that our finances may become a source of stress. There may be good reason to deviate from some aspects depending on an individual situation, and hopefully there will be some takeaways for all.
- Make Sure you’re Protected Against Any Nasty Surprises
For most of us, successfully meeting our financial objectives is predicated on our capacity to generate savings, pay down debt etc. from earning an income. If illness, injury or death were to significantly impact your ability to earn money, the consequences for an individual or family unit can be severe. Although such events have a relatively low probability of occurring, the financial impact can be extreme. As such, for these “low probability, high impact” events, serious consideration ought to be given to having sufficient replacement income for these scenarios. Whether it is some form of insurance, or an asset which generates an income is not really important, once you have something sufficient for your needs.
- Hold Enough Cash for Unexpected Expenses
Each of us are very likely to experience unexpected costs from time to time. These are the relatively “high probability, low impact” items such as car repairs or unexpected medical costs. The objective here is to have funds which are easily accessible to meet such items, without having to borrow at unattractive personal loan or credit card rates.
A typical guide is to hold 3 to 6 months living costs depending on your circumstances.
- Avoid Borrowing at Unattractive Credit Card or Personal Loan Rates
Before moving to the next step, which is saving for your future goals and objectives, if you hold any personal loans or have credit card balances not paid in full each month, then clearing these first tends to make most sense. The reason for this? The interest rate you are being charged is going to be higher than the likely return on savings or investment. Take a personal loan rate of 6% for example. In order for an investment to generate the same return for your money, you would require a pre-tax return of 10.16%, assuming 41% exit tax.
- Allocate Savings for Pre & Post Retirement Goals
The 4th step is to begin saving towards pre-retirement & retirement goals. These could be items such as paying for a child’s education, buying a holiday home or being able to step back from work early (read more about how we help clients identify & set goals here.
We tend to use deposit accounts for shorter term goals occurring within 7 years. Even though deposit rates can be zero or negative at present, the point is that you do not expose funds required for short term use to volatility. For longer term goals with a timeframe of 7+ years, investments or pensions are appropriate as they offer the potential for returns which match or exceed inflation over those longer periods.
- Early Repayment of Mortgage
I’m sure a lot us of us will view having mortgage debt as unpleasant but necessary and may even be tempted to prioritise the repayment of this debt over saving for the future. While early repayment of mortgage debt can be a prudent use of resources as it cuts down the cost of loan interest, there are sound reasons for prioritising saving.
For example, if all surplus income is used to accelerate mortgage repayments and an unexpected short-term expense arises, your only option may be to borrow to fund it. This might involve swapping relatively cheap mortgage debt for a higher rate personal loan, placing a higher strain on cash flow, which further impacts savings capacity.
Furthermore, out of all our typical objectives, our retirement plans may require a significant level of resources & careful planning. Therefore, determining the amount of income you require and how much you need to save to achieve it, is paramount to ensure we are comfortable in the long run. It is for this reason we view allocating resources to retirement planning as a priority over early repayment of debt. To read more about the importance of understanding your individual cashflow in retirement, & how retirement trends are changing, see our previous article here.
If you would like to explore how we can assist you in planning for the future, please contact me at firstname.lastname@example.org or speak to your Invesco consultant.