Want to check your financial health? Let’s start with the key behaviours that influence wise money decisions…
What you know about money matters is ‘financial literacy’. But desirable financial outcomes require more than this… they need the wise application of that knowledge. Unfortunately, there is a yawning gulf between ‘knowing stuff’ and successful behaviour.
Financial health also involves some forces beyond our control. Just as physical health is a combination of behaviour, genes and access to good medical care, financial health arises from our personal decisions and abilities, market behaviour and access to astute, impartial financial services.
Ultimately, meeting your financial objectives is all that matters. So, how can you optimise the chance of this occurring?
Here are 5 ways to test your financial fitness:
1. Do you spend less than you earn?
This is the foundation of financial health. You can’t get out of debt or save for the future if your expenses eat up all your available income. As Charles Dickens pithily observed long ago (updated for currency)… income $105, expenses $100… result happiness. Income $95, expenses $100… result misery.
Once retired, you might need to slowly consume your investment capital over time. This is best done within a spending plan that manages the risk of running out of capital over time. If you’re interested in how this can be structured, ask us for a demonstration.
We live in a world where the advertisers cleverly exploit our emotions, encouraging us to accumulate lots of ‘stuff’, much of which we don’t really need. So, before buying, ask yourself… do I really need this? Would I rather reach my goal faster or buy this?
Though houses usually rise in value, it’s not relentlessly true and to justify house spending on that basis may prove to be folly.
2. Can you comfortably manage your debt?
Do you sleep easy, knowing you only have the level of debt you can afford… and no more? As a benchmark, aim for total loan repayment obligations that are less than 30% of your disposable income. Interestingly, the portion of median weekly family income needed to meet loan repayments in South Australia is currently 26.2%, while in New South Wales it’s 36.1% and the Australian average is 30.4% (REIA Affordability Index, March 2017).
You could consider applying the 50/30/20 rule, where 50% of your disposable income is used for your general living expenses, 30% for debt repayments and 20% is allocated to savings.
Having acquired debt, plan to eventually eliminate it… even if it’s tax deductible (repay debt that’s not tax deductible first). Choose credit cards wisely… You can waste much of your savings advantage if you choose an expensive credit card.
3. Are you prudently managing tax?
Despite relentless political interference, superannuation is the best example of this. Another is negative gearing of growth assets – though this is often misunderstood and used against assets with decidedly dim growth prospects. In any event, the use of tax advantages requires a clear view of underlying trends to avoid disappointment.
4. Do you adhere to your long-term investment strategy?
This means clearly evaluating the evolving investment environment and avoiding the natural desire to simply conform by following the ‘herd’. It is especially important when the widely accepted reality is significantly at odds with objective data. The long-term behaviour of assets (shares, property and fixed interest) is well understood, but will you confidently recognise when the popularly accepted view doesn’t match current data? More importantly, will you be confident enough to then take corrective action against the herd’s behaviour?
US research over many years suggests that investors without good advisers underperform by about 3% p.a. in the long run. Even so, it is, unfortunately, true that not all advisers add value. Some sell product rather than objective advice and even those that are impartial may be poorly informed. So. It’s important to know how to choose a financial adviser … and what to ask them.
5. Are you adequately insured / do you have a safety net?
Despite the best-laid plans, we‘re all vulnerable and if your ‘number comes up’ through injury or worse, you may appreciate having insured your life and your income. It’s at least as important as insuring your home and car.
It’s also important to have an up-to-date Will, Powers of Attorney and Advance Care Directive (Living Will).
So, are you financially fit?
If you can manage your day-to-day financial life, absorb a financial shock and you’re on track to meet your longer-term financial goals, you’re likely to be financially fit! But keeping things on track over time is the challenge.