One of the most common reasons clients engage us through the Financial Autonomy programme is a realisation that all their hard work is not translating into financial wealth and security. It generally seems to be that people in this predicament have put all their energy and focus into developing their careers and therefore just haven’t had the headspace to focus on their personal finances. I guess it’s similar to the carpenter who’s house is falling down or the mechanic who’s car chuggs along, smoke pumping out of the exhaust.
Now of course everyone’s circumstances are different, and therefore the plans that we develop are unique. However in this week’s episode I thought I might share with you some of the key things we recommend to help solve this problem for our clients. We want to ensure that their prime working years result in personal wealth, which provides financial security and therefore the choices in life that are of course the overall goal here at Financial Autonomy.
If you’ve read the Financial Autonomy book, much of what we go through today will be very familiar to you.
1. Cash flow management and having a savings capacity
The people we help with this problem – great income not translating into financial security – typically have incomes north of $200,000 per year. At that level, they earn comfortably sufficient to cover their living costs and at least in theory should have a capacity to save and build wealth. They also pay plenty of tax.
Commonly when people speak to us they express frustration. How can it be that I have so little to show for this great salary package?
For those with a mortgage, to the extent that there’s any strategy, it’s typically that everything goes into the offset account. This is very far from a terrible idea, but given the current low interest rates, perhaps not optimal.
For those without a mortgage, surplus income is usually just left in the bank, almost certainly earning less than the rate of inflation, and therefore having its purchasing power eroded through time.
Then there’s retail therapy, for which the rise of online shopping has been a huge enabler.
One of the key things we determine then when helping people with this problem is how much can they commit per month to some sort of investment plan. Most people will say somewhere between a and b. We take the lower figure in such instances to ensure the strategy is sustainable, with the ability to raise contributions in the future once the strategy is up and running.
Foundationally, if we are to succeed in converting income into long term wealth, we need to grab a portion of that income and use it to purchase assets that grow in value and perhaps generate income into the future. For those who’ve done a little accounting in their life journey, we’re trying to shift from the profit and loss statement over to the balance sheet.
2. Goals and time frames
Having nailed down an amount that can be used each month to build wealth, we need to consider your goals and the timeframes associated with those. The appropriate solution for building financial security will differ considerably between a person with 20 or more years until retirement compared to a second person who is only five years away. In the Financial Autonomy book I have a whole section on goal setting, and the prioritisation exercise in particular is something that I’ve had a lot of positive feedback on, so if this is an area where you need to spend a bit of time, do check that out.
3. Where does super fit in?
Superannuation is clearly a very important piece of your long-term financial security. High income earners by default will have significant employer contributions going into their superannuation account. Too often though they have given no consideration to how this money is invested when it hits their fund. This comes back to the earlier point around objectives and timeframes. Someone with a long time to retirement should be able to handle short term volatility and therefore have an asset allocation tilted strongly towards growth assets. All too often I see people where their super is simply in the default fund which typically has somewhere between 30% and 40% in low risk assets such as bonds. The purpose of these low risk assets is to smooth returns, the idea being that they reduce the stress levels of individuals in periods of down markets. However there is a cost for this smoothing of returns. Whilst it may mean that in a bad year the fund doesn’t perform quite as badly as investors may have anticipated, it also means that in the strong years performance is held back. Whilst periods of negative returns are an inevitable fact of investing, it is also the case that positive returns occur far more frequently than negative returns and so implementing a strategy to protect you from the perhaps one in five chance of a bad year, means that you are sacrificing returns in the other four out of five years that are strong.
Because high income earners pay a lot of tax, taking maximum advantage of the superannuation system is particularly important. Things like unused concessional contribution caps, and Div293 tax are important considerations that we need to plan for.
4. Automated investment program
Once we’re clear on how much you can save each month, your goals and timeframes, and where superannuation fits into the picture, we next look to build out a wealth creation plan. Often that plan might include some form of gearing, which has the advantage of accelerating your wealth creation, whilst potentially also providing some tax advantages.
Automation here is extremely important and the key to success. A successful person in their career is time poor. When you do have a few hours to spare, you don’t have the headspace to think about investment allocation. Just as the key to the success of superannuation is the way it happens without investors conscious thought, so too we look to build wealth creation strategies that operate on autopilot. Flexibility is important of course, and that is also a consideration, however automation provides such a huge benefit that we always ensure it is very much a central element of strategies that we develop.
I’ll wrap up there. As I said at the top, everyone’s circumstances are a bit different, so I don’t think there’s value in going any further down the rabbit hole. But if you’re not yet quite ready for a personalised one on one plan, perhaps these key points might be useful in pointing you in the right direction.
The 4 things to focus on if you’re struggling to convert your great income into financial security are:
- Cash flow management and having a savings capacity
- Goals and time frames
- Where does super fit in?
- Automated investment program
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