The source of financial stress

Two years ago I wrote about relieving financial stress for Stress Down Day.

Fellow financial educator Carl Richards of Behavior Gap just released a new diagram that summarises one key source well:Circle-Stress

One value of financial planning is in removing the uncertainty and replacing it with clarity of direction and the confidence to act.

So if you’re tired of constantly thinking about and even stressing about money related issue then I recommend you invest in professional financial planning advice.

P.S. Carl writes some insightful articles about how our behaviour impacts our financial situation. I recommend you consider subscribing to his newsletter.

Better budgeting

For many people the word “budget” conjures feelings of restriction. (Just like the word “diet”.) However a good budget should be the exact opposite. It should facilitate you having enough money for the things that really matter so you need not feel restricted. In this article I reveal a better budgeting technique using the model “Pay Yourself First (in practice)”

Cue Skyhooks tune…

Budget…is not a…dirty word! Budget…is not a…dirty word!

Once on live TV I was challenged to come up with a better word for a budget. The interviewer felt the word was too creepy.

The reality, as you can probably guess is that it has nothing to do with the word but the meaning we associate with it.

In fact the origin of the word “budget” is in the leather case or wallet that bureaucrats used to carry their financial plans.

Of course the problem is that for many people budget conjures feelings of restriction. (Just like the word “diet”.)

A good budget should be the exact opposite. It should facilitate you having enough money for the things that really matter so you need not feel restricted.

You achieve this this by following the wealth principle I call “saving for the significant and minimising the insignificant.”

Pay Yourself First (in practice)

It’s likely you’ve heard of the principle to pay yourself first.

Back when I was a graduate engineer I thought this principle meant to put a certain percentage of my income away for wealth creation. Then I wondered “what next? How do I manage the remainder?”

Now that I’ve had the benefit of working with lots of people on their cash flow I’ve created this model to help you create an effective budget that sets aside money for the significant things in your life plan.

(Download a PDF version of the model here)

Top-down or bottom-up?

To follow the principle of pay yourself first ideally you work from the top as you allocate your income into pots of savings.

However, if you find that you never have any savings and in fact spend more than you earn the top-down approach won’t feel possible – because it’s not yet. To extricate your butt from the spending fire first you need to get control. You do that by starting at categories 5 and 6 and working upwards as you increase your control.

In short if you are in stages 1 or 2 in the Six Stages of Wealth Creation you would start at the bottom and work upwards to improve your cash flow management. Everyone else can take the planning approach and go top-down.

Your pots of money

1. Financial Independence

The first pot you allocate is how much you need to regularly invest so you accumulate enough net wealth to “retire” – or make work optional – when and how you want it.

In addition you include the additional regular loan repayment s you need to make to ensure you are free of personal (non-investment) debt by your financial independence target date.

2. Pre-retirement Essentials

The second allocation is to all the big things you want and need to do, buy or experience between now and the point you achieve financial independence.

For example: car upgrades, major home maintenance, family holidays, replacing major household items, parental leave. (The list goes on.)

In my experience many people find these items either blow their savings or are funded by debt. Why borrow and pay interest on predictable expenses when instead you could be earning interest? Earning interest in advance actually reduces the true cost of the items and the amount you need to save.

3. Irregular Expenses

In this pot I include all expenses you pay at least every year but less frequently than monthly.

For example: clothing, utilities, insurance, gifts, parties, subscriptions.

Again from my experience it is often the irregular expenses that end up blowing the savings of otherwise consistent savers. The problem for them is that whilst they are saving, usually by automated pay deductions, they are not saving enough. Month-to-month they may have savings but not year-to-year.

Often when clients actually separate their irregular from their regular expenses they are shocked by how high a proportion are irregular expenses. That observation alone is an insight into why they may be spending too much.

The expenses may be out of sight but they should not be out of budget.

4. Existing regular commitments

This category is the allocation for repaying all of your existing debts as per the current minimum required repayment.

For many people this is the first line item they put in when working out their budget.

The reason loan repayments is item 4 is that when you take a planning approach you first allocate items 1 through 3 to work out how much you can afford to borrow.

The way many people actually work out how much to borrow is a combination of:

  • What the lender says they will lend them
  • Their income less the regular spending that comes to their mind (i.e. untracked)

5. Regular Essentials & Comforts

All the regular items you spend at least every month.

When you take the planning approach you get to this point and discover how much you can afford to spend on comforts. And some things you thought were essentials get re-categorised.

It’s at this point many people start prioritising between lifestyle now and future significant goals.

  • Which is more important to me?
  • If I don’t save up for that future goal, but still want it how will I create the money to afford it? (e.g. I’ll only be able to afford X if I get a promotion – so I’d better start investing in professional development.)

6. Impulses and Indulgences

The final category is a little allocation for spontaneity.

How much to allocate to each pot

If everyone were identical in situation and value-system then we could define a nice neat package of percentages to allocate to each pot.

But we’re not.

To create a budget that is meaningful and motivating to you it needs to relate to your goals for your money.

That’s not as hard as it may sound. You already know what you want – it’s in your head, you probably think about it regularly. Just get it out of your head and onto paper and then put a number and time frame next to it.

Automatic wealth creation

Once implemented good budgeting should also be as automatic as possible. That’s the next step of smart cash flow management.

If you’re interested in how to put this all into place talk to me about Cash Flow Coaching.

Is now the time to fix interest rates?

Eighteen months ago when I first wrote about fixing interest rates there had been just two RBA rate rises and fixed rates were much higher than the variable interest rates. It was also still early in the recovery and for many it may have been too early to call. So a decision not to fix interest rates may have been easier to stomach.

Now fixed interest rates are similar, even lower than the variable rate as shown in the table below. And while the RBA has recently softened its talk future rate rises seem probably to many – especially those living in boom regions. So fixing rates may be starting to look attractive to some.

Source: Cannex (accessed 20th April 2011)

History

The real problem with fixing anything for a time period is that you need to be very confident in the accuracy of your crystal ball. The last boom seemed to last long enough to affect people’s memory and lull them into thinking it would go on for much longer.

Inflation was getting uncomfortable for the RBA so rates had been up going up. That lead many of the boom-believers to fix their interest rates in the hope of beating the rises – sometimes for 3 and 5 years.

What transpired was much gnashing of teeth when interest rates plummeted, as summarised in the graph below of the RBA cash rate.

The consequence of an error-prone crystal ball can be very costly.

So should you?

For a detailed examination of the considerations in fixing rates read my earlier article. There are some circumstances when you would fix interest rates.

Right now include the following when contemplating your decision:

  • The recovery is not certain. Rates may not move for some time. So if you fix your rate you may trade off flexibility for no benefit.
  • Another sharp down-turn is possible. How will you feel if you’re paying a higher rate than the variable rate?
  • The future gets increasingly uncertain the further out you project. Exercise greater caution when considering longer terms for fixing rates.

A personal observation

In my role as a financial planner I have seen how rapidly people’s life and goals change in just a few short years. For those who fixed their interest rates (before becoming clients) I’ve noted how the lack of flexibility has inhibited their money management and wealth creation.

Don’t underestimate how quickly life evolves.

If you’ve had some big changes in the last 3 years then maybe you also will in the next 3 years – it may just be the way you roll. So,  perhaps a 3 year fixed rate is not the best thing for you right now.

Misleading marketing finally acknowledged

I shudder whenever I see the big newspaper and magazines advertisements of companies that purport to teach people how to easily & profitably trade shares and derivatives (like options, warrants & CFDs). They promise so much confidence and certainty of gains.

According to their website (accessed 20 April 2011) the business Safety In the Market (operated by The Hubb Organisation Pty Ltd) has “assisted thousands of Australians [to] discover how they can trade the financial markets safely and profitably” since 1989.

That’s over 20 years of big promises.

Finally the regulator ASIC has reigned in their promises by obtaining court orders preventing Safety In The Market from making or publishing misleading or deceptive representations about its trading methodology.

ASIC’s concern was about claims that the methodologies were “proven”. A nice piece of marketing bollocks you will read in lots of adverts.

This kind of grandiose marketing can go on for years before the regulator gets around to taking action – as you can see by SITM’s longevity. So just because an organisation has been around for years don’t interpret that as being evidence of a basis to their big claims.

As always be aware and ask yourself if you have what it takes to be one of the minority with the intelligence and discipline to consistently make a profit.

 

Famous Will Catastrophes

This article was originally published in the LawCentral Bulletin 362 on 19th April 2011 and is republished with permission of the author, Brett Davies.

You’d be surprised at how many wealthy people die without a Will. Or don’t update their Will to reflect their changing circumstances. Some of the best examples of leaving things until it’s too late are:

  1. Howard Hughes the eccentric billionaire who founded PanAmerican Airlines. Died in 1976 at the age of 70. His Will was discovered at the headquarters of the Mormon Church in Salt Lake City. However, the Will was proved a forgery and his estate was divided among his 22 cousins.
  2. Pablo Picasso died in 1973 at the age of 91. He left a fortune in assets including artwork, properties, cash,gold and bonds. Because Picasso didn’t make a Will, it took 6 years to settle his estate at a cost of US$30m. His assets were eventually divided up among six heirs.
  3. Stieg Larsson who wrote, amongst other titles, The Girl with the Dragon Tattoo, died in 2004. He too died without a Will.Swedish law dictated his estate be divided between his father and brother. His life long partner of 32 years, Eva Gabrielsson received nothing. The family did grant her ownership of the couple’s apartment.
  4. Jimi Hendrix died in 1970. He didn’t leave a Will regarding the distribution of his estate. The battle over his estate raged on for more than 30 years for one simple reason. His estate continued to generate money long after his death.
  5. Heath Ledger died in 2008. He had a Will which left everything to his parents. The problem is, since he made that Will in 2003 – Heath had a child, Matilda. By not updating his Will to accommodate his new circumstances, Matilda got nothing in the Will. Fortunately,Heath’s parents made sure she was looked after, but without the aid of any tax protection like a 3G Testamentary Trust.

Don’t leave it to the Courts todecide the fate of your assets. Even worse, if you don’t have a Will and there is no next of kin – the Government takes it all as the default. You’ve alreadypaid enough tax in your lifetime, so why give the Government more when you die?

(Ed – And let’s not forget the estate disaster that followed Peter Brock’s death.)

If you don’t have a Will yet at the very least get a decent and cost effective one from LawCentral.

B.S. from GE Money

I just heard on the radio the latest advert for the GE Money Personal Loan. It claims to give you more money to enjoy the things that matter. A lovely marketing tug on your emotions but total B.S.!

I just heard on the radio the latest advert for the GE Money Personal Loan. It claims to give you more money to enjoy the things that matter.

A lovely marketing tug on your emotions but total B.S.!

After you’ve blown the loan amount you’ll have lots of interest to repay – at a rate not much lower than credit cards. So a personal loan such as this will actually give you LESS money to enjoy the things that matter (for a long time).

Save for the significant. Minimise the insignificant.

If you really want to ensure you have enough money for those things that really matter to you follow this process:

  1. Identify those things that matter most
  2. Work out how much money you need for them, and when you’ll need it.
  3. Establish automated saving and cash flow management plans to ensure that money is there when those things that matter occur.
  4. Enjoy life with the peace of mind you’ll have the money to enjoy what really matters most.
  5. If there is any money left over you can spend it on insignificant things suchs as impulses and indulgences.

If you need a personal loan (or credit card) to fund experiences and items that matter to you take it as screaming alarm bells that your cash flow control is on fire. Run away from the lenders and towards a financial counsellor or decent financial planner.

Learn more about my cash flow coaching here.

Margin call calculation

When you have a margin loan it is important to understand how much your portfolio value can fall before you receive a margin call. This article reveals the formula for calculating the percentage fall to trigger a margin call.

A margin call occurs when you no longer own enough of the investment to keep the lender confident they’ll get their money back. If you receive a margin call you are asked to either:

  • Add more security for the loan – this can be cash or other approved investments
  • Reduce the loan balance – either through cash or by selling some of the investment

Neither of those remedies can be particularly pleasant so when you have a margin loan it is important to understand how much your portfolio value can fall before you receive a margin call.

The formula for calculating the percentage fall to trigger a margin call is shown below:

LVR stands for Loan to Value Ratio. It is calculated based on the amount you owe (the loan) divided by the total value of the security (the investment). For example an $80,000 loan against a $100,000 investment has a LVR of 80%.

The abbreviation in the margin call formula are:

  • Base LVR% = maximum allowed LVR% based on the quality of the lodged security (the investments)
  • Current LVR% = your loan ÷ your current portfolio value
  • Buffer% = the allowed buffer before triggering a margin call

Generally lenders won’t call you as soon as your Current LVR hits the Base LVR. Since the investments often fluctuate in value daily they give you a bit of leeway – know as a buffer. Many lenders give you a buffer of 5% but some have a buffer up to 10%.

For example if your Base LVR is 75% and the lender’s buffer is 5% they will call you when your Current LVR hits 80%.

Below is an example calculation of how much your portfolio needs to fall to trigger a margin call. The parameters in the calculation are:

  • Base LVR% = 75%
  • Current LVR% = 50%
  • Buffer% = 5%

If you choose to gear conservatively (at 50%) against quality assets with an allowed LVR of 75% (base) then your portfolio value can fall 37.5% before you trigger a margin call. That has happened but it is rare, which should give you confidence to consider margin lending.

If you can’t be bothered doing the calculation the following table gives you some examples of the percentage fall required. Note the buffer in this table is 10%. (Source: Leveraged Equities.)

From the above table you can see that when your buffer is 10% rather than 5% in the earlier example then for a current LVR of 50% and base LVR of 75% then your portfolio can fall by 41% before a margin call is triggered.

SMSF Guide

If you are contemplating a self managed superannuation fund or already have one then you may be interested in this useful SMSF Guide produced by Macquarie’s technical team

Over 29,000 self managed superannuation funds were established in the 2009-10 financial year, taking the total number of SMSFs to 427,491. (Source: ATO, Sept 2010).

If you are contemplating a self managed superannuation fund or already have one then you may be interested in this useful SMSF Guide produced by Macquarie’s technical team. (Look in the section called ‘Education Centre’. The Guide is called “Self Managed Super Funds – from set up to wind up“)

Self managed superannuation funds are increasingly popular as people believe a SMSF gives them greater control over their money. However a SMSF is often not needed to get the level of control you desire. Read my earlier article to discover when you may or may not need a SMSF.

Crazy ways it could happen to you

Most of the time most of us have our wits about us and therefore don’t get injured.

But it only takes a momentary lapse in concentration or a ‘brain freeze’ moment and injuries or even death can occur to smart, cautious people.

Following are some statistics I come across of crazy ways that people got injured or even killed.

3 Australians die each year testing if a 9V battery works on their tongue.

71% of people over the age of 50 are injured due to opening supermarket packaging.

43 Australians were admitted to casualty departments in the last 2 years from attempting to open beer bottles with their teeth or eye socket.

142 Australians were injured since 1998 from trying on a brand new shirt & not taking out the pins first.

18 Australians were seriously burned in 1988 from putting on jumpers while having a lit cigarette in their mouth.

31 Australians have died since 1996 from watering the Christmas tree while the fairy lights are still plugged-in.

19 Australians have died in the last 3 years by eating Christmas decorations they believed were chocolate.

Hospitals reported 4 broken arms last year after cracker pulling incidents.

58 Australians are injured each year by using sharp knives instead of screwdrivers.

8 Australians have cracked their skull since 1997 after falling asleep (passing out) while throwing up into the toilet.

The above stats are courtesy of CommInsure.

If you are mostly healthy and careful but, like me, are the occasional victim of brain freeze then an accident-only insurance policy may be worth considering as a cost-effective way to protect your lifestyle.