9 steps to financial success
1. Set Clear Goals
Simply, if you don’t know where you are going, it is very difficult to get there.
You are likely to have goals in your work (they may be called Key Performance Indicators), and if you participate in sport, your goals might be to win a trophy or a competition, or just to get faster on that run than you were last week.
Managing your money is no different. You need to work out what you want to achieve. And those goals should have a time frame and dollar value associated with them.
For most of our clients, the big goal is having enough money to have a financially comfortable retirement. We can work out how much money that will require, and when, and then work backwards to work out how much needs to be saved and by when.
You might have a goal to repay your mortgage, to save for a trip or a new car, or to provide a certain level of education for your children.
Of course, with the realities of life, those goals regularly change. Our spending habits change as we go through the different stages of life, we may decide we want to work for longer than we initially thought we would because we are enjoying ourselves.
As a consequence – as outlined in step 9 – your goals and your plan need to be regularly reviewed to keep up with those changes.
Investment returns and interest rates do matter
To achieve your retirement savings goals, and to get through retirement, you need to understand how investment returns work.
It is important to know how to compare the assumptions in any articles that you are looking at, and make sure that you are comparing like with like.
The first step is to start thinking about investment returns after tax, after fees and after inflation. (link to article on inflation, tax and fees)
Inflation means that your money will be worth less and buy less in the future, as prices go up each year. Taxes reduce the return to you as you legally have to pay taxes. For many of the investments that you will use to get you to and through retirement, you will have to pay fees. It is important that you understand what your returns are after these three items.
For our clients, Moneyworks advisers always talk in after tax, fees, and inflation returns when we are doing our retirement savings analyses, and working out how long their money will last them. These returns range from 1.00% to 2.50% - and each return will be personal to each client as it will depend on their tax rate when they are earning and then when they are no longer earning.
The second step is to understand how much different an extra 1.00% (after tax, fees and inflation) return can make to how long your money will last for.
The table below shows you how much difference 1.00% per annum will make if you have $50,000 invested for 30 years.
|After tax, fees and inflation return
|Amount you will have in 30 years, if you invest $50,000
Assumptions: $50,000 invested for 30 years with these after tax, fees and inflation returns, compounding.
The third step is to understand how much additional risk you have to take to get those returns.
For example, if you currently invest in a term deposit for 3.50% - there are no fees payable, but if your tax rate is 33.00% - your after tax return is 2.35%. Inflation is currently around 2.00%. Therefore, a term deposit will give you an after tax, fees and inflation return of 0.35% - not even on this table. (If your tax rate is 17.50% - the after tax, fees and inflation return is 0.68%).
What this means is that you will have to save more money to provide for your retirement as your money won’t be working for you, than if you get extra returns from your investments.
On the other hand, to get a return of 4.00% after tax, fees and inflation, the total actual return that you would need to get (at a 33.00% tax rate) is actually 10.80% (on average each year). This is a very aggressive and high risk profile – we only have one or two clients that fit into this category.
If you are a Balanced investor, then you should be looking at a return after tax, fees and inflation of around 2.50% pa.
9. Regularly review your plan
If the only steps that you take are step one of setting your goals, and this step – regularly reviewing your plan, you will be ahead of other people who haven’t even done that.
The reason that you should regularly review your plan is that things change. For many of our clients, their life changes every few years in the phase between age 25 and 45, then around every five years after that until retirement.
But more importantly the financial solutions change continuously – every day there are changes to insurance products, and investment and KiwiSaver solutions.
We often work with people who have done absolutely the right thing in the past and put in place insurances, superannuation and investments, based on what was available at that time.
But things change, locked in superannuation, high fee and underperforming investments, insurances that cost more than if you put in place new insurance today (depending on no significant changes in your health), KiwiSaver managers who are consistently underperforming……
You should be monitoring all these things and making sure that your financial solutions are the best for you and working for you.
You should review your financial plan every couple of years (or annually if you work with Moneyworks on an ongoing basis), but at least every five years. This means that you will keep up to date with trends and you will keep your money working for you to reach those goals.