A Comfortable Life

Ask any middle aged person what their financial goals are and at the top of the list you are sure to find a goal that is based around having a comfortable life, free of financial worry. You see, most people have no desire to become millionaires, unless by way of a windfall or inheritance.

While many people might fancy the idea of suddenly being wealthy beyond their dreams, the thought of having to create that wealth themselves is enough to scare them into mediocrity. The reason is, creating wealth involves three basic ingredients most people lack:

• The ability to seek out and follow through on opportunities
• The willingness to take risks
• The ability to manage cash flow (money coming in and money going out).

Financially savvy people are those who have these skills and use them to create substantial wealth. Such people are a minority of the population. Their substantial wealth doesn’t necessarily mean however, that they have a more enjoyable life than those whose aspirations are not quite so grand. Having a comfortable life has less to do with how much wealth you have stored up and more to do with your state of mind. Happiness comes mostly from good relationships with others and your emotional well being.

At the most basic level, being comfortable means having enough money set aside to cover any unexpected expense or loss of income, and being able to keep your outgoings to an amount that is less than your income. Anybody who can achieve these two things has the potential to have a comfortable life, free of financial worry.

The most magical thing about getting to this most basic level of comfort is that once you reach it, your life begins to get more and more comfortable as your wealth grows!

The Next Crisis

The year 2008 will long be remembered as the start of the Global Financial Crisis which was triggered by defaults in sub-prime lending in the US and a downturn in the housing market.

A global slump in economic growth followed along with a considerable amount of pain resulting from losses in failed financial institutions, mortgagee property sales and failed businesses. In response to the crisis, central banks and Governments rushed in with bags of money to shore up the ailing financial system and to stave off what could have been the worst economic event since the Great Depression.

The trouble is central banks and Governments now find themselves in the same position as the fabled Dutch boy with his finger in the hole in the dyke, trying to prevent a major disaster. Somehow this temporary measure needs to be replaced with something sustainable. There is a limit to how long a finger can be held in a dyke and the challenge for the financial system is how to deal with the increasing amount of debt faced by governments, particularly in Europe.

There is potentially another crisis looming.

Already share markets are reacting nervously to the situation in Greece, where the Government budget deficit has now reached around 13% of GDP. Ireland, Britain Portugal, Italy and Spain are not far behind. Yields on Greek Government bonds have increased dramatically as the risk of default rises.

If the Greeks do not regain market confidence, they may not be able to refinance debt that falls due in the next few months and then the government would default or have to be bailed out. If Greece falls over, the cost of borrowing for other euro countries would go up as well.

Investors in international bond markets will need to proceed with caution over the next few months.

Letting Go

The end of a long term relationship is a traumatic event even when the end is by mutual agreement. Unfortunately, failed relationships are becoming increasingly common.

As well as the emotional turmoil, there are huge financial implications to come to terms with and the prospect of dealing with these issues sometimes leads people to stay in relationships that don’t work.

For couples who are newly separated, one of the major issues to deal with is what should happen to the family home, particularly when there are young children involved. At a time of emotional instability, the family home is a safe haven. It is enough to deal with a relationship breakdown, let alone adding a house move into the picture.

There are a number of reasons why it makes good sense to divide relationship property as quickly as possible after the end of a relationship. A clean break allows both parties to move forward both emotionally and financially and is less complicated.

Retaining the family home in joint names means both parties are entitled to have access to the property and existing mortgage arrangements can potentially be used for the benefit of one partner but with both partners still being liable for the debt.

The burden for one partner of taking over the ownership can be made easier by taking in a boarder, getting financial help from family members, taking out an interest only mortgage, extending the term of the mortgage or taking a mortgage repayment holiday for a few months. Often it is best to sell rather than live in financial difficulty.

This is not necessarily a bad thing. Property prices are not expected to increase markedly in the medium term and renting for a while gives some breathing space to create a stable financial base from which to move forward again.

Test Your Financial IQ

Financial literacy is one of the most important keys to financial success. If you want to make a success of managing your money, there are some basic principles you need to be familiar with. You can test your Financial IQ by asking yourself which of the following concepts you understand:

• How to spend less than you earn
• The difference between good debt and bad debt and how you can use good debt to increase your wealth
• The difference between good expenses and bad expenses
• Why your home is not an investment
• How the power of compounding interest can work for you or against you
• How to minimize the amount of interest and tax you pay by structuring your affairs correctly
• The difference between saving and investing
• What is meant by financial risk and how to manage it
• The relationship between investment risk and return
• The advantages and disadvantages of the various types of investment (cash, bonds, property and shares)

If you found there are many things on this list that you don’t know, be reassured this applies to the majority of people. Knowing what you don’t know will help you seek out the information you need through research or talking to experts, so that you can increase your Financial IQ.

Time is Money

One of the fundamental principles of managing money is that time and money are inextricably linked. People who are successful at creating wealth are those who understand the connection between time and money and use it to their advantage.

Time represents opportunity. You have choices about how you use every hour of your day. You can choose to exchange some of your time for money and you have a degree of choice about how much money you exchange it for.

You can use the principle of leverage to increase the amount of money you receive. Leverage is simply finding ways of using other people’s time or resources to multiply the value of your time; for example by running a business where you hire people and sell their time for more than you pay them.

Another way in which time and money are connected is the value of one dollar now is higher than the value of one dollar received at some time in the future.

One reason for this is that with inflation, a dollar you spend at a time in the future will buy less than a dollar will buy today. Inflation favours those people who borrow, particularly if they borrow to buy assets that go up in value, such as property.

Another reason is money can be invested for a return. If you have a choice between having one hundred dollars today and receiving one hundred dollars in two years time, it makes sense to have the money now, because you can invest it so that in two years time you have more than one hundred dollars.

By investing at a rate that is higher than inflation, people who start saving and investing early in life have a huge advantage over those who leave it until later.

Savers are Losers

One of the key lessons we learn in life is that it is important to save. There is a big difference though, between what we learn and what we do and many people find saving difficult.

Those people who feel guilty about not saving will be interested in a concept being promoted by Robert Kiyosaki, author of Rich Dad, Poor Dad, who suggests that savers are losers. Before all non-savers get too comfortable with that proposition, his point is not that everyone should spend rather than save. Saving implies putting money away on a regular basis into a bank account where it will earn interest and slowly increase in value with compound interest.

There are three reasons why you could argue that people who save are losers.

• Firstly, the return on your savings is reduced because you pay tax on the interest earned.
• Secondly, over time, the effect of inflation will reduce the purchasing power of your money. In other words, if you save $100 and choose to spend it ten years from now, you will not be able to buy as much with your money as you can today.
• Thirdly, bank deposits offer a low rate of return when compared with other investments. That is because bank deposits are seen to be less risky than other investments.

The point made by Kiyosaki is that if you really want to get ahead financially, you are better to invest rather than save.

Investing in growth assets such as property and shares or investing in a business of your own should give you better protection against tax and inflation, and a higher return over the long term.

In my view, the best approach is to do a little of everything; invest for a good return, save for security and spend to enjoy life.

How’s your Banking?

It seems that banks are finally getting the message that helping their customers manage their money better is a good thing to do. It wasn’t that long ago that the main focus for bank advertising was to tempt its customers with overseas travel, new cars and home renovations financed by an increased mortgage.

While some would argue that banks are still focused on increasing the amount of money people borrow, they are beginning to balance this out with new services designed to help you manage your money so that you can reduce the amount of interest you pay.

The ASB has some great resources available on its website under the heading Your Money Explained. These include How To guides on setting a budget, managing your mortgage, dealing with debt, saving and investing. BNZ have a great system called Total Money, which allows you to have up to ten different accounts for a small monthly fee. This is a great help if you want to set aside money for a number of specific goals. The amount you save can be offset against a variable rate home loan, so that you pay less interest.

Banks are also now offering Visa Debit Cards, which can be used to make purchases online or over the phone but which deduct money from your everyday EFTPOS account. That way, you won’t be tempted to spend what you don’t have.

To help you keep on top of paying your bills, Kiwibank has a Bill Blaster account that lets you set money aside for your bills. This can be done automatically using their Paystream service, which splits incoming money between your everyday, savings and Bill Blaster accounts.

Set yourself some financial goals for this year and have a look at what banks can offer to help you achieve them.

Why you Should Never Retire

The end of the year is often the time when weary workers wish they could take a holiday and never have to go back to their jobs.

Retirement is seen to be the ultimate but somewhat elusive goal that we all aspire to and for which financial planners chide us that we must be well prepared. In their book Avoid Retirement and Stay Alive (Harper Collins, 2007) David Bogan and Keith Davies put forward the idea that no one should feel compelled to retire and indeed no one should want to retire.

The key message of the book is not that everyone should work hard until the day they die. Rather than retirement being a life changing experience that takes one overnight from being a productive worker to being permanently on holiday, it should be a seamless process where life is a continuous combination of productivity and pleasure, with the balance between the two simply adjusting over time.

There is a common expression that life is journey, not a destination. Too often we are so busy focusing on how much better our lives will be in the future that we forget to enjoy the present. There is no reason why we have to wait until we are no longer working to enjoy travel and leisure activities. Similarly, there is no reason why we have to feel that after a certain age we are useless to
society.

The concept of retirement is a modern one. Early last century, the average person was lucky to survive into their sixties and if they did, they were likely to be ill or frail. Retirement on a pension was intended to allow such people to have a few meagre years of life without having to work while frail. Thanks to improved lifestyles and modern medicine, it is not unrealistic these days to expect to live thirty years in retirement.

Somehow the concept of retirement changed to one of forcing people to give up a productive life on a given date. Continuing to be productive in retirement doesn’t mean however that you have to stay working in a job you don’t enjoy. There are many examples of people who use their later years to work at things they really enjoy or are passionate about. Some even choose this time to set up new businesses.

On the flip side, if you plan to have an active, income-producing retirement, there is no reason why you can’t do now some of the things you were planning to do in retirement. If travelling to Peru or learning to play golf are on your wish list find a way to make them happen today. It’s easy to have excuses. If only I had more time… if only I had more money….if only I didn’t have children to worry about….

Doing fun things while you are younger and being more active and productive in your later years have been shown to help people live healthier, longer and more meaningful lives. Taking regular breaks is crucial to your physical and emotional well-being and new experiences let your mind know you are still alive. You are in charge, so make your own decisions about how your life will be lived.

Why Consumer was Wrong

Consumer Magazine, once regarded as a trustworthy if somewhat fusty publication dedicated to providing its readers with an objective assessment of the performance of washing machines and hair straighteners, has recently published the results of a major project to uncover something that we already know. The standard of financial advice in New Zealand needs to be improved.

This was clearly a report for which the headline had already been written, aimed more at using sensationalism to sell magazine subscriptions than providing consumers with an objective review.

There are already numerous initiatives underway to improve standards of competence, ethical and professional behaviour, disclosure and dispute resolution for financial advisers, none of which will be enhanced by the findings of the Consumer report. The principal outcome has been the destruction of public confidence in financial advisers, which means that sadly many people who need good advice won’t ask for it.

Consumer asked 11 mystery shoppers to obtain financial advice from 33 financial advisers and then rated the financial plans that were written. The complexity of financial advice is such that a mystery shopping exercise is an inappropriate methodology to test the quality of advice given. Financial advice is a process, not a written plan and the quality of advice is best measured by the outcome of the advice; something that is not easy to do objectively. It most certainly cannot be measured by the quality of documentation.

A major focus of the Consumer report was what were termed ‘pre-retirement plans’. Consumer have correctly identified that there is a huge gap in the market in that people with low equity, high levels of debt and little in the way of savings find it difficult to obtain financial advice.

The reason however, is not as contended by Consumer that the standard of financial advice available is scandalously low; it is quite simply that such people either cannot afford to pay for advice or are unwilling to do so.

Advisers who offer written pre-retirement advice generally do so at a loss and hence many choose not to offer this service, or to give verbal advice only, often with no charge.

Consumer described the average cost of pre-retirement plans (around $700) as expensive. Based on an average hourly rate of $200, this would cover around 3 ½ hours of time, of which at least two hours would be taken up by meeting with the client. Few are willing to pay the $2-3,000 I estimate it costs to prepare a detailed pre-retirement plan. For Consumer to say on one hand a $700 plan is expensive and on the other hand to reject 5 of the 7 pre-retirement plans on the basis that they lacked detail is absurd unless they consider that advisers should be offering a charitable service.

Consumer’s recommendation to investors that they only use advisers who charge an hourly rate rather than a percentage fee is difficult to fathom and would result in advisers being nothing more than transactors unable to give pro-active advice.

Had Consumer intended to use a fair process with this study there are several things they would have done differently. The panel would have omitted those with a known anti-adviser bias; the rating scale (good, disappointing and rejected) would have been objective rather than sensational; reasons for ratings would have been given and mystery shopped advisers would have been offered the right of reply.

It will be interesting to see what effect this Sunday tabloid style of journalism has on Consumer’s credibility.

Media Update

You will no doubt be aware that Moneymax has attracted considerable attention in the media over the last two weeks as a result of two key events: the publication of the Consumer Magazine report on financial advisers and my resignation from the Code Committee, a Government Committee established to set standards for financial advisers.

The Consumer report was based on a mystery shopping survey which involved 11 mystery shoppers seeking advice from 33 financial advisers. Of the 33 advisers, only 3 were deemed to have given ‘good’ advice based on the Consumer assesment criteria. Moneymax was asked to prepare a pre-retirement plan for a mystery shopper. A pre-retirement plan is one that is prepared for a person who has a mortgage and little in the way savings but who wants to get ahead. I spend many hours giving free advice to such people and in some cases I prepare a basic written plan for $600-800 plus GST depending on complexity. The true cost of preparing these plans is at least $1,600. Detailed plans cost around $2-3,000 and this is beyond the reach of people with no savings. My plan for the mystery shopper was rejected on the basis that it was not sufficiently detailed.

To maintain public confidence in the work of the Code Committee, I offered my resignation from that Committee to the Chair, Mr Ross Butler. Mr Patrick Middleton of Westpac offered his resignation for the same reason. Both resignations were accepted and Ms Annabel Cotton, the Commissioner for Financial Advisers, has stated publicly that these resignations do not in any way reflect our competence or our contribution to the Code Committee. A copy of the media release from Annabel can by read by clicking here.

Consumer Report

The Consumer Report has been condemned by the financial advice industry as flawed and sensationalised. You can read some of the industry response on two financial planning websites, Good Returns (click here) and Financial Alert (click here). I have written a letter of complaint to the Chief Executive of Consumer and you can read a copy of that letter by clicking here.

I was asked by Asset Magazine to write an opinion on the Consumer report. This will be published in the next issue of the magazine and you can preview the article titled ‘Why Consumer was Wrong’ by clicking here.

Support from Clients and Colleagues

I have been overwhelmed by the support I have received from both clients and fellow advisers over the last two weeks. I remain passionate about my profession and being able to help people make the most of their money. If you have any concerns about what you have read or heard, please contact me.