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I recently read that one of the main reasons the majority of consumers do no financial planning, is the perception that they do not have sufficient money to justify one. Add to this the perception that financial planning is a really onerous and complex process, and it is no wonder many people are scared off.
Certainly there are many players who would have us believe that financial planning is complex, and only for the wealthy. That is a myth. Everyone should have a financial plan.
What is financial planning?
Simply put, from a financial planner’s point of view, it is about objective (measurable) advice that results in a plan to manage current and achieve future financial needs and goals. It is not about product or sales! These come right at the very end of the process, and may be used to flesh out the plan if necessary. It is quite possible that the plan identifies that no products are needed or appropriate.
From a financial planning point of view, most people face four or five common risks. They are:
- Dying too soon and leaving debt or dependents
- Living too long (insufficient funds on which to retire)
- Disability (over a short or extended period)
- Funds for short-term emergencies.
- Debt!
A financial plan should identify the potential impact of any of these areas (as well as any others) and should be designed to minimise negative impact.
Dying too soon
Life insurance is not an investment – it pays when you die. As such, it should only be used to cover risks that you cannot (or do not want to) take. These could include leaving debt on a bond, and to provide liquidity for your estate. If you have no debt, sufficient cash/investment reserves and no estate duty problems, and you probably don’t need any life cover.
Living too long (insufficient funds on which to retire)
Again there is little rocket science involved here. Remember the power of compounding (see below). The sooner you start saving for your retirement, the better (even if it is in the very distant future).
In order to determine the capital lump sum you will need at retirement, you will need to determine your (equivalent) income at retirement. This is a “simple” future value calculation – click here for a calculator that will help you work it out – and is dependent on your current income and inflation over the period. The future income value will allow you to determine the capital required. The longer the period to retirement, the greater the effect of changing inflation and investment returns over the period so you will need to review it on an annual basis (at least)!
Disability (over a short or extended period)
This is a tough one. The Association of Savings and Investments of South Africa (ASISA, formerly known as the Life Offices Association) has set limits on the amount of disability cover anyone may buy. Disability is also unfortunately often a very subjective matter.
If you work for a (large) corporate then you will most probably be covered through their group scheme. This usually consists of an income replacement benefit which is paid after an initial waiting period (usually three months) – by implication the company will look after you during that initial three-month period.
It is the self-employed and those who don’t belong to a group scheme who are most at risk. Find out what you have before you rush out and buy – you don’t want to over-insure.
Funds for short term emergencies.
It is good financial planning practice to have around three months’ income in a cash account. This is to cover unforeseen expenses which seem to pop up with such regularity. If you have an access bond, you should use it for this purpose. If the bond is paid off then you should use a money market unit trust account, which has a higher interest rate than most other savings vehicles.
Debt
Debt is the most expensive thing you can buy! Don’t make the classic error of compartmentalisation. You should probably not be investing while you are paying off debt because the rate of return you are likely to receive from the investment is likely to be significantly less than the rate of interest you are paying on the debt. Once your debt is paid, you will also most probably be able to pay for the things for which you were saving (e.g. school fees) in cash each month!
Every financial plan needs to address this list of five life issues. Together, they add up to peace of mind.
The power of compounding
There is a great story told of a king whose pride and joy was his lily pond. He would spend the mornings and evenings beside the pond watching the frogs and dragonflies and contemplating his kingdom. One day he noticed a new plant that had appeared. He did not recognise it, and so he consulted with his advisors who told him that it was a highly invasive weed that was doubling in size each day, and that if left unchecked, would choke all the other plants and destroy the pond. He was advised to destroy it immediately.
The king thought about it a bit and told his advisors that he would deal with it when the pond was half-covered…
The point of the story is that if it is doubling each day then by the time it was half-covered then the next day it would be fully covered.
There is a similar story which was part of an Investec TV ad years ago and revolved around a peasant who saved the emperor’s daughter. The emperor was so thankful that he offered the peasant anything he wanted. He was a wise peasant, so he asked the emperor for a grain of rice on the first square of a chess board, and then to double it each square thereafter.
One grain becomes two, then four, eight, 16, 32 and so on – each square being double the one before. The second-last square is two to the power of 62, and the final square is double that (two to the power of 63). There is not enough rice in all the world to cover that number.
(Gregg Sneddon , Health24, March 2011)
