The one thing standing between you and financial security is in your head
Why is it that you find teachers that are financially secure all their lives and retire comfortably but CEOs earning 100 times more aren’t in the same place? It all boils down to one thing, spending less than you earn and investing the rest – for decades. Sounds simple right? Why is it then that so many people just can’t get it right? Essentially it has to with what is going on in our head. Our spending or saving habits are a result of years, often decades, of behaving in a certain way. Every time you behave in that way, the habit is ingrained in your psyche and changing it to get better outcomes very difficult. Difficult, but not impossible.
When you want to change a habit you can do it cold turkey or by taking baby steps, the method you choose is up to you but the problem with ‘cold turkey’ is that, unlike smoking or drinking, you still need to spend money. This is not unlike dieting, you have to eat to live, so you can’t just cut out all food. Crash diets rarely work in the long term, because the basic habit that caused the weight gain hasn’t been changed – changing poor financial habits are very similar. Slow and steady usually wins the race.
So, let’s take the principals of dieting and apply them to changing your spending habits.
- Know what you’re consuming. I hate to use a new-agey buzzword word but by becoming more ‘present and aware’ of what you’re doing with your money you will bring you closer to a better financial outcome. In the (good) old days it is the equivalent of not balancing your cheque book and leaving your envelopes of statements unopened. Today it is not much different, it is just all digital. The good new with that is that you can get the technology to put it in your face so you can’t ignore it. I am sure you’ve tried to have a ‘budget’ many times in the past, but they are time-consuming and depressing. Free apps like 22seven make this dead simple today, but you have to interact with it, set the categories and limits and watch the notifications when you’re going over your target. Make friends with your money. Start watching what is going in and out, and make your own assessment if that is helpful, that change alone will start to change your behaviour.
- Cut out the carbs. These days fat is good, carbs are bad – but either way, when you’re dieting you have to moderate the food-to-mouth disease if you want to lose weight. Once you’ve made friends with your money and put your consumption into categories you’ll soon find your weak spot (if you didn’t know it already). If you’re lucky, by watching your consumption you might also find long forgotten debits that can be killed off. If you’re paying for a loyalty program and not using the benefits, that alone can save you several hundred Rand month. What about bank fees? If the bank’s loyalty program isn’t virtually paying for that every month, look at changing banks. Use loyalty programs to their max, I personally get around R2,500 a month back on mine – and I am not talking about discounts.
- Don’t have the food in the house. In financial terms, having the bank/credit card instantly available – even embedded in your cell phone – makes it much too easy to consume. Show your brain something it can understand – cash. Once you have identified your weak spot, or the place you think you can save money, take the month’s allowance out in cash and stop using the card. Many banks allow you to get ‘cash back’ at the grocery till which costs you a fraction of using an ATM and is way safer. If you have cash left over at the end of the month then spoil yourself with a little treat or take out less next month and move the balance into savings.
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Hidden traps waiting for unsuspecting entrepreneurs
Entrepreneurs, especially if they haven’t been cursed with climbing the corporate ladder or an MBA, have some unique challenges when navigating the field of personal and small business risk and finance. Perhaps it’s that fearless spirit and boundless confidence that will guarantee your success, but “jump and build your wings on the way down” sometimes ends in a bloody mess at the bottom. A bit of homework on wing design and jumping with the right tools would have prevented that – and the same goes for that entrepreneurial venture you dream about.
Test your idea: Unless you’re buying a franchise, a new venture usually starts with an idea, and with a product (which could be a service of course). It is important to iron out at least some of the bugs before you sink too much money into the venture. Who is your target market? What are their expectations? How much are they prepared to pay for the product? What after sales service do they expect? How often will they buy your product? How can you retain their loyalty? Don’t let a poor product sink your venture before it even starts.
Everyone needs to ‘maak’ a plan: Seat of the pants ventures or bootstrapping your way through the early years probably works a charm in your early twenties when you don’t have obligations, not so much later on. One of the biggest mistakes entrepreneurs make is to buy into the fallacy that business plans, financial plans, marketing plans, business qualifications are all bureaucratic nonsense designed to kill your dreams. Dreams and visions are all very well, but unless you know what your “break-even” is for example – and when you might achieve that dream – then it can become a nightmare. The good news is that all this information is freely available on the net, in books and online courses. Do all that homework and put your plan together before you leave your day job. If you’re ‘between jobs’ then use the time to do this homework, but keep looking for a job, even if it as a temp, Uber driver or from your rented room while you rent out your house. Money to launch your venture is hard enough to come by without spending it doing the homework and learning basic business skills.
Who are your clients going to be and how are you going to get them? This is key to any venture’s success. If you’re starting a business very similar to your ‘day job’ tread carefully, if you cannibalise their clients or copy their products, you might spend a chunk of your change in court. Brushing up on social media marketing and building your potential network takes time and trail and error as you find out what works and what doesn’t. You can also use social media to test your product or use free tools like Survey Monkey
Never abdicate your responsibility
Personal finance can be overwhelming and complex, but if you want to partner with an advisor to help you protect and grow your wealth there is a bare minimum you need to know so you can assess whether your wealth is invested properly and you have the factors you can control on your radar. There is nothing more dangerous than being ‘unconsciously incompetent’ – not knowing what you don’t know.
Here are the handful of numbers you must know (in order of priority):
- The “repo” (repurchase) rate (currently 7%), prime interest rate (usually 3.5% above repo rate, now at 10.5%) and the interest rates of all the loans, mortgages (usually close to prime), credit cards ( as high as 18-24% at the moment), car loans etc. that you have. Why? This will illustrate which debt must be paid off first. Read HERE for more on ‘Smart debt’. This will also give you a benchmark that you can rate your investments against.
- The inflation rate (currently 6.3%, the top end of the target range is 6%.) If you know this number then you can do a simple calculation on how well your investments are doing. If your investments don’t keep up with inflation then the ‘purchasing power’ of your investment erodes. The actual rate of return, minus inflation, gives you the ‘real’ rate of return which is what you should focus on, not the bottom line.
- The difference between “Interest” (money market), “Yield” (bonds but taxed as interest), “Dividends” (from shares) and “Capital growth” (shares and property). These all grow your wealth but are very different, have different risks and are taxed differently.
- The very basics of your annual budget. Your net income, fixed expenses, investments, variable expenses (groceries, entertainment, clothes, fuel, cell phones etc) and ‘disposable income’ (what is left over.) If you ever apply for a loan or mortgage you’re going to need these numbers anyway. Disposable income should never be zero. If money burns a hole in your pocket, put it out of the way on payday, say into a call account. Living within your means and continually saving is the key to long-term wealth.
- The age at which you (realistically) want to retire. This is the line in the sand where you essentially stop investing and start drawing down on your income.
- What your annual budget will look like at retirement. Once you have your present day budget, this is easy. You take out things you won’t be doing at retirement – mortgages, school fees, debt and add back things you will – travelling more perhaps. You or your advisor will now be able to project how much you will need in investments to retire and live on your income until at least 95 or 100 years old.
- The monthly contributions you need to go into your investments to retire on your due date, at your desired income. Knowing the actual capital amount you need (above) is useful 10 years out from retirement, longer than that it is pretty meaningless, focus on eating the elephant one month at a time.
So, let’s just recap from Part 1 (which you can read HERE if you missed it). Wealth is what is left after you have consumed your income. In part one we looked at the income component. I debunked some of the myths around passive income before you think that is going to answer all your problems. I also emphasised that the working world is changing and it is not cool to be clueless, especially when it comes to technology. If you don’t keep learning and making yourself relevant, you’re going to come short. Nobody wants the money to run out before they do. You might not want to hear it, but it is the consumption component of your wealth equation where you can make the biggest difference, and most of it immediately. There is no point in scrabbling around to reduce the fees on your investments if you’re living large and beyond your means, making those few basis point saving on your investments fade into insignificance.
Most of our spending is a result of years of habits. Some of those habits, or perceptions, about money were laid in childhood. If you really want to make a difference to your wealth mind-set, you need to let go of blaming everyone else for your behaviour and own it. Sure, you might not have been set the best example in the world, your parents might not have been able to afford the best education, but as soon as you are an adult and have control over your own money it is time to stop blaming your parents or teachers and claw back that power. There are so many resources out there (including this one) that will help you do that. Irrespective of what you earn you should know, almost on a daily basis, what money is coming in, and what is going out and where. Fortunately there is an app for that. If you gave a huge sigh of frustration at that comment perhaps you need to go back to Part 1. It is not cool to be clueless, embrace technology, and not demonise it because you’re too lazy to learn. (Harsh and not politically correct I know but now, more than ever before, simple apps will save you massive amounts of time.) The app I like best for this daily money management is 22seven (free on Playstore and iStore). Why? It pulls all your transactions from all your accounts and most investments. You can then decide on your own categories and once done, all the transactions from that place (say Pick n Pay or Builders warehouse) will go into that category. You can then set the limits for each category. After a couple of weeks it is very clear where your weak points are. If you rarely look at your bank statement, then you might find long forgotten debit orders. It is those day-to-day expenses, accumulated over years that erode your wealth.
Does it have to be either/or?
In case you hadn’t noticed, there is a noisy revolution going on in the investment environment and it’s all about ‘robo advisors’ taking over from flesh-and-blood advisors (the origin of the phrase pound of flesh). As with all dastardly plans this started in the States (JK). Robo advisors are nothing more than computer programs, strings of ‘algos’ that take the information you feed them and spit out a recommendation and lods of followup reports, and very kindly, don’t charge you for it – providing you use their platform of course. Why on earth would you want to do that? Fees of course. Cutting out the middleman is the quickest way to dump a bunch of fees.The robo advisor revolution is just a small part of the rebellion against bloated advisory and investment fees – and it is coming to South Africa. Post 2008 that wunch of bankers, investment bankers, have not been popular. They were responsible for lumping hoards of bad debt into one pretty little package, getting it rated A+ and flogging it to the unsuspecting public by way of sub-prime loans. Fees that exceeded the meagre returns the market was offering stuck in the craw of the investing public and led to this revolution.
The first signs of this change was the rapid replacement of traditional Unit Trusts (called Mutual Funds in the States) by ETFs (Exchange Traded funds) and ‘trackers’. This started off with ‘retail investors’ (we, the people…) buying these directly, and they are now popping up on traditional investment platforms. If you aren’t sure what these are you can read my blogs HERE and HERE. This is ‘passive’ investing. Investment done by a cold-blooded computer, supervised by an even colder blooded asset manager. This is way less work than an asset manager doing it all by himself – an ‘active’ asset manager. Most of the costs associated with ETFs and trackers are admin, software or buy-and-sell costs. Obviously with active asset managers you have to add payments on the Ferrari and beach house in Clifton. There is also yet another layer of active asset managers who take pre-existing unit trusts (that they aren’t smart enough to make themselves) and make another unit trust (layers upon layers of fees). If you see FOF or Fund of Funds tacked onto a unit trust take a look at the fees – then run.
Having eroded the fee base of asset managers, fees paid to financial advisors was the obvious next target. To be fair, all robo advisors did was take the same information that inexperienced or lazy financial advisors used to stick into a computer program to churn out your investment recommendation without another thought and turned it into a DIY model. The catch is that if you want to use the robo-advisor you usually have to invest on the robo-advisor platform – and those are usually traditional unit trusts and feeding those ‘active’ fees to asset managers (but, to be fair, as economies of scale kick in those fees are also coming down.)
The good, the bad and the ugly
Group benefits – including pension and provident funds – are often ignored, even by financial advisors when coming up with a financial plan. This may be due to the fact that the average employee doesn’t actually understand what they have and what they can and can’t do with it. For the majority of South Africans, this is the only retirement savings or life cover they have and it is a crying shame that isn’t respected more. I have recently had the opportunity of uncovering some nasty excessive fee-taking in a group retirement fund that had been going on since 1998, and allowed to continue despite being transferred to a very large employee benefit specialist company (with an ‘ag sorry, but we’re too big to care’ or words to that effect).
Part of the problem is that fees in group retirement funds are not capped ( because they aren’t called ‘commission – remember that next time you moan about commission which is regulated), and are ‘acceptable’ as long as they are disclosed. That is all very well put it out there in black and white on a benefit statement, but when the employee is completely oblivious as to what an ‘acceptable’ fee is and the employee benefit consultant is too big to care, then this practice carries on unabated.