Over time overgrown plants and dead wood will accumulate in your garden, and if ignored can kill off everything around it. It doesn’t matter how carefully things were planned at the start unless that plan is revisited and maintained, you can end up with a weed filled jungle that is almost impossible to get back into shape. Spring cleaning is not about throwing everything out, it’s about pruning, splitting, composting so that it will look better in the future. So… Using this botanical analogy, what can you do about your wealth portfolio?
Pruning: This is the cutting back of plants so that you get a better flush in the next year. Just like you should prune roses and fruit trees every year, so should your wealth portfolio be examined and trimmed every year to maximise its potential. Wealth is what is left when you have consumed your income – the simple Wealth Equation. The Consumption side of the Wealth Equation is where you need to prune. Use your banking software or a free app like 22seven to see where you need to prune. Everyone is going to be different so it is difficult for me to say what is important or not. If you’re not sure, list all your expenses for a month then put a priority rating of 1 to 5 next to them, the order that you’d drop them if you absolutely had to, with 1 being the most important. Put everything there including your mortgage, car payment, medical aid. Some people would rather eat baked beans for a month than drop their DSTV subscription for example.
Pinching out. This is the mini-pruning of shoots so that the plant will bush out and produce many more flowers or fruit – increasing your ‘harvest’. Fuchsias are an excellent example of this. Pinching out effectively delays the flowering or fruiting of the plant – delayed gratification for the greater good. Take a topiary for example, getting a pleasing shape depends on knowing what you want it to eventually look like (an objective), and having the patience to keep controlling it until you get there. If you want to increase your harvest you need to have as many points of diversity as possible, so that if one branch dies, the other branches can pick up the slack. All portfolios should have an objective : What are you going to use the investment for and when? This timeline will dictate how you should treat the investment, and how important it is to preserve the capital. Probably the biggest capital accumulation you’re going to need to make is for your retirement, but how big this pot needs to be will depend on what you want your retirement to look like (in present value terms). This calculation is far too important to ‘wing it’, get professional help.
Compost and Fertilise: Over the year plants deplete nutrients out of the soil to produce leaves, flowers and fruit, if you want them to keep on producing you need to compost and fertilise. Your wealth portfolio is no different. You can compost it ‘organically’ with interest and dividends that are ploughed back into the portfolio – or inorganically by adding to the portfolio with new, man-made (you-made) contributions. Most of you probably already contribute to some sort of investment every month, but what do you do with your bonuses? Why not commit to putting 50% of that bonus into investment. You could also do this with other little windfalls like Insure cash payments or other loyalty program paybacks. The free app Stash# will also make it easy for you to get that money out of your pocket before it burns a hole.
The wealth equation part 1 : Income
Is it possible to boil the secret of wealth down to a simple formula? I think it is not only possible, it is necessary. It is so easy to over-think wealth. Our relationship with money is extremely complex. We unwittingly give it different meaning and power way beyond its value. There is no other ‘concept’, with the exception perhaps of religion, that can stir up so much passion in a person that they are willing to kill for it.
We all know of people who will throw every single value they have ever held out of the window in the pursuit of the almighty buck. To be more exact, in pursuit of more income. But that is wealth isn’t it? Nope. Wealth is what is left after you have consumed your income. Even an ecosystem can be boiled down to some very basic elements so that they can be understood better. Inputs minus outputs equals growth. In an ecosystem the Inputs are numerous; sun, water, elements, oxygen, carbon dioxide, soil, food. Outputs include energy, pests, elements, oxygen, carbon dioxide, harvest, offspring and consumption – to name a few. The growth is the increase, of the plant, the animal, the population. If the outgoing is more than the incoming there is no growth. For dinosaurs (and millions of other species) they become extinct.
The equation is simple. Income minus consumption equals wealth. That means there are 3 components of your financial life you can tweak to grow your wealth. You can increase your income, decrease your consumption and manage your wealth.
Emotion and wealth – a lethal mix?
Avarice: Coveting something is a very familiar behaviour, but is often disguised and whitewashed to be almost acceptable. It can be disguised as ambition, determination, desire or drive. Kept in check, these emotions can drive us to be better, do better, innovate and create. When out of control it will eat into your consumption and lead to the collection of ‘stuff’. Steering avarice into the ‘collection’ of true assets – rental property, investments, stocks, even gold – is the doorway to long term wealth. If you want some independant help with this, consider some financial coaching. Have a look HERE.
Envy: Keeping up with the Jones. Consuming your income without any concern for simultaneously building your wealth. It is so easy to fool yourself, call something an ‘asset’ when it isn’t. Your home, your holiday house, your cars and toys. Envy usually masks an underlying need to be recognised, a lack of self-esteem. Unwinding this behaviour alone would have a huge impact on your wealth.
Wrath: When you see red, your vision becomes very cloudy and decisions made in anger one will inevitably repent at our, much poorer, leisure. There is nothing like losing money unexpectedly – whether in reality or merely ‘on paper’ to get the blood boiling, and a great way to dissipate that is to blame someone else. The best way to stop this emotion impacting our wealth, and relationships with your advisors is with knowledge. I don’t respond well to anger, and one of the main reasons I blog so extensively is so that my clients don’t get nasty surprises or have unrealistic expectations.
Take an aspirin and call me in the morning
Doctors are under constant pressure to give a patient a quick fix – “Prescribe me something that will make this go away – quickly.” Rather than spending a few months uncovering a psychological problem, they can, and would much rather, take a pill to make the ‘pain go away’. We live in a world where instant gratification is available for almost everything – If only investing had a quick fix. One of the reasons so many investments go pear-shaped is because there are people constantly seek that quick fix. They follow every investment tip they hear round the braai, give day trading a bash, throw money at charlatans promising above average returns, fire advisors who don’t give spectacular returns and pile into over-heated stockmarkets.
FOMO – Fear of Missing out. They hear how much money their friends are neighbours are making (usually BS) and pile into markets when smart investors are cashing-in their profits and protecting their capital. Unfortunately psychology and investment are inextricably linked. If you mix emotion and investing you are going to get hurt. If your advisor plays no other role than ‘saving you from yourself’ then leaving unemotional investment decisions up to her will save you thousands. Financial advisors may not be able to take their own advice (a common problem across all professions) but when it comes to their clients they are able to inject their objectivity. It is this same objectivity you get from a doctor that saves you from yourself when you try and DIY your medical symptoms (and end up with a diagnosis of a brain tumour instead of a hangover).
Pay the bond off first?
Everyone’s ‘relationship’ with money and debt is different, and it also evolves over time. At the beginning of our working lives we are likely to have been influenced by our parent’s money values, either behave in tune with it, or diametrically opposite. Few of us have the means when younger to be able to afford a house or car without financial assistance, so this is often the first debt we take on. Whether we get store cards or credit cards, and whether or not we pay them off in full at the end of the month, or rollover the minimum is probably one of the first financial behavioural cross-roads we come across. I have never been a fan of the ‘slippery slope’ philosophy, but there is no doubt that it exists – it just that most of think we are too smart to fall into that trap. Starting to accumulate debt for everyday expenses – rather than for major assets – is often the start of that slippery slope that far too often leads to a slew of maxed out credit cards with very little investing taking place.
Bonds are usually the biggest debt, and the one people are most concerned about paying off first. I often come across clients that want to use provident/pension on changing jobs to pay off bonds, so let’s look at it objectively:
The interest rate on your bond is probably around 9.5%. This debt is ‘cheap’. You might have been able to get a low interest rate from your car finance (they need to move their stock, not have it on the show-room floor so when demand is low, they ‘subsidise’ the interest rate.) Do you know the interest rates on your credit cards ? (Most of them now have it both on your online profile and on the statement). It is likely to be between 18-28%! Short-term loans are probably also in this range. So-called ‘payday’ loan’s effective interest rates are horrific – 600-1000% per annum plus all sorts of admin and late fees. Should you be ‘investing’ in your credit card or in something that is actually going to be an asset
As soon as the interest rate you’re paying on your debt goes over 10 – 12%, your investment is unlikely to do better, so paying off that debt makes the most sense. Store cards that have no-interest for 6 months might seem like a cheap alternative that will ‘save’ you interest, but it is unnecessary debt for day-to-day non-essential expenses. Theoretically, if you shop at a store that has ‘free’ credit you should be able to get a 5% discount for cash – ask for it. You won’t get any discount for paying with a credit or debit card – the retailer pays a fee for that transaction.
There is a very simple step-by-step strategy when it comes to taking back control of your debt, and diverting those funds into your wealth building instead:
A little bit of knowledge is dangerous
If you’ve been following my blogs, you will know that I am passionate about helping to educate my clients and making some of the more complicated issues around personal finance – from medical aids and life cover to investment and retirement – easy to understand. More than 100 blogs later, I feel that I haven’t even scratched the surface. Not only is it a massive field, but it changes all the time. I will admit that this ‘crusade’ to make the financial services industry easier to understand is as much in my interest as it is my clients, and potential clients. Knowledge isn’t just power – it saves time, increases trust, protects my reputation and reduces stress.
However… I don’t always win, and as hard as a try, irrespective of the number of different ways I try to explain a concept, not everyone understands – and all that happens is that confidence is increased without an increase in ability. That is way more dangerous. That is when stupid decisions are made, and sometimes those mistakes can’t be undone. Fortunately I am not the only one battling with this problem, a very interesting paper has been written on just this issue: Against Financial Literacy Education, Lauren E. Willis, Loyola Law School Los Angeles. HERE.
I wouldn’t go as far as to say that financial literacy education shouldn’t happen, but advisors need to be able to identify clients that are ‘unconsciously incompetent’ (to steal a phrase from Covey) AND have added ‘confidently’ to that descriptor. If that client can’t be moved to ‘consciously incompetent’ – in other words they know what they don’t know – and quickly, my recommendation is to ‘let them go’. A client that is making ill-considered decisions will impact on your reputation. The financial advisor is going to be blamed for the decision, no matter how effectively they try to ‘cover their ass’ with records of advice. Reputation takes years and years to build, and can be destroyed in one day flat, even if the accusations are bogus. It just isn’t worth it.