We tend to look at the external manifestations of wealth rather than whether we’ve got a solid foundation on which to build. But come hard times, these can disappear in a heartbeat. What’s holding up our “walls”?
When you walk into a beautiful home you immediately focus on what you can see – the curtains, the colour of the walls, the garden, the finishes in the bathroom and kitchen.
Yet if you want to buy that home, what really matters is the quality of the building. How strong are the foundations – will they stand up to a flood or earth movement? The colour of the walls are important aesthetically, but can be easily changed so what is important is the strength of those walls – have they used quality bricks that will stand the test of time? The architecturally designed roof may have a real “wow” factor but does it have leaks?
The same applies to our personal finances – people tend to look at the physical trappings of wealth around us to determine our financial security, rather than the wealth they cannot see. Our house, car and lifestyle are really just our furnishings, but without a solid foundation those furnishing are meaningless and can be wiped out overnight.
5 steps to building a solid financial plan
1. The foundation
A home starts with a foundation. A strong foundation protects the house and forms a platform on which to build. The foundation also protects us against those unexpected events such as a flood or earth tremor.
You need the following financial foundation:
- Sound money habits: Write down a planned budget and then track your money each month so you have an understanding of what it is you are spending your money on.
- Eliminate short-term debt: Debt, like rising damp, undermines the foundation of any financial plan. Before you can build wealth you have to eliminate debt so that you can earn interest rather than pay it.
- Emergency fund: An emergency fund prevents us from going back into debt or having to draw down on our wealth creating assets. Start with enough to cover basic emergencies and then aim to build to three months’ worth of expenses.
- Protection: We need to protect our biggest asset, our future income and to cover any liabilities such as our home loan. Risk cover is an important foundation of any financial plan.
2. The walls
The next step is to build our walls – these walls must surround and protect us well into our golden years and therefore represent our retirement savings. We need to make sure that we have sufficient bricks to build those walls so we must put enough money away each month. We also need to ensure that the bricks and mortar we use are of a good quality just as our retirement money should be invested with care in reputable investments.
Solid retirement strategy:
- Commit from the first pay cheque: The earlier you start putting money away for retirement the less money you have to save, thanks to the power of compounding growth.
- Maximise your tax breaks: You can invest up to 27.5% of your income in a retirement fund without paying tax. Depending on your tax rate, it’s like receiving 1.6 bricks for the price of one brick bought with after tax money.
- Invest for the long-term: Like your bricks, your retirement money has to last you a long time and the only way for your investments to keep ahead of inflation is to invest in growth assets such as equities and property.
3. The roof
Once we have a solid foundation and have prepared for the future it is time to place a roof on our home. This roof represents our discretionary savings – saving towards our children’s education, a deposit on a property or building an investment portfolio. The type of roof we build will be based on our own goals and dreams, but we still need to ensure that we are financially prepared for those further liabilities such as our children’s education, otherwise like a leak in a roof, they will start to damage the rest of our financial plan.
A sound investment strategy:
- Prepare: Plan for those future expenses and calculate how much you need to be putting away each month. By the time a child born today reaches university, you can expect to pay R1.2 million a year in fees.
- Time horizons: Make sure your investment plan matches your time horizons. If you are saving for your child’s school fees for next year, you need to stick to cash-like investments. If you are saving for your child’s tertiary education in 10 years’ time, you need to be investing for growth.
4. Maintenance
The value of a home can only be maintained if you take care of it. You may also find over time that you need to renovate or extend your home to adapt to your changing needs.
Maintain your finances:
- Meet with your financial adviser at least once a year to review and adapt your plan.
- Update your policies as your life circumstances change.
- Update your will when there are major life events.
5. The interior
It is only once we have spent the time and money on making sure we have a solid structure that we look at those finishings. These would be the luxuries which represent our lifestyle aspirations be it a new car, an overseas holiday or a pair of designer shoes. |
