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The 5 Pillars of Personal Finance
Are you using tomorrow’s money today? What happens when tomorrow comes along? Are you spending more than you earn? What if your income stops? If you are spending money today that was meant for tomorrow, then you have a problem. You will at some stage need to catch up. Are you getting the right information?
- Basic money management concepts
- Cover against Risk
- Build your retirement nest egg
- Build Wealth
- Get advice
1. Basic money management concepts
It might be easy to assume that people are just born with a wealth mindset. Yet on reading the self-help money management books, listening to the personal finance gurus, you get to realise that habits are the best predictor to wealth and prosperity. Often, small behaviours, repeated often, are enough to build up or tear down our stated aims.
By way of example: Buying the Rolls Royce products instead of the cheaper Toyota, that still serves the same function but will cost you five times the price. I use that example because it is highly recognisable, but the same could be said for the tin of beans (Heinz or store brand), milk (Mainland or store brand). Saving a couple of dollars on your supermarket each week, might seem trivial, but those positive behaviours stack on top of each other. This is taking a longer term view of your finances. Time and money can be for you or against you.
What do you want, really? Have you thought about your financial goals? I don’t mean your dreams, but the life you are looking to have for your future self, for your future family. How does that look? Are you working towards that, or are you actively walking away from it through the choices you are making today?
One of the simplest things that you can do, to start getting ahead, is to spend less than you earn. Simple maybe, but not always easy. I say this, and I know there will be some who read this and think I am stating the bleedin’ obvious, and I am. Yet look at the increasing household debt level that we have, not just mortgages, but credit cards, store cards and the like. Let’s not forget the latest money trap for people, buy-now-pay-later. You are using tomorrow’s money today. What happens when tomorrow comes along? Find a way to spend less than you earn. This is the bedrock of changing your money situation.
I am a squirrel with money. I have it in different accounts in different banks and institutions. I do this for two reasons. 1) so that each account has a purpose and 2) so that I don’t have a false sense of financial security. Let me explain. I have an account for debt payments, for everyday expenses, for enjoyable fun money and lastly for long term goals. I also have an emergency fund that I contribute to regularly. Each account has a purpose and cannot be used for a different purpose. The false financial security might come from thinking that I have more available to use right now than I really do. And surprisingly, because I know I have the basics covered, I get more financial security. That really helps my mental health and stamina about any money worries that could build up.
The last nugget in this section is compound interest. Understand that using tomorrow’s money today comes with a cost. That cost is interest. Understand the magic and pain of compound interest is essential for you to think about the future value of money and, more importantly, how it can help or hinder your financial goals. The savings that you get from money in the bank is using compound interest. The extra amounts that you get charged for credit cards, is tied to compound interest. It can work for you (with investments, KiwiSaver and savings), or work against you (with mortgages, credit cards and pay-day loans).
2. Cover against Risk
Personal insurance is the foundation of personal wealth creation – in my opinion. Let’s work backwards for a moment. In retirement, there is a certain amount of money that would satisfy your needs. What ever that amounts is, there is a number that you will need to live comfortably.
For you to get to that number, you need to be working throughout your live, saving and investing as you go, over a period of 20, 30 or 40+ years.
What happens if you cannot work for one or two years because of accident or injury? In all likelihood, you will draw on the money that you have been saving for retirement. Meaning that you have far less for retirement. You now must work harder and faster to make up the significant shortfall, the money you’ve just spent on your recovery.
This is why people use personal insurance as part of their financial risk protection planning. Disability insurance (or the other insurance products) work to stop you haemorrhaging money, by paying to keep your financial life moving forward. It is a key part of their wealth creation plan, and it should be yours too.
The Bolster House, pictured below; insurance is the foundation, the walls are your income, your retirement sits on top as the roof. If the income stops the rest falls down. Your debts don’t get paid, the rent doesn’t get paid. You can’t feed the family, any savings are used, any investment properties are sold… which means that retirement plans are even harder to get to. The insurance protects your income, which in turn protects your retirement plans.
If you are spending money today that was meant for tomorrow, then you have a problem. You will at some stage need to catch up. Personal insurance solves this.
3. Build your retirement nest egg
In New Zealand, this is quite easy with KiwiSaver. Essentially it is forced savings that are ring-fenced until retirement. This is the point. You are not meant to be able to access it, unless you are investing in your own home.
The minimum 3% contribution from you is probably not enough though. But it is a start. It all depends on where you start, how old you are and how much you have in KiwiSaver. Remember compound interest will work for you (or against you) given enough time. The more you tip into KiwiSaver, the greater your chances of having a better fund to use in retirement.
Remember too, that it is a long-term investment. Markets, and therefore your KiwiSaver balance, will go up and down. That is part and parcel of investing. Become emotionally dull towards your KiwiSaver balance. Let time and compound interest do their job, on your behalf.
4. Build Wealth
This section might not be for everyone, but if you have placed the previous blocks in place, then this becomes a logical next step. You might build wealth to pass it along to your children, or to leave for a charity or cause that you believe in. It might just be to allow you to retire earlier than your initial retirement plan had allowed. Maybe retiring early will allow you to spend your time helping other organisations that are dear to your personal values.
Understand that the time frames for investing are different from retirement investing. Knowing what you are building and investing for is crucial. Partly because it allows you to exit the investment once your goal has been achieved (or to know when to exit because the investment has turned bad).
The typical Kiwi investment is property. This is the tradition. That still holds great psychological power for a great many New Zealanders. But this has turned now, with a whole generation of people locked out of the property market due to the ongoing sky-high valuations. That said, there is also a new wave of low-cost entry platforms like Sharesies or HatchInvest where people can start investing with small amounts, learn and make mistakes, without losing fortunes. The caveat here is the same as elsewhere in this article. Do your research and take the time to learn. You don’t need to know everything to become smarter with money. Small steps repeated often will see you succeed more readily than taking “big bets on sure wins”.
5. Get Advice
Success is not built by individuals, there is always a support crew. Don’t wait to get advice for when you are a multi-millionaire. Get different types of advice for different parts of your personal finance journey.
It may be from your accountant, or from the online platforms (Spring.kiwi and Sorted.org) that provide financial education and learning support. Advice might be direct and specific to your circumstances, or general and informative. We provide a range of tools to help people, and you don’t need to be a client to use them. We also offer specific client advise. Find out more here. Understand that there is a difference between the two. Don’t be afraid to ask for help.
The finance industry in New Zealand has just gone through a major shake-up. In most cases we are more heavily regulated than your accountant or lawyer. There are certain things that we need to do, to make sure that we give you the best advice for your situation. If you are unsure of the types of advice, or what is on offer, perhaps start here, the Financial Services Council NZ.
Personal money management can sound daunting and difficult. It shouldn’t be. Take small bite-sized steps to improve your situation. Given enough time and effort, it can be staggering what you are able to achieve.
<My Disclosure statement can be found here>
Dominic started Bolster Risk Management to help people along their personal finance journey.
He believes that personal insurance is the bedrock to financial security and wealth creation. You have to protect your greatest asset, your ability to earn an income.
Underpinning this is a philosophy that says Your Money Matters.