The road to success

Smart Investor, November 2011

A short while ago, we received a letter from a reader. “I would like to ask if Smart Investor can explore the financial road map for investors,” the reader said. He asked if we could tell readers how to develop their own financial roadmap, “and get their financial house in order and then keep it that way.”

It’s an intriguing idea: how do you prepare your finances for the many watershed moments of your life? So we set out to do it. But just remember: if you’re going to get any good use out of a map, you need to know what destination you’re trying to reach with it.

To see this article as it ran, click here: financial roadmap 1 financial roadmap 2 financial roadmap 3

“Your requirements do change,” notes Sergio Arcaini, a financial planner at Chiltern Peak, part of Genesys Wealth, in Kew, Victoria. “While the regulator can keep talking about risk and return, I think the focus of people should be to create a budget and try to stick to it. Once you have done that, you can work out what your goals are and what you would like to achieve in life. One problem we have as an industry today is we don’t teach clients to set goals and stick to them.”

“Anything you lie awake at dreaming about, anything you want so badly you can taste it, you can find ways of making it happen if you are prepared to make the sacrifices to achieve that goal,” he says. A practical example: “It is much more important to say I would like to get a Porsche than to say I would like to have $250,000,” says Arcaini. “If you are dreaming about a Porsche, it becomes a powerful motivating factor. If it’s just a figure, it doesn’t have the same power.”

Goals can be anything: the property on the beach. A family; or education for that family. Early retirement. A part-time existence for much of your life. A return to study. Or simply breaking even and providing as best you can for your dependents. But it’s only with the goals in place that you can build a roadmap towards them. With that done, here are some typical life stages and the issues they tend to raise.

GETTING STARTED

The first big life stage for most of us in financial terms is leaving home, starting work, and just trying to make some progress.

The priority of many young people, having bought their first home, is to pay down the mortgage as much as possible, and there’s nothing wrong with that: after all, home loan debt is not deductable. Planners recognize that saving at this age is more easily said than done, but they recommend if there are any surpluses, they be put aside in a savings or investment plan.

Many Australians, when they first do begin to accumulate money, opt for the tried-and-tested route of an investment property. That has pros and cons: on the plus side, if everything goes in your favour, it’s a great way of growing your assets over the long fun, as a tenant pays down your mortgage, your equity increases, and hopefully the property itself increases in value. On the downside, there’s a big up-front cost, and issues around what happens if it is not tenanted: can you still pay the mortgage?

It’s a big ask to try to get very young people to put money into super, though planners do suggest salary sacrifice where appropriate to build for the future; the earlier you put money in, the greater the power of compounding returns over time. Others recognize that there are likely to be short-term requirements to liquidate investments when young, for a first house or to upgrade to a bigger one, and therefore suggest managed funds or exchange-traded funds.

Since this age bracket is largely about accumulation of assets from a low base, some recommend borrowing to invest, but remember this is a double edged sword: leverage increases rewards when things go well, and losses when they go badly. Borrowing to invest has a tax benefit, but that should never be the main reason you do it.

Another important component of this bit of the roadmap is insurance: particularly income protection. If your greatest asset is your ability to earn income, then that’s worth protecting.

THE KIDS

Let’s be honest: you didn’t have kids to improve your wealth. For at least a couple of decades they are a strictly one-way street when it comes to cashflow.

When kids come along they present both a need for long-term saving and a barrier against doing exactly that, particularly if you’re paying Sydney or Melbourne childcare rates. If you’re in state schools, they become considerably cheaper once they’ve started primary school.

Saving for the kids depends on what you proposed to do for them. If you want to put them through private education, and have a rough idea where you will do so, then you can look ahead to the likely costs and build a savings plan to be ready when the time comes. Likewise if you want to pay Uni fees rather than the kids paying them back from HECS, then that can be planned and saved for, as can the living expenses for that time if they won’t be living at home.

Some families, such as in one of our case studies, help their kids by buying investment properties and allowing their children to live in them with subsidized or no rent while they find their feet. This isn’t an option for everyone; it means another mortgage without income coming in to service it. But it does mean an investment in an asset which will hopefully enjoy capital growth.

SELLING A BUSINESS

Another of our case studies revolves around this: selling out after 20 years of hard work and pondering what to do with the income, and indeed the next 20 years.

Andrew Buchan of HLB Mann Judd in Brisbane, the financial advisor for Martin Meek in our case study, notes that people who have built a business can have different needs and priorities. “Martin’s wealth is his ability in business,” Buchan says. “It doesn’t matter if I could get him a 5% or 10% return on an investment. His real ability is his business nouse.” Buchan believes this applies equally to, say, a sports star with a brand name: wealth management for people like this is not just about the split between equity, bonds and property, but encouraging an individual’s attributes and their assets as a person.

People like this are natural candidates for self-managed super funds, so that they can match their expertise and enthusiasms with self-directed investments.  Buchan says for an entrepreneur figure there are three phases. “Phase one was the wealth protection prior to building the business. Phase two is wealth generation during the business. Phase three is the business sale and the investment of the proceeds for income and growth.” Involving an accountant on the tax side is crucial.

APPROACHING RETIREMENT

One of the biggest moments in all of our lives is retirement, and this of course is where your financial roadmap has been aiming. But fewer and fewer of us suddenly shift from full-time to retirement one day; we’re more likely to reduce hours, do part-time work for a few years, and potentially continue to do a bit of work while drawing on super for many more years.

Either way, when the day approaches, transition to retirement rules become important. Once you reach preservation age, between 55 and 60 depending on when you were born, you can reduce your working hours and top up whatever income you get from your part-time job with an income stream from your super. Planners generally urge people in this age bracket to get as much money into the most tax-effective vehicle possible (super), then into an account-based pension. Minimising tax is naturally a crucial consideration now: having spent your whole life building wealth there’s no sense in giving any more than necessary to the taxman. Again, salary sacrifice can make a lot of sense at this age.

If they haven’t done it already, people in this group should make sure their estate planning, wills and insurance arrangements are in order. Who is the beneficiary on your super, for example?

It’s also common for people approaching retirement to reduce their risk profile: a bit less in equities, a bit more in bonds, for example. Not everyone agrees with this capital preservation approach; some feel that this is the time to increase wealth to the greatest degree before retirement.

CASE STUDY: Rob and Jan Burdon

Rob and Jan Burdon are retired now, living comfortably in Port Macquarie. They’re smart people who have always known the importance of putting money to one side. “We were always conscious that you need to try and save something somewhere,” says Jan. But like all of us, their financial roadmap has had to change over the years according to the events that take place in our lives along the way.

Rob worked for Qantas in Sydney for 26 years; during that time, financial planning was fairly straightforward. Qantas at that time had a good superannuation scheme, and allowed its employees to make the best of it. “Sometimes if he got a small raise, instead of taking it into the pay packet, he would put it into super,” Jan says. “In those days we didn’t have all the fringe benefits you have now: if you stopped work to have children you didn’t get assistance, or Centrelink; you had to save for it,” she says. Jan stepped out of the workforce for some time, not returning until the youngest of her three children was 14, but even so they put money aside where they could.

So far so good. But then change started to come to Qantas and the airline offered voluntary packages for redundancy; Rob opted to take one, and to retire. It’s one of those pivotal moments that changes the way your life will go, and the way your finances will evolve, and this was when Jan and Rob first took financial advice. “My husband’s question was, if I take this early retirement, do I have to go back to work or live on what I’ve got?” Jan recalls. “They [the planners] said yes, you can live on what you have. So he stayed at home for maybe a year – I was working and earning good money – but then Ansett came looking for him and he worked for them, and then the NRMA. It was a matter of something to do.”

Along the way in Sydney they had saved enough outside of super to buy two investment properties, sometimes allowing their three daughters to live in them and subsidising the rent as they got their own lives underway. This, too, is a life stage that changes the family economics for many of us: kids finishing education, leaving home, but perhaps needing help to get started in an entry-level job in an expensive city.

The next big change came with semi-retirement, when the two moved to Port Macquarie. They sold the Sydney properties in 2000 – “I wasn’t comfortable with having property there and not being able to keep an eye on it,” Jan says – and bought an investment property on the coast. They did some casual work for a time, but options were limited and they decided to retire completely. They sold the investment property, turned the money over to their new financial advisor, Port Macquarie-based Julie Berry, bought a caravan, and hit the road. “We travel four or five months a year with the van,” Jan says.

They have now both reached the age where they can access their superannuation (Jan is 69, Rob 67). They place a lot of trust in their financial advisor. “She changes things for us as she thinks is necessary, and notifies us,” Jan says.

Life is pretty good for Jan and Rob: two of their three daughters and their families are now also in Port Macquarie, and the third on Queensland’s Sunshine Coast. “I think we’ll be all right,” Jan says. “I don’t think we would go for a holiday on the Queen Mary, but being able to have time away in the caravan, and knowing we’ve been able to help our children along the way, we’re reasonably comfortable.”

So what’s the secret of navigating the different things that life throws at you? “Start saving when you’re young,” Jan says. “It doesn’t matter if it’s only a couple of dollars a week set aside: it’s growing and compounding if you put it somewhere.” And encouragingly, she thinks she’s passed some of this onto the next generation too. “Our eldest daughter has wiped the floor with us with what she’s saved.”

CASE STUDY: MARTIN MEEK

Martin Meek is an example of an entrepreneur with a clear goal. Like many successful businessmen, he got his big break from an unexpected route.

A teacher at first, Meek’s wife’s family was in retail. One day over dinner he disagreed with his father-in-law about plans for a new store. “Do you think you could do better?” the older man asked. “Yes I could,” said Meek. He redesigned the store, then gave up teaching to build it, and finally ended up running it.

Two years on, Meek reached the next life-changing moment. Looking at having children, he looked at his financial prospects and decided he wanted to buy in to the business. “I didn’t have any money,” he says. “But I had a house. So I sold it and bought in. That was 20 years ago.”

It was a bold move not all of us would make, but that’s entrepreneurs for you; and it worked. Along the way Meek and his father-in-law shifted from a previous model – build a health food store and sell it – to a franchising model in which buyers could use the name. This became Flannerys Natural Grocers, which thrived for two decades and was sold in 2008.

This, of course, was the next pivotal life moment: the windfall from a working lifetime’s effort. But Meek was still young; even today he has only just turned 46. So he had to decide on the next step. He had signed a non-compete clause, so retained two stores and ran those as a franchisee until the clause ran out two years later, and then sold the stores. Now, he’s setting up a new organic commodities import-export business. “I’m moving up the food chain, supplying to the people I used to be competing with,” he says. Noting his risk profile has diminished as he has got older, the new business is structured to have low costs. “The upside is good, but if things don’t work out I can fire sale the stock and walk away having dropped 10 or 20 grand and a bit of time,” he says. “As I get older, I look more at the possibility of: what if it goes wrong. When you’re young you think you’re indestructible. You don’t have that fear. Now I’m older, I’ve got more to lose; I don’t want to have to start again at 46.”

Meek is a canny operator and has appointed advisors who understand that his main asset in building wealth is his own skill as an entrepreneur. (Andrew Buchan, his financial planner, is quoted in the main text). They haven’t tried to push him towards a traditional portfolio model, but have accepted his expertise and enthusiasms and worked around them. Unsurprisingly for a man who has built and run stores all his life, Meek has a familiarity with property, and that represents the main pool of his assets today: he has two warehouses on the Gold Coast (“No-nonsense, easy, give a good return for a low amount of outlay”) and a residential property in Brisbane that is a double block development zoned for townhouses.

It should be no surprise to learn that Meek has a self-managed super fund; the vehicle was invented for people like him. “I enjoy research,” he says. “I’m a little bit of a control freak.” He’s built it to produce income. He holds quite a large sum in shares, having been quite lucky with the circumstances of his pay-out in 2008; it took him 12 months to get the money from his business sale, which was irritating at the time, but in fact saved him from investing into the share market immediately before the financial crisis.

Having reached one key life stage moment with the sale of the business and readied himself for the next, Meek and his advisor sat down and came up with a number. They worked out how much money he wanted to have, per day, upon retirement, and then worked back to establish what that total figure needed to be. It was a big number. “It was a scary thought. But a good scary thought to have,” he says. “It made me more proactive on: this is what I need. When looking at things and making decisions, I ask: does this get me closer or further away from that number? It really simplifies things. I would encourage people to have a number.”