Pass or fail? Your financial health check

30 Jan 2015

By Andrew Pidgeon

​When was the last time you reviewed your financial position and asked yourself whether the plans you have in place are still appropriate given your current circumstances, or is there more you could be doing to get you where you want to be?

What's your strategy?

Too often people simply meander along with their finances, without any clear direction.  Most people with busy lives do not have the time to review their finances as often as they would like, which can result in missed opportunities or worse, costly mistakes.

As they say, failing to plan is akin to planning to fail, and this certainly applies to the household finances.

Developing an appropriate strategy always starts with goal setting, where some realistic and attainable goals are articulated, preferably over the short, medium and long term.  These may include:

  • Short-term - Taking the family on an overseas holiday in the next twelve months
  • Medium-term - Funding the kids (or grandkids) education starting in four years time; and
  • Long-term - Retiring on $80,000 per annum at age 65

Once you've set some goals, the next step is to carefully analyse your cash flow to determine how to allocate the surplus to achieve your targets.  Clearly your goals will need to be reassessed where a deficit exists!

The allocation of surplus cash flow requires some careful planning to achieve the best outcome from a tax, access to capital and risk/return perspective.  This step usually requires some professional input to ensure you achieve the optimum outcome - especially given the complex legal framework that exists around tax and superannuation law.
When examining cash flow, the analysis is only as good as the data that is used.  In most cases household income is fairly predictable and fixed, whereas expenses can vary considerably from period to period so there is a lot more 'grey areas' in trying to determine the outgoings in a family budget.

Maintaining a family budget

Do you maintain a budget? Having a clear understanding of where your money is spent is critical in formulating a meaningful financial plan and is often the step that is missed by most people.  Whilst preparing a budget is not the most exciting way to spend an evening, it can shine a light on some expenses that can be cut back or eliminated altogether.

If you don't know where to start, there are many apps and guides available online that can prompt you on the common household costs.  With internet banking it's also easy to download three months of data from your bank statement and then break down costs for example utilities, household bills, food, health care, etc

Are you adequately protected?

You can have the best laid plans in place, but without carefully structured risk strategies in place an unforeseen event can derail your family's future.  People commonly insure their house and car but forget to insure their most important asset, their ability to earn an income.  Unfortunately there are too many stories of people being underinsured and families' lives being turned upside down by health events which eliminated the major income source to the family.

Are investments appropriately placed?

Time poor individuals might have a strong cash flow position, a vague understanding of their goals, some protection in place and a rough budget scribbled down, but the 'plan' can fail once they start to invest their surplus cash flow.  Common traps include chasing the latest 'fad' on the market, or taking advice from a friend at a barbeque who forgets to tell about his string of losses as he tells you about the one win he has had on a speculative stock.

Drilling down to the core issues, at the heart of any investment strategy, should be a carefully thought out risk profile that allows you to sleep at night.  This risk profile will then translate into an asset allocation, and from here specific assets can be chosen to match to your risk profile.

There are plenty of studies that show asset allocation has a bigger influence on returns than individual asset selection.  This flies in the face of common practice where most people spend the majority of their time picking stocks and chasing term deposit rates without thinking about how the asset they are about to invest in fits in with their overall plan.

There are some sophisticated risk profiling tools available which can take some of the guess work out of the process. This avoids portfolios evolving in a piece meal way, that can often lead to over exposure to a particular asset class or industry sector, which is the most common way people lose capital during a downturn.

Bringing it all together

Put simply, the more time and effort put into your personal finances the better the outcomes are likely to be.  It often helps to treat the household finances in a way a Chief Financial Officer (CFO) runs a company; set goals and targets, maintain a budget, monitor cash flows and assess results.  Just like a CFO, it also pays to engage professionals along the way for expert guidance and to ensure you are not missing out on opportunities that may be available to you.

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