Escaping financial hell

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CLIMBING THE STAIRWAY: Financial adviser Liz Koh suggests eight steps to escaping financial hell.

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Living from payday to payday is not ideal. Financial adviser Liz Koh suggests eight steps to freedom. 

What most Kiwis aspire to is having a comfortable life free of financial stress.

That doesn't mean they necessarily want to be millionaires; it just means they want to be able to spend money on things that give them an enjoyable life without having to worry about where the money is going to come from.

If you feel trapped by your financial situation, buying a weekly lottery ticket is not the only chance you have to break free. There are eight simple steps that will help take you on your way to financial freedom.

1. Spend less than you earn. It's a simple concept and yet the most difficult to implement. The ability to spend less than you earn is the one thing that separates wealth creators from those who stay trapped in the cycle of living from payday to payday.

If you are not able to save, you need to either reduce your spending or increase your income (or do a bit of both). This requires effort, discipline and motivation, so it helps to have very clear goals. Decide how much you want to save each payday to achieve your goals, and then set a budget that will enable you to do that. The easiest expenses to cut back on are discretionary items such as entertainment, gifts, and other non-essentials. Once you have started spending less than you earn, there is an order of priority (Steps 2-8) for how you should use your savings.

2. Join a subsidised superannuation scheme. One of the best returns you will ever get on your money is to invest in KiwiSaver. By contributing 4 per cent of your pay, you will be eligible for a $1000 Government kickstart, a tax credit of up to $1040 a year and an employer contribution of 1 per cent of your pay this year, increasing by 1 per cent a year to 4 per cent a year by 2011. A KiwiSaver on an average wage of $45,000 in 2011 will be contributing $1800 a year of their own money and receiving Government and employer contributions of $2840 a year. Joining a subsidised scheme is the best way to start your retirement saving.

3. Pay off short-term debt. Debt is a negative wealth creator. When you are investing, the power of compound interest works in your favour; when you are borrowing, it works against you. Short-term debt, such as credit or store card debt, usually arises for one of two reasons. The first is that you have unexpected bills such as car repairs or dental bills. The second is that you are spending more than you are earning, or in other words, living beyond your means. Getting rid of short-term debt should be one of your top priorities once you are spending less than you earn.

4. Set up an emergency fund. Life doesn't always go according to plan. You can have your budget pinned down to the last cent, but something might catch you by surprise. Your budget should comprise expenses that you incur regularly such as mortgage payments, food, power etc. Money should be set aside each payday to cover large, one-off expenses (such as new home appliances) or unexpected bills (such as car repairs or dental bills). Your emergency fund will also come in handy if you have a sudden drop in your income through loss of your job or illness.

5. Buy at least one house. If one of your goals is to have a comfortable, secure retirement, you are more likely to achieve this if you own your own house. The sooner you buy one, the more time you will have to pay the mortgage. It isn't essential that you live in the house you own. Buying an investment property as your first house purchase can be more affordable and more tax-effective.

6. Pay off your mortgage. The sooner you can pay off the mortgage on your own home, the quicker you will be able to start creating wealth. Your mortgage usually has a lower rate of interest than other debts, so focus on getting rid of your high-interest debt first. Try to pay off your mortgage faster by making fortnightly rather than monthly payments, voluntarily increasing your repayments and making lump-sum payments. Get some advice from a good mortgage broker on how to structure your mortgage so you can pay it off faster.

7. Set up a savings and investment portfolio. You will need two streams of saving; one for short and medium-term goals such as holidays, a new car or home renovations and one for longer- term goals such as retirement. Though strictly speaking it is better to pay off your mortgage than invest, it is good to get into the savings habit early so that once your mortgage is paid off, you find it easier to save. It's important to have a good balance between spending money now and saving it so you can spend it later in life.

Having clear goals will help you decide what the right balance is. Only you can make that decision, but it should be one you make consciously rather than by default.

8. Protect your wealth. Creating wealth takes time, effort, focus and discipline. It's important to protect the wealth you create from adverse events that might destroy it. As well as insurance, good estate and tax planning will help preserve your wealth.

Achieving financial freedom is not rocket science, it just requires determination, focus and a commitment to follow these eight simple steps in a logical sequence. Start with the first step, spending less than you earn, and the rest will be easy.

* Liz Koh is the author of Your Money Personality; Unlock the Secret to a Rich and Happy Life.

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