Managing your money

BY AMANDA MORALL

Financial planning may not figure in Generation Y's want-it-all, want-it-now world view but it is an exercise many would do well by. In our latest MoneyMakeover, we find out how to balance the scales of current wants versus future needs.

Bill and Jodie are a Marlborough couple in their late 20s. Bill has a young child from a previous relationship and the couple is looking at starting a family of their own in the next few years. In the meanwhile, they are planning to get married, and will likely finance the big day on their own.

In addition to wedding expenses, the couple is hoping to upgrade one of their vehicles and also buy a boat valued at $18,000. While they have cash savings of $25,000 they also have a $380,000 mortgage for which they pay $1272 per fortnight. Jodie has a stable job and regular income of $63,000 while Bill is a self-employed builder. As such, his earnings are unpredictable.

Despite their short-term goals and material wants, Bill and Jodie recognise they need to start saving for their future. The trouble is, they don't know how to go about it given the inconsistency of incomings generated by Bill. Jodie has enrolled in KiwiSaver and makes annual contributions of $1260 but Bill has not subscribed. Jodie questions how well prepared they will be for retirement and whether they are managing their money as well as they could be.

"We are confused as to how we create wealth for our retirement or how we become debt free faster with unknown income from my partner," confides Jodie.

"If we pay off the home loan in the 25-year time-frame, assuming we take on no more debt which we really don't want to do, we would then be debt free but very close to retirement age with not much time to save further."

Here's how their situation breaks down: Combined gross annual income: $94K. Assets: Home $530K; two vehicles $8500; motorbikes $7K; trailer $2K; savings $25K.

Liabilities: Mortgage $380K; credit card $2K; car loan (business) $4.5K.

For a professional opinion, MoneyMakeover consulted James Smith with Bradley Nuttall Ltd in Christchurch and Richard Harden with Richard Harden Investment Services in Nelson. Here's what they advised:

Richard Harden

"Creating wealth in most instances is done through hard work, prudent savings and getting good advice, unless you win Lotto.

You should consider working with professionals and get a comprehensive financial plan. I cannot cover the essential 15 elements to a plan which could be a 40-page report but I can make some suggestions to get you started.

Importantly, your goals and objectives should be realistic and achievable. Thinking about your future and how to get ahead is positive. Also, congratulations on having around $200,000 of net assets at your age.

The concern is your level of debt is substantial. Your mortgage repayments are about 35 per cent of joint income which is at the top end of borrowing limits and would scare me a little.

Based on your income and outgoings, your options are limited, requiring a tight rein on your budget. As you will be using your savings for the upcoming wedding, this limits your wish list for a new car and boat. Nice to have toys, but buying depreciating assets won't get you ahead, especially if you borrow for them.

With a $380,000 mortgage fortnightly payments are better but explore ways of increasing income. Work towards getting rid of credit card and consumer debt with any surplus cash being channelled into debt reduction. If your home is suitable, consider taking in a boarder which could provide $100 per week tax-free. With the uncertainty of your partner's income you need to look at how to grow the business, get advice from your accountant.

You have joined KiwiSaver but your partner should join, contributing $1042 annually to qualify for the $1000 Government kickstart plus the $1042 tax credit. Don't underestimate KiwiSaver's potential over the long term. It won't satisfy all your retirement needs but could provide you each around $9000 net annually in today's terms. As you reduce debt, you can look at increasing savings.

I am concerned about your insurances. Being in a blended family, owning a business and looking to marry raises issues regarding risk management, legal and estate planning. Getting advice in these areas is a priority.

You have built your own home which has helped to build up some assets. You may be considering doing this again or building a rental property, however I would urge caution as this could entail taking on considerably more debt, risk and have possible tax implications. Do the sums carefully.

Your goal to start a family will be more achievable once you have a plan. It would be hard for you to start a family on one income but look for family support. You also have the option of downsizing which would make it more achievable."

James Smith

"Given their ages and stage in life, Bill and Jodie have got themselves in pretty reasonable shape financially. Over the next few years they will have to make some choices if they plan on starting a family and may even have to manage on a lower income for a time. However, provided they remain sensible and continue to live within their means, they have every chance of fulfilling their goals.

Cash and future spending

Bill and Jodie have established a decent cash buffer of $25,000, but there are now items on their wish list including a new boat, vehicle upgrade and a wedding.

I suggest they write all these items down, specify exactly how much money each goal will require and give each a specific date (yes Bill, this includes the wedding!). Using this approach will help the goals become clearer in their minds and will naturally help to stimulate the action needed to achieve them.

For their cash reserve I recommend they retain a minimum of three months' expenses, which for them will be around $10,000.

Risk management (insurance)

In terms of life cover, I recommend they both have sufficient cover to repay the mortgage, which means increasing their levels of cover to around $380,000 each. As well, Bill will need to decide whether a higher level of cover is appropriate if he wants to provide some financial support to his son from his previous relationship.

They both have income protection policies with stand-down periods of four weeks. They could consider increasing this to eight or 13 weeks, given that they have a cash reserve to tie them over, which will help reduce their premiums by up to 50 per cent [The stand down period on an income protection policy is the period of time you must be unable to work before the policy will start paying a claim].

This saving can then be used to help fund an increase in levels of income protection cover, to better reflect their current earnings and outgoings.

It is also important they think through how they would like their estate distributed if something happens to them. This involves considering the ownership of their assets (single, jointly owned, tenants in common) and if they have not already done so, speaking to their solicitor and writing a will.

Future savings

Whilst Bill and Jodie are in good shape for their ages, accumulating enough wealth for a comfortable retirement takes time. The earlier you start, the better and even small contributions made early on can make a big difference to the total.

Like most people their age, Bill and Jodie should focus on joining KiwiSaver and repaying financial liabilities to become debt free as early as possible. Because he is self- employed, Bill isn't eligible for a contribution from an employer, but by paying $20 per week he will still be eligible to receive a matching $20 per week contribution from government.

Jodie and Bill's mortgage repayments represent a high proportion of their discretionary income which makes it difficult to increase their savings. However, this won't always be the case. For example, if their earnings rise by 3 per cent per year, in 15 years time their earnings will have risen by around 55 per cent whereas the mortgage repayments will have remained the same. The repayments should therefore represent a much lower proportion of their discretionary income, which will help free up income for additional saving and repaying their mortgage faster.

No person or entity will be responsible or liable for any errors, omissions or inaccuracies in this article or liable to anyone for any loss, damage, injury or expense suffered or incurred as a result of reliance on the information provided and opinions expressed in the article. Disclosure documents for Richard Harden and James Smith are free and available upon request from the parties.

* Are you interested in being the subject of a free MoneyMakeover for The Press? Email: amanda.morrall@press.co.nz

- © Fairfax NZ News