Find out how to get a financial plan to match your income
Planning your spending makes perfect sense
How a plan will make you better off
Many people are under the impression that financial planning is a complex process requiring great expertise. In fact, creating a financial plan is a remarkably straightforward activity involving three easy steps:
- Decide what your financial or money objectives are, and prioritise them;
- Assess what resources you have available to you now, and consider what resources you may have in the future;
- Work out what actions you need to take to make your financial objectives come true.
This short chapter explains the ‘ins and outs’ of writing a first-class financial plan.
Your financial plan should help you to reach your destination; to make your journey as fast as possible; and to prevent you wasting time or energy.
Suppose you don’t bother with a financial plan at all? Leaving something as important as your financial future to chance is risky. True, we live in a country with a relatively generous state benefit system. But would you really want to rely on it? You probably wouldn’t starve, but you wouldn’t have an easy time of it. Incidentally, many people assume that the worst thing anyone can do is ignore financial planning completely.
In fact, in my experience the people who are worst off are those who compartmentalise their money decisions.
Let me give you just three examples:
- When you want to buy a home, you look for a mortgage;
- When you begin to think about retirement, you start a pension;
- When you have a young family, you take out life insurance.
The trouble with a compartmentalised approach to money is that it is both wasteful and risky because you may:
- End up spending more than you have to on borrowing money;
- By default, pay more tax than you need to;
- End up with inferior and expensive financial products;
- Risk your capital, your income, and the standard of living of you and your dependants;
- Miss opportunities;
- Make yourself unhappy worrying about your financial security.
A symptom of this approach is responding to ad hoc situations in a kneejerk manner, for example, subscribing for newly issued shares on a whim, or paying for education fees when you hadn’t expected to do so.
Your financial plan may be no more than a single piece of paper on which you’ve jotted down appropriate notes. You might think of it in the same way that you think of a career plan or any other sort of life plan. It is to guide you, save you time, and ensure that none of your effort is wasted.
Or, if you are comfortable using spreadsheet software, you could also do it electronically. Whatever way you choose to complete a financial plan, remember it is essential for giving you a map for your financial road to the future.
Obviously, there is no set period for a financial plan. My general advice is to write it so that it covers the current and next phase of your life. For instance, if you’ve just left university and you’re starting your first job, then you might write a financial plan designed to take you through to when you own your home.
Bear in mind that financial plans need to be flexible. You may change your own ideas about what you want or circumstances may intervene and require a change of direction.
A financial plan that only covers a specific, short-term requirement (for instance, saving for your retirement) isn’t going to bring you lasting financial success.
However, despite drawing up your own plan, you may decide you’d like some professional help. There are any number of people who would like to help you with your personal finances, from bank managers to life insurance salespeople, from credit brokers to pension specialists.
The golden rule is: the fewer options the ‘experts’ can offer you, the less you should trust them. Let me give you one pertinent example. If you go to your bank and express an interest in taking out a pension, whoever you speak to is duty-bound to offer you something from the bank’s own range of products, if they have their own tied agency, even if he or she knows that you would get a better deal elsewhere. If, on the other hand, you go to an independent financial adviser he or she should recommend the best and most competitively priced product for your needs.
Writing a financial plan
If you’ve put off writing a financial plan because you thought it would be both time consuming and tedious, then this chapter will reassure you. Not only is it possible to produce a detailed financial plan in a matter of hours, but as you get involved in the process you may find it considerably more interesting than you ever imagined.
But what should your resources be? My advice is to start by dreaming. Consider what you’d like to be doing in, say, five years, 10 years, and 20 years.
Consider what work (if any) you’ll be doing, where you’ll be living, and how you’ll be spending your leisure time. What will your family situation be? Once you have a clear picture of the future life you’d like to have, start expressing it in financial terms.
Your possible financial objectives might include:
- Owning your own home, outright, without a mortgage;
- Making sure you have sufficient income to retire (possibly early) and live in comfort;
- Ensuring that you and your dependants will not suffer financial hardship regardless of any misfortunes that may befall you;
Having sufficient wealth to pay for things that you consider important, whether it’s an education for your children, or some other item such as a second home or a caravan;
- Having sufficient wealth to allow you to spend your time as you wish, for instance, having the money to start your own business.
Having produced a list of financial objectives, your next task should be to put them in order of priority. What you consider important will be determined to a great extent by your personal circumstances.
For instance, if you’re in third-level education, you’ll have a very different view of money to someone five years away from retirement.
Someone with a lot of debts will have different concerns to someone with a lump sum to invest.
Nevertheless, regardless of your age, existing wealth, health, number of dependants, or for that matter, any other factor, I would recommend you keep the following principles in mind when deciding what your financial priorities should be:
For most people, their greatest asset is their income. Unless you are fortunate enough to receive a windfall, it is almost certainly your income which you will use to achieve your financial objectives. Under the circumstances you don’t want to risk it and you don’t want to waste it. There are all sorts of relatively inexpensive insurance policies designed to protect your income. And by making sure that you don’t waste a single cent (especially when buying financial services) you can ensure it’s used to optimum purpose.
Personal debt (by which I mean everything from store cards to mortgages) will be the biggest drain on your income. If you’ve borrowed money (and, obviously, there are many circumstances under which this makes excellent sense) then you should make it a priority to repay your loans as quickly as possible.
It’s vital to have a safety net or emergency fund to deal with those little trials, tribulations and extra expenses that life often throws our way.
If you’ve got a good, secure income, it doesn’t actually matter what other assets you own.
Emotionally, it’s nice to have the security of owning your own home. Financially, it certainly makes sense. But actually, the best investment that most people could ever make is in a really decent pension plan. With a good pension plan you can leave work early and – if you live to 100 or more – never have to worry about money again. One of the best things about modern pension plans is that they are flexible and diverse.
It is not inconceivable that we will live to a very old age and in some cases suffer a reduction in our mental ability to handle money matters. Before this may arise it is worth considering setting up an enduring power of attorney. This is a document providing for the management of a person’s affairs in the event of their becoming mentally incapacitated. The appointed person (the ‘attorney’) may be allowed to take a wide range of actions on your behalf in relation to property, business and social affairs.
He or she may make payments from the specified accounts, make appropriate provision for any specified person’s needs and make appropriate gifts to the donor’s relations or friends. You can appoint anyone you wish to be your attorney, including a spouse, family member, friend, colleague.
Know thyself! There’s no point in setting financial objectives that you’re going to find impossible to attain. Your financial objectives may involve modest changes in your behaviour, but they shouldn’t require a complete change in your personality. Ultimately, financial planning is about tailoring a solution to meet your precise requirements.
However, there are a number of ‘universal’ needs that most of us face. To my mind they are:
- Having an emergency fund to cover unexpected expenses.
- Paying off any expensive personal loans and credit card debt.
- Short-term saving for cars, holidays, and so forth.
- Income protection, in case you are unable to work for any reason.
- Life assurance for you (and, if relevant, your partner.
- Starting a pension plan (in my opinion it is never too early).
- Buying a home with the help of a mortgage.
- Saving for major purchases.
- Planning for education fees (if you have children), whether for private school or university.
- Building up your personal investments.
To this, I suppose I might add long-term care planning if you’re worried that your pension and/or the state may not provide for you sufficiently in retirement.
If the first stage of a financial plan involves deciding what you want, then the second stage is all about working out where you’ve got to so far. You need to produce an honest and realistic assessment of:
- What resources you have.
- What demands there are on your resources.
- What action you are already taking to meet your targets.
Once you have this information you’ll know what surplus is available to you and whether you have a shortfall that needs to be made up.
Getting out of debt
The greatest threat to your financial wellbeing is borrowing. I am not talking about reckless borrowing, either, but ordinary borrowing in the form of personal loans, overdrafts and credit cards.
This is because the cost of borrowing money is a huge drain on your most valuable asset — your income. What’s more, the cost of borrowing can’t just be measured in terms of the interest you are paying. You must also factor in the opportunity cost — the money you would otherwise be making if you were investing your income instead of spending it on servicing your debts.
Let me give you one simple example: €10,000 repaid over seven years at an interest rate of 10% will require monthly repayments of €166. Total interest cost €3,945. Invest €166 a month into – say – the stockmarket for the same period and assuming the same sort of growth as we have seen over the last 10 years bar the last few — you’ll have a lump sum of almost €20,000 in seven years.
Most people borrow money but fail to think of themselves as being in debt. The fact is:
- You don’t have to be in any sort of financial difficulty to be in debt.
- When you add up the cost of servicing your debt, including your mortgage, it may come to more than you imagine.
- Debt is the single greatest threat to your financial freedom and security. It is sucking away your most valuable asset: your income.
- The first benefit of being debt-free is that your money becomes your own to spend or invest as you prefer.
- Not having any debt will make you less vulnerable. You won’t need so much insurance, for instance.
Over the last 20 to 30 years consumer debt has increased at a frightening pace. Why should this be? Some borrowing is unavoidable — for instance, loans taken out when ill or unemployed.
Some can be attributed to other factors such as changing social values, lack of education at school, our consumer society and ‘impulse’ spending.
However, I believe the main reason for the borrowing boom is that debt has become a hugely profitable business.
Bluntly, lenders use clever marketing tricks to ‘push’ debt onto innocent consumers. They are doing this because the returns are irresistible.
Look at how much money they can make:
If you leave money on deposit at a bank you’ll typically earn less than 1% (€1 for every €100) a year by way of interest.
That bank, however, can lend your money to someone else at anything up to 24% (€24 for every €100) a year.
Under the circumstances, is it any wonder that financial institutions are falling over themselves to lend money? Or that they devote themselves to coming up with new ways to sell loans to their customers?
The trouble with the word ‘debt’ is that it has all sorts of negative connotations.
Many people believe that providing they are never behind on their repayments they are not in debt. This isn’t true. A debt is when you owe someone money.
It could be:
- An unpaid balance on a credit card.
- An overdraft.
- A personal loan.
- A car loan or loan for some other specific purchase.
- A mortgage on your home.
- A secured loan.
- A hire-purchase agreement.
- An unpaid balance on a store charge card.
- A business loan.
- A loan made by a friend or family member.
It is important to remember just because you are never in arrears and have an excellent credit rating, it doesn’t mean you are debt-free.
Taking the first steps
There is one thing you must do before you set out to eradicate all your debt: stop borrowing. After all, you can’t get yourself out of a hole if you keep digging.
Take a once-and-for-all decision to:
- Not just to pay off your debts, but to stay out of debt.
- Not to borrow any more money unless it is absolutely unavoidable (or there is a very reasonable chance that you can invest the money you borrow to make more than the loan is going to cost you to repay).
- Not to live beyond your means.
Avoid ‘bargains’. In my book a genuine bargain is something you need to buy but which you manage to get at a lower price than you expected to pay for it. Something that you don’t need but you buy because it seems to be cheap is definitely not a bargain.
There are various actions you can take to make this easier on yourself. You can:
- Cut up all your credit cards and store cards.
- Cancel your overdraft limit. But remember, most banks will allow a ‘shadow’ overdraft on your account. This means that informally they may allow your account to overdraw by say €500 before you are contacted. This is costly and may eventually have to be formalised, so you are back in the overdraft trap again. Keep track of all transactions on your account.
- Use a charge card where the balance has to be paid in full at the end of each month or take the prepaid card option.
- Avoid buying any unnecessary items.
- Do not take out any new loans, including hire-purchase agreements and overdrafts.
- Do not increase the size of any existing loans.
- Pay with cash whenever possible (nothing reduces one’s tendency to spend money as paying with cash).
- Once you have stopped making the situation worse, you need to take stock of your situation. In particular, you want to gather together full details of your debts.
- The information you require about each of your debts is:
- To whom you owe the money.
- How big the debt is.
- How long you have to pay it back (the term), if relevant.
- What the rate of interest is and whether it is fixed or variable.
- Whether you will be penalised for paying back the debt early (and if so what the penalties are).
- What the minimum monthly payment is (if this is relevant).
- Whether the interest is calculated daily, monthly or annually. Obviously, it is important not to overlook any possible debts, so here is a quick checklist to remind you. Don’t forget to include any money that your spouse or partner may owe, too:
- Mortgages.
- Secured loans.
- Credit cards.
- Store cards.
- Overdrafts.
- Personal loans.
- Car loans.
- Hire, or lease, purchase.
- Catalogue company loans
- Family or friends who may have lent you money.
- student loans.
Most of the information you need should be supplied to you each month by your lenders. However, if it isn’t, then you should telephone or write asking for full details.
Objectives
Having a financial plan will bring material and emotional rewards. From a material perspective, a financial plan will make it possible for you to meet your financial objectives. These might include some or all of the following:
- Wiping out all your personal debts.
- Paying off your mortgage years earlier.
- Never having to borrow again;
- Having enough money to afford the things that are important to you, such as an education for your children or a second home.
- Having enough money to retire early.
- Knowing that you and your dependents are protected against financial hardships;
- Being wealthy enough never to have to worry about the future, whatever it may bring.
And the emotional benefits? You’ll feel a tangible peace of mind once you have your financial affairs in order. In addition, a well-considered financial plan guarantees that you will never need to waste energy worrying about money again.
Some people’s circumstances, of course, may be such that they will not manage to achieve any or all of these objectives.
For these people, financial planning is crucial to getting the maximum advantage from limited resources even with insolvency.
The 10 most common ways of borrowing — from best to worst
1. Loans from family, friends, and employers. Often family members, friends, and employers will make interest-free or low-interest loans. My advice is always to regularise such loans with a written agreement so there is no room for misunderstanding or bad feeling at a later date. Also, such loans may give rise to tax liability.
2. Mortgages and secured loans. Since the demise of tracker mortgages, interest rates have increased, but are still low in relative terms. However, due to funding difficulties, most lenders will no longer consider equity releases or top-up mortgages to finance other non-property purchases. If you are fortunate enough to have a sympathetic lender and have sufficient equity in your property, this can still be an inexpensive way to finance a major purchase.
However, bear in mind that if, say, you buy a car and add it to your mortgage, what you should do is increase your monthly repayments so that that bit of your debt is paid off in less time. Otherwise, you could be paying for your car over the whole term of your mortgage. If you do this, however, ensure that your extra payments reduce the capital (loan) rather than credit your repayment account.
3. Asset finance and leasing. I am a big believer in asset finance and leasing when available. Although not as cheap as a mortgage, this can be an economical way to fund major purchases and it has the benefit of being very tax-efficient if you are self-employed or running a business. You should ask an authorised financial adviser with access to all providers to find you the best possible rate. Leasing is also very quick and you can receive your cheque within 48 hours of your application.
4. Overdrafts. If you have a bank current account you can ask your manager for an overdraft facility. Once approved, you will be able to spend money up to this amount. There won’t be a set repayment period but there may well be an annual arrangement charge. Authorised overdrafts are usually fairly competitive. Exceeding your overdraft limit, however, can lead to heavy charges and the embarrassment of bounced cheques. For this reason, unauthorised overdrafts should be avoided. Bear in mind, too, that most banks expect your current account to be in credit for 30 days a year and will charge you extra if it isn’t.
5. Credit union loans. We are fortunate in Ireland to have a network of local credit unions willing to lend money to its members at a competitive rate of interest. To qualify for a loan you must first join the credit union and then, normally, save a regular amount with them for a set period of time. Because credit unions are non-profit-making they tend to offer much better value for money. Not all credit union rates are the same and while it is worth shopping around, you can only open a credit union account in the nearest office to where you live or where you work.
6. Personal or term loans. The cost of personal or term loans varies enormously. Essentially, when you borrow the money you agree to a set repayment period or ‘term’. The rate of interest charged is normally variable and you should always pay close attention to your statements to check that it hasn’t risen out of line with market rates. Where a rate is fixed in advance — giving you the security of knowing what your repayments will be — it is likely to be higher. Where a loan is provided by a dealer or retailer, check the conditions closely. Sometimes you may be offered a low or zero rate for an agreed period that will rise dramatically in cost after the set term. Also, the cost of providing this credit will be built into the price of whatever you are buying.
7. Credit cards. Used properly, a credit card will give you as much as 45 days’ interest-free credit. On a certain day every month your bill will be calculated for the previous 30 days and sent to you for payment by the end of the following month.
If your cut-off date is, say, the 17th of the month, all charges between December 17 and January 17 would have to be paid for by the end of February.
If you can’t pay the full amount then you are given the option of paying a reduced amount. This could be less than 5% of the total outstanding.
The catch is that you will be charged an extremely high rate of interest — possibly 20% a year. Credit cards are an extremely expensive way to borrow and credit card companies are very aggressive in their marketing methods. If you are going to use a credit card then don’t fall into the trap of making the minimum payment each month. A relatively small balance could take you years to clear.
Note: If your income is high enough your bank may offer you a ‘gold’ credit card with a built-in overdraft facility at a preferential rate. Your credit card balance will be settled each month using the overdraft. This can be a cost-effective way to borrow and is worth investigating.
8. Store cards. I am not at all enthusiastic about store cards. They work in the same way as credit cards except of course you can only use them in the store (or chain of stores) that issues the card. Their single advantage is that having such a card may entitle you to an extra discount on first purchase and again during any sales.
Their huge disadvantage is that the rate of interest charged on outstanding balances almost always makes normal credit cards look cheap by comparison. My strong advice, unless you are very disciplined with money, is not to use store cards.
9. Hire-purchase. This allows you to buy specific goods over an agreed period of time. It is a bit like a personal or term loan.
The difference is that the rates charged for hire-purchase are normally somewhat higher and you might be better looking at alternatives such as a personal loan or a lease. Remember, too, that with hire-purchase you don’t own whatever you are buying until you have made your last payment. This is not the case with, for example, a personal loan. However, if you have paid over half the term in the HP agreement, you can return the goods (eg a car) with the loan scrapped at that point.
10. Money lenders. Whether licensed or unlicensed, money lenders are always about the most expensive way to borrow and the rates are outrageous. When they are trading illegally there is the added risk of violence or intimidation if you don’t pay what they say you owe. You should avoid them like the plague. Incidentally, the definition of a money lender — licensed — is an entity or someone who charges a minimum 23% interest a year. A list of licensed money lenders is available from the Central Bank.
How to borrow sensibly
There are times when it makes sense to borrow. And times when borrowing is unavoidable.
Either way, you want to make sure that you don’t pay a cent more than you have to. If there is one area of personal finance where consumers get ripped off regularly, then it is when they borrow. Nothing better illustrates the way consumers can overpay for a loan than a quick rates comparison:
- Secured loan from one of the specialist lenders 6%+.
- Personal loan (unsecured) from any main bank 10%+.
- Credit card from any of the main providers 17% +.
- Store card from any of the major retail outlets 19% +.
As a consumer it is not impossible that you might simultaneously be paying anything from 6% to 20% to borrow money — ridiculous. There are times when it makes sense to borrow. If you want to:
- Buy, build or improve your home;
- Finance a property investment.
- Pay for education.
- Pay for a car or other necessary item.
- Start a business.
There are also times when it is impossible not to borrow money — if you are temporarily unable to earn an income for some reason beyond your control.
There is no intrinsic harm, either, in genuine short-term borrowing for some luxury item. What is really dangerous, however, is short-term borrowing that becomes long-term borrowing without you meaning it to do so.
This is not only extremely expensive but makes you more vulnerable to financial problems. I can’t emphasise enough how bad it is for your financial wellbeing to borrow money to pay for living expenses. In particular, you should definitely avoid long-term credit card and store card debt.
