How easy is it to put off until tomorrow what you should do today?
Well, there is a significant cost of doing so which financially speaking will compound each year. As this cost becomes steeper, more and more people appear to give up trying.
Imagine this simple example; you wish to save £100,000 by the time you are 60. Let’s assume you get a net return of 5% on your savings.
If you started saving at age 50, you would need to save £643.99 per month.
“I can’t afford that!” you might say. “I’ll start next year when things will be better.”
OK, so you start when you are 51. Using the same assumptions, you now need to save £735.06 per month. Wait just one more year and the amount goes up to £849.33 (that’s over £200 more per month). I know I’ll never win prizes for pointing this out but failure to recognise the basic law of “cost of delay” is one of the biggest reasons why people working today are likely to have to continue working for much longer.
Now take a reality check; whatever it is you wish to plan for (from a holiday to retirement), the earlier you identify your goal and start planning for it, the more likely you are to achieve it.
With the budget just 3 weeks away, I thought I would dust off this particular story. I have not changed any of the words. They are (to my knowledge) just as the author intended… Enjoy
Suppose that every day, ten men go out for beer and the bill for all ten comes to £100…If they paid their bill the way we pay our taxes, it would go something like this…
The first four men (the poorest) would pay nothing. The fifth would pay £1. The sixth would pay £3. The seventh would pay £7. The eighth would pay £12. The ninth would pay £18. The tenth man (the richest) would pay £59. So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve ball.
“Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily beer by £20”. Drinks for the ten men would now cost just £80.
The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still drink for free. But what about the other six men? The paying customers? How could they divide the £20 windfall so that everyone would get his fair share? They realised that £20 divided by six is £3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer.
So, the bar owner suggested that it would be fair to reduce each man’s bill by a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.
And so the fifth man, like the first four, now paid nothing (100% saving). The sixth now paid £2 instead of £3 (33% saving). The seventh now paid £5 instead of £7 (28% saving). The eighth now paid £9 instead of £12 (25% saving). The ninth now paid £14 instead of £18 (22% saving). The tenth now paid £49 instead of £59 (16% saving). Each of the six was better off than before. And the first four continued to drink for free. But, once outside the bar, the men began to compare their savings.
“I only got a pound out of the £20 saving,” declared the sixth man. He pointed to the tenth man, “but he got £10!”
“Yeah, that’s right,” exclaimed the fifth man. “I only saved a pound too. It’s unfair that he got ten times more benefit than me!”
“That’s true!” shouted the seventh man. “Why should he get £10 back, when I got only £2? The wealthy get all the breaks!”
“Wait a minute,” yelled the first four men in unison, “we didn’t get anything at all. This new tax system exploits the poor!”
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn’t show up for drinks, so the nine sat down and had their beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and government ministers, is how our tax system works. The people who already pay the highest taxes will naturally get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas, where the atmosphere is somewhat friendlier.
David R. Kamerschen, Ph.D.
Professor of Economics.
These are the essential building blocks to taking control. It goes without saying that if there are ways of helping you achieve your goals more efficiently, they should be considered.
Efficiency can be achieved on many levels.
Within your business
Do you know what your true “hourly rate” is? Well, in doing this exercise, you will know how much you need to bill in order to earn each £1 you take out of the business. What can you do to make that more efficient? Increase prices? Reduce costs? What can you do to reduce the effort and time taken for you to earn each £1? Get help in the business, outsource non-core tasks?
What about tax? We all pay it on what we earn. Could we find ways to legally and ethically reduce your tax bill on income or profits?
Out of the business
How can you be more efficient in the way you build wealth? Well, tax again plays a big part. Your wealth is likely to be subject to 3 main taxes; income, capital gains and inheritance tax. There are always ways to be more tax efficient.
What about where you hold your wealth? What investment or savings vehicles are you using? Can you gain potentially greater rewards by doing different things?
Much of the success of your own planning will be down to your own efforts, but if you can somehow leverage these efforts in a controlled way through efficiencies, you may well reach your goals much quicker than you had planned.
Well, OK. Not quite sure if Enid Blyton’s Famous Five is the best link in the world for what I’m talking about here but there is no doubt that understanding the importance of my “5” things will help you take better control of your lifetime money decisions.
A lot of what us financial advisers talk about can be filed in the section called “efficiency”; what can we do to save you tax, what can we do to increase your investment returns etc. BUT, efficiency in achieving what is the question. The real key to taking control over your financial lifetime lies in understanding
- Your Assets
- Your Liabilities
- Your Income
- Your Spending
- Your Timeline
Somebody once said to me that “People don’t want drills. They want holes” It took a while for this to sink in for me, but in the end I got it. A drill has one purpose; to make a hole. At the end of the day, does it make a difference if I used a £20 drill or a £200 drill? In this philosophical sense, no. So my point is this; A Solid lifetime financial planning exercise is not about pensions or ISAs or this company being better than that one. Those things are the “efficiencies” – how do we get you there quicker.
First and foremost, you need to understand what money you will need to fund your chosen lifestyle year in, year out for the rest of your life. This is basically cashflow planning. What money do I have today? What income do I know I will receive? What will my cost of (ideal) living be? No rocket science there. Are you ready for the kicker?
(I’ll make up some numbers to help demonstrate). Imagine you’ve been used to earning £3,000 per month after tax. You get to your retirement and you realise your income has now fallen to £1,500. You’ve worked out your average cost of (ideal) living is £2,500 per month. What are your options?
- Increase your INCOME. Maybe take on a part time job?
- Decrease you (ideal) lifestyle SPENDING? Well, the trouble with that is that it’s no longer you ideal lifestyle your planning for – you’re making sacrifices.
- Consider deferring retirement for a few years – changing your TIMELINE.
- Look to your ASSETS & LIABILITIES. No, I’m not saying take out a loan. That serves no benefit at all. What assets do you have and how could you use them better? Could you use your capital better? Is it feasible that you could slowly eat into your capital each month or year to make up the difference between income and (ideal) spending?
Many retired people today are sacrificing (ideal) lifestyle because they are income shy. When they have assets, this may mean their sacrifices are in vain. I’ve seen many many scenarios where those in retirement feel restricted in their lifestyle because their income is less than they might like BUT they have relatively significant amounts of money in savings and investments, plus they have properties with significant value.
In a controlled way, there is no reason why SPENDING cannot be funded through a combination of INCOME and ASSETS. Turning assets into something you can spend is a different matter – we can help with that. But, for you in taking control over your financial lives, you must first understand your ideal lifestyle and consider your TIMELINE. We do this through a process of layering which is a subject all of its own but starts with layer one – life is not forever. All of us come to the end of the road. Sooner or later, we must realise that capital left because we have been too afraid to spend it ourselves will either get hit by the tax man or spent by our children.
Sure, some aspects of financial planning can be complex and even quite dull but considering these five factors (and importantly, planning for them) will give you a solid first step toward better living through great financial planning.
A universal fact is that there are 86,400 seconds available to every person on this planet every day. You’ve just spent 10 of them getting this far into this blog.
The world is full of clichés about goal setting, aspiration and success but ultimately, it all comes down to this; when you are 98 years of age with your great-grandchild bouncing on your knee, what do you want to be able to tell them about what you did with your life? Is it about material things, is it about relationships, is it experiences? Great, but if you had to choose, which would be most important?
Stephen Covey (author of The 7 Habits of Highly Effective People) calls this (his 2nd habit) starting with the end in mind. Knowing what you want to achieve and setting out to make it happen.
Only you can judge how “good” or complete your life is – it’ll be based on your own standards but understanding what you want from life and putting those things into some form of priority order will help you to make them happen – a large part of which is making sure the money is there to pay for it.
Dare to dream, write yourself some goals. Use whatever categories you like but we use 8;
- Family & relationships
- Health & Fitness
- Home & Environment
- Career or Business
- Personal Development
Remember that some goals will conflict – wanting to lose weight but also wanting to dine out at the finest restaurants 4 times a week might mean that one goal is never achieved.
Remember too that one of the biggest reasons why people fail to set goals (thereby taking some control for the future direction of their lives) is the fear of failing to achieve them. Well, to quote Canadian Ice Hockey player Wayne Gretzky, “You’ll always miss 100% of the shots you don’t take”.
Knowing what you want makes planning much, much easier.
If you’re still a while away from any anticipated future financial liberation, there could be nothing less advisable than leaving it until you get there before you assess how good your planning efforts have been.
On the flip side, you can over analyse. This is unhealthy.
If you know where you are and where you want to be, you can break your journey into sections. In money terms, this might mean setting a target for your wealth generation over the next 10 or 20 years and each year, plotting your progress against it. It doesn’t matter which route you take as long as you are in control.
For this to be of value, you need a clear vision of what you are trying to achieve. Whatever action to you take in order to reach your goal they will always be based on certain assumptions. Some you can control, some you cannot. Each year as you progress, you will need to re-assess your projections and take corrective actions accordingly. It is interesting to note that airline pilots report, from London to New York, a plane is off course for 95% of the time!
Remember; Keep measuring. Keep adjusting.
Has it been a good week?
Following the theme that clichés can have a profound positive impact on your life, I offer this week a further two tips for achieving a better lifestyle through focussing on the right things:
No.7 – Take care of your health
As a man closer to 40 than I might like, I have only just in the last year or so discovered the benefits of being fitter. It’s easy to find an excuse to avoid going to the gym or to get out for a brisk walk or run (especially if it’s cold and wet outside but warm and dry in). It’s also easy to reach for the wine bottle after a hard day rather than do some exercise. But, it is now no surprise to me to discover that when if you go to your GP complaining of stress or tiredness, one of the first things they ask you about (and even prescribe) is exercise and diet. Find something to get the heart rate up – it can become addictive!
No.8 – Forget the Joneses
Madonna once said “we’re living in a material world” – that was some 27 years ago (wow, that makes you feel old doesn’t it!). Our pursuit of “stuff” encourages us to spend rather than to save. Possibly encouraging us to stretch ourselves financially which just adds to the pressures of life. Dedicate your time and effort to the richness of life’s experiences but not because of what others will think about you but because of what it does for your own happiness.
Where do these thoughts come from? Read more…