CENTS AND SENSE- Personal Finance Article 4
By George Chege
HOW SECURE IS YOUR WEALTH PLAN
“If you know where you are going, any road will take you there. If you do not know where you are going, no road will take you there”, said a wise person. This quote is very relevant to your quest for wealth and financial independence. If you know where you are headed to financially, then you will be able to answer questions like the following;
- What is your FIN, I mean Financial Independence Number?
- Do you know how much you need to invest today so that you can retire to a lifestyle equal or better than what you currently have?
- Do you have a wealth strategy that will protect you and your family should the storm of peril attack in the middle of the night?
If you aren’t sure where you stand, this article is what the doctor ordered for you. It will show you how to develop a sound wealth plan and seal gaping holes in your current plan. At least you will be sure of where to start.
There are 3 basic components of a wealth plan. Where you want to go, where you are today and what you need to do.
Why is it important to have a wealth-building plan in the first place? If you live to a ripe old age, as we all wish, a time will come when you will be either too old or too sick to work on a full time basis. However, you will still need to pay for life’s necessities and for other activities that will occupy your time. Healthcare, travel and insurances will be significant expenses in your budget. It is for these reasons that you will need a reasonable, steady and reliable source of income to enable you maintain an enjoyable lifestyle during your retirement years.
Plans do not become reality just because they are good and desirable. We must put them into action. Yoweri Museveni.
1) Where do you want to go?
There are 2 places you ought to be thinking about – pre-retirement and after-retirement. It is easier to plan about pre-retirement because you know your current financial situation, earning ability and preferred lifestyle. For example, if you want to live in the greener neck of your woods, it’s easy for you to determine how much income you require to afford a lifestyle similar to the Joneses who live on the greener, quieter and safer side of town. It’s also easy for you to decide how to increase your income - whether you need to do extra shifts or a side job or go back to school or start a home business.
It is the after-retirement part that most people ignore; yet it is a very significant 25-to-35 years of your life. Thanks to discoveries in science and medicine, people are expected be live longer after retirement. What lifestyle do you want to have for 25 years when your regular paycheck dries out? It depends on you. It also depends entirely on how you invest your money many years before you retire.
Let me give you a clue. Joe is 65 years old and will retire at the end of this year. His Financial Independence Number is 1.2 million and it equals the value of his investments. Joe can therefore expect to spend $50,000 every year for the next 35 years till age 100. He will invest the $1.2 million in an interest earning account that will give him at least 5% interest per year during his retirement.
Is $50,000 per year good enough for Joe? That is up to Joe to determine. More importantly, what is your FIN? I mean your Financial Independence Number? This is the magic number that will determine how good your retirement lifestyle will be.
2) Where are you today?
If you are like majority of the people, you are only 80% sure of your financial situation. You have no idea how 20% of your financial transactions affect your financial well-being. The average person retiring this year has only $25,000 saved for retirement. If the average retiree is honest with you, they will whisper in your ears that it is the small expenses that add up to the 20%. It is these expenses they ignored to control and they got hit below the belt.
Let’s briefly check where you stand. If your answer is yes to all the following questions, you are on safe ground:
- Do you invest consistently at least 10% of your gross income every month for your retirement?
- Do you save 5% of your gross income every month for emergencies and large purchases?
- Do you have less than 4 credit cards that you pay off in full every month?
- Do you use credit only for expenditures that will improve your financial status e.g. education, mortgage finance or business?
- Do you have these essential insurances: medical, motor, property, disability, term life insurance and personal liability umbrella insurance?
3) What do you need to do?
Creating wealth can be equated to building a house with a foundation and 3 floors.
The most important structure is the foundation. Unfortunately this is the most overlooked part when people start to build their financial house. We call this foundation insurance. The value of a good foundation is known when sudden violent storms blow and the house is able to withstand and remain intact. A house built without a foundation cannot withstand a big storm. It is blown away and the efforts of the builder are wasted. Make sure your essential insurances are in place to weather the storm of financial misfortune.
The first floor is debt management. Avoid credit card debt like the plague. Do not use credit to pay for luxury items, utilities and fun activities. Use cash or debit cards. If you use credit cards to pay for these expenses, then pay off the balance at the end of the month. Interest rates and numerous fees charged by credit card companies are too expensive and will deprive you money to invest. Read bonus report of Personal Finance Article 1 to know the best way to pay off credit card debt.
Some debt is good e.g. house mortgage and education loan. Just make sure the interest rate is fixed and payments are affordable. Remember to shop around for the lowest interest rate and the shortest payback time.
The second floor is savings and investment. Save money for two types of expenses. Large one-off expense e.g. vacation, furniture and car. Also save consistently every month for emergencies - because “life happens” to your family, friends and dear relatives at the most unexpected time. Invest to improve your lifestyle during your working years and to ensure a good and comfortable retirement.
Invest at least 10% of your gross income and save at least 5% for emergencies and large purchases. As a rule of thumb, make sure your investments have a potential of earning 10% interest per year and your savings earn at least 4% interest per year to keep up with inflation.
The third floor is income management. Is income from your investments large enough for you to live on? If the other floors are taken care of and your answer is yes, then your house is complete. You are financially independent. You can stop working for money and start enjoying life. If your answer is no, then pull up your sleeves and get to work. Be creative and use your talents to boost your income. You have a deadline to beat. It is called retirement day. It is the day you will wake up to face your financial independence number, eyeball to eyeball. We hope it will be a day of celebration and jubilation.
Do you need help building any of the floors? Please write to us at GeorgeChege@AjabuAfrica.com and we will be happy to direct you on the right track.
HOMEWORK NUMBER 4: Fix your wealth-building plan
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These articles are intended for educational purposes only. Please seek professional advice on tax, accounting, investment, legal and similar matters. Each case requires personalized assessment with regard to individual preference and local laws.