Many of us are just trying to get things back in order after the effects of COVID lockdown on our finances. Some are blessed and were able to go through the lockdown with little or no financial losses. Some others got into financial difficulty due to poor financial management habits. Whichever position we are in, it is always helpful to periodically review the way we manage our finances and investments, and then conduct full financial makeovers that would set us on a better course. This review and makeover should cover our incomes, debts, savings, investments, expenses, financial prowess, financial discipline and maybe more.
Let us start with our incomes. Can we survive on just one source of income? Is it wise to rely on just one source of income? We need to begin to actively cultivate additional sources so that if one is lost or threatened, we can maintain our peace of mind as other source or sources will tide us over until we can restore the lost income. Of course, in order to maintain our quality of life, the additional sources should generate passive income – money earned passively like dividends, interest, rent etc. So, our first makeover task is to develop additional sources of income, more precisely passive income.
Next, we discuss our savings especially the emergency fund. This is a very liquid investment in cash or near cash assets like savings accounts, fixed deposits and treasury bills and so is easily accessible. The rule of thumb for emergency funds is that it should cover up to six months of living expenses. Therefore, it is our first fall back support when we lose income. Emergency funds are also useful when unexpected large personal expenses come up when we are still gainfully employed. If we spend part of this fund when we have not lost our jobs, we should immediately begin to build it up again. The second financial makeover task is building an emergency fund.
However, if we have high amounts of expensive debts especially credit card debts, we must prioritize their repayments. Consumer debt attracts up to 48% per annum – there is no point putting money into investments that earn less than 5% per annum if you have debts that charge multiples of your interest income. So, pay down expensive debt and then begin to rebuild the emergency fund. Other debts e.g., mortgages, business loans etc. should also be reviewed. Are the interest rates and other loan conditions the best you can get? Can you re-finance to obtain lower interest and better borrowing conditions? Has your financial condition improved since you took the loan? If yes, do you still need the loan? Or can you repay faster than stipulated – even if you have to strain yourself? This is because, the longer a loan term, the more expensive the loan because interest accrues with each additional day. We must also remember that we do not need to borrow from financial companies to create a credit history anymore. Banks can now use alternative credit scoring models that use payment data from cable companies, phone companies etc. to determine our credit worthiness. So, the next financial makeover task is this, take time to review personal and business loans and determine which of them should be paid down and which should be restructured.
When last did we review our investment portfolio? The review should analyze the size of the portfolio and the quality of individual assets in it. Is your portfolio commensurate with the income you have earned over your working years? Although everyone has peculiarities that make a generalization almost impossible, there is a rule-of-thumb method that we can use. If you, as a monthly salary earner, have earned an average of one million Naira annually for the last 5 years, then your investment portfolio at the end of year 5 should be at least one million Naira. This does not mean you save/ invest 20% of your income annually. That is impractical for most people. The suggestion from financial advisers has always been that we invest 10% of our income and then earn an average of 10% compounded return on investment (ROI) through both capital gains and revenues. Therefore, the next question is – are individual assets delivering the expected ROI?
(TO BE CONTINUED)
Get a Financial Makeover II
Do you have a standard, a minimum return on investment you expect from each asset class? Portfolio restructure may require that we sell low yielding assets and buy more profitable ones. Of course, before every fresh investment, we must do a fresh due diligence not only on the investment asset and those who manage it on our behalf – the company management and their corporate governance culture. This implies that every time we buy more of an asset we already own, we should do a fresh due diligence exercise. In addition, must be careful not sacrifice healthy portfolio diversification in our bid to retain only high yielding assets. Our portfolio must not be concentrated in one asset class or one asset. Of course, concentration is unavoidable when we start, but our goal must always be efficient diversification. So, another financial makeover task is investment portfolio review and restructure.
Next, we must carefully evaluate our expenses. This may require the whole household sitting together to evaluate things, otherwise, family members can jeopardize our best efforts at making over our expenses. Explain the benefits of financial prudence. Develop the habit of shopping around before buying. Review all the subscriptions you have, are they all useful? Do you need all the 700 TV channels you subscribe to on Cable Television especially in these days of YouTube etc.? How about your mobile phone package, could it be cheaper? How often do you go to the gym, yet you have a full annual subscription? Wouldn’t it be better to replace it with a pay-as-you-go package? How about financial costs and bank charges? Have you considered what your insurance premium covers on various policies? Would your premium be lower if you changed the coverage or even moved to another insurer? Many banks have various types of accounts. Do you still need a current account? Why pay stamp duty on every deposit into a current account especially now that most of your payments are via electronic transfers? Itemize expense that can be reduced or even eliminated but make sure you replace that with more budget-friendly, fun alternatives. The whole family needs to work together to achieve this financial makeover task.
Another aspect of financial makeover we need is to improve on is our financial intelligence. We have started at this already, just by reading this article weekly. To gain financial intelligence, we need to have a good working knowledge and understanding of the financial concepts that govern wealth management. A key one is compound interest – interest accruing on interest. It works well for you if you have money market investments, but it can kill a business or render an individual bankrupt when it is accruing on debts. We must also understand how to appraise return on investment (ROI) – is the return per annum? Does it come in revenue (cash) form or as capital gains (increase in asset value) or both? Which fees and taxes will be applied to the ROI and what is the adjusted return? We need the knowledge of ROI to be able to accurately compare investment options and determine which asset to invest in. How about market knowledge? Every investor should read financial news especially those concerning sectors we have invested in. Such news may be the determinant between exiting an investment before you lose money or watching helplessly as the asset deteriorates. There are many other aspects of financial intelligence, and these are readily available on the internet as we can subscribe to free personal finance sites. So, that continue this very vital task that determines the success and sustainability of our financial makeover.
Next comes financial discipline. This is actually the foundation for all financial success, and it would determine the success of our financial makeover. For some of us, the reason we need makeover in the first place is due to financial recklessness. So, how then can the cause of our problem be the solution? Sadly, it is the only lasting solution. Support for financial discipline can be obtained through the use of technology – mobile personal financial management (PFM) app, available in your phone’s store, can assist with financial discipline. We can also join investment clubs where there are peer support and peer review mechanisms to motivate us to be financially disciplined. So, the task for financial discipline is getting tech or human support. Also, you can check online for past articles on effective strategies for financial discipline.
Not all of us need a full financial makeover, but everyone can undertake one or two of the tasks to improve our financial efficiency. Let us make the necessary changes. Happy investing.
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