DO YOU WANT TO BE RICH OR POOR IN THE FUTURE?   PERSONAL FINANCIAL PLANNING FUNDAMENTALS   

                                             

 

WHAT SEPARATES THE FINANCIAL NON-ACHIEVERS AND ACHIEVERS?

 (a)   Lack of Knowledge  

- don't understand the investment market.

-  lack of desire to gain that knowledge.

-  don't know where to turn to for advice  

 

(b)  Lack of Foresight

-  failure to put money aside for the future.

 

(c)  Lack of Planning

-   failure to work towards a goal with a plan.

 

(d)   Spend Now Rather Than Later  

-   do not live within means-  would rather buy it now on credit and pay interest rather than later when have built up savings and can afford it.

 

(e)   Invest in Items Which Lose in Value Rather than Items which Gain in Value

-  non-achievers invest in expensive motor cars, appliances and other luxuries which don't increase in value over time and invariably take out hire purchase with high interest rates to pay for these items which means that they end up repaying much more for them than original cost.

-  achievers buy items such as houses which increase in value and borrow at relatively low interest rates.

 

(f)   Bad Money Management

-   living an expensive life with expensive cars, clothes, entertaining etc. and not putting money aside  for a future emergency.

 

(g)  Bad Mental Attitude

-  successful people have an optimistic attitude and unsuccessful people have a pessimistic attitude.

-  achievers mix with successful money managers with similar optimist viewpoints.

-  achievers have strong desires to become financially secure, are willing to borrow, invest and take risks to obtain gain.

 

(h)  Inefficient Use of Time

- a good time manager can achieve more in a day than someone who manages their time poorly.

 

(i)   The Need To Conform

-   the majority do not take investment risks and are not financially rewarded.

-   the creative minority who dare to be different and seize opportunities are generally financially rewarded.

 

(j)   Lack of Action

-  the person who says "I am getting around to it" but never takes action will not be rewarded financially.

 

 

THE FOUR STEPS TO FINANCIAL SUCCESS

Step 1

Set yourself a measurable financial goal, being the minimum lump sum of capital that will return a permanent flow of income.  

  

Step 2

Place a specific time frame on the achievement of that goal.

 

Step 3

Develop a strategy for the achievement of the goal within your time frame.

-  assess your risk tolerance

-  decide the investment portfolio mix to suit your needs

-  start a regular savings programme  

 

Step 4

Retain that strategy, monitor it and progress towards your goal.

   

 

HOW MUCH INCOME WILL YOU NEED IN RETIREMENT AND HOW MUCH YOU WILL HAVE TO INVEST TO ACHIEVE THIS INCOME?

                Working out how much income in addition to New Zealand Superannuation you'll need in retirement depends on what you expect your cost of living to be.

              A good guide as to this calculation is to base your annual retirement income needs on 60 to 70 per cent of the annual income you are receiving, or expect to receive, just before you retire.

              The total amount of savings you will need to cover your retirement income gap depends on whether you use only the income (e.g. interest) from your savings each year to meet your annual expenses, or whether you use part of the lump sum (your capital) you have built up as well.

              If you want to use only the interest and leave the lump sum intact, then you'll need a lot more.    For many people, using only the income from interest on their savings to supplement New Zealand Superannuation will not be a realistic aim- they will need a lot more than just these income forms.

              The following Table helps you work out the total amount you will need to save, so as to get the annual investment income you need on top of New Zealand Superannuation.   The amounts are calculated on the basis that you use income and a portion of your capital each year for 20 years.   After that you would be dependent on New Zealand Superannuation.

 

Annual Income ($)

Lump Sum Needed Using Interest and Capital for 20 years ($)

       5,000

                                      78,000

      10,000

                                     156,000

      15,000

                                     234,000

      20,000

                                     312,000

      25,000

                                     390,000

      30,000

                                     468,000

 

              The next Table shows how much you will need to save each month to give you the annual income you need.    Depending  on how many years away from retirement you are now, the amount will change.

                                                                                 Years

Annual Income

    5

    10

   15

   20

   25

  30

  35

  40

       5,000

1,219

  572

  357

  251

  188

  146

  117

  95

      10,000

2,439

1,144

  715

  502

  375

  292

  233

 191

     15,000

3.658

1,716

1,072

  753

  563

  438

  350

  286

     20,000

4,877

2,288

1,430

1,004

  751

  584

  467

  381

     25,000

6,096

2,860

1,787

1.254

  938

  730

  583

  476

     30,000

7,316

3,432

2,144

1,505

1,126

  876

  700

  572

 

(Assumptions- based on 2.5% compounding rate of return after tax and inflation)

(Source- Retirement Commissioners Booklet  "Welcome to Your Retirement)  

WEALTH BUILDING PRINCIPLES -  COMPOUND INTEREST BENEFITS- THE EARLIER YOU START THE BETTER OFF YOU WILL BE  

               The principle of compound interest is that you do not withdraw earnings or growth from an investment,  but leave them intact to be added to the principal.   Thus you earn interest on the sum of the principle plus interest you have already earned.

 

THE RULE OF 72

               The Rule of  72 lets us calculate how long it will take for an initial investment to double in value if you divide 72 by the expected rate of growth.

              It works like this:  

Investment Return (%) 

  Calculation

Time it takes to Double Your Money (Years)

              4

   72/4

                         18

              6

   72/6

                         12

              8

   72/8

                           9

             10

   72/10

                           7.2

             12

   72/12

                           6

                                                                     

AN EXAMPLE OF THE EFFECTS OF COMPOUND INTEREST

               An initial investment will increase in value faster and faster as time passes.                        

               For example,  the following table shows what a single deposit of $10,000 will grow to by age 65 at varying rates of interest (excluding the effects of taxation).

 

                                          Age of Person When $10,000 Invested

Compound Rate (%)

  20 Yrs ($)

 30 Yrs ($)

 40 Yrs ($)

 50 Yrs   ($)

                5

     89,850

    55,160

    33,863

    20,789

               10

    728,904

   281,024

   108,347

    41,772

               15

  5,387,692  

  1,331,755

  329,189

    81,370

 

Thus at a rate of return of 15% the person who started at 20 built up over 4 MILLION DOLLARS more than the person who started 10 years later.   That delay cost him nearly $8,000 PER WEEK.

 

CONCLUSION

****  SMALL INCREASES IN RATE OF RETURN OR IN LENGTH OF TIME INVESTED MAKE DRAMATIC INCREASES IN THE INVESTMENT VALUE BUILD-UP  

 

WEALTH BUILDING PRINCIPLES MAKING INFLATION WORK FOR YOU  

               In periods of inflation your dollar buys less every year.  

              For example, it would take over $140 today to buy the same amount of goods as $15 would in 1970. 

              The result for people on fixed incomes is a steadily declining standard of living.

 

CONCLUSION  

****  INVEST ONLY A SMALL PART OF YOUR INVESTMENT PORTFOLIO IN LONG TERM FIXED INTEREST INVESTMENTS AND BANK DEPOSITS WHICH ARE LOSING VALUE EVERY DAY.   SUCH INVESTMENTS HAVE NO CHANCE OF CAPITAL  GAIN,  NO TAX BENEFITS ATTACHED TO THE INCOME STREAM (DUE TO THE FACT THAN ANY INTEREST INCOME IS SUBSEQUENTLY TAXED) , AND YOUR CAPITAL IS DEPRECIATED BY INFLATION WHEN YOUR INVESTMENT MATURES.  

****  KEEP THE MAJOR PART OF YOUR ASSETS IN A FORM WHICH SHOULD INCREASE IN VALUE.

e.g. Property

        Equities

       Superannuation Scheme investing in Property and Equities

       Managed Funds investing in Property and Equities  

****  USE THE EFFECTS OF COMPOUND INTEREST TO YOUR ADVANTAGE.   

****   TIP FOR PARENTS AND GRANDPARENTS FOR EDUCATION FUND FOR CHILDREN-   PUT $10,000 IN MANAGED FUND FOR CHILD AT BIRTH AND ARRANGE FOR DIVIDENDS TO BE REINVESTED-  ASSUMING 10% GROWTH AFTER FEES THE FUND WOULD HAVE GROWN TO $67,275 AT AGE 20 AND WILL BE AVAILABLE TO PAY FOR UNIVERSITY EDUCATION.   

 

WEALTH BUILDING PRINCIPLES -  DOLLAR COST AVERAGING           

                Dollar Cost Averaging advantages occur when you invest a fixed sum, on a regular basis, into the same product and over an investment  period of time unit prices rise..

              It serves to offset the effects of volatility of unit prices over investment periods.

              Because you are always investing the same amount, if the market drops your next investment will buy a larger number of units.   As the market rises, you will buy fewer units with each  purchase but your existing units will rise in value.   The net result of this process is that more units are purchased at relatively low prices than at relatively high prices.   You will always be buying units at an average cost which is lower than their average over the investment period.   This is because you are buying more units at the lower prices and fewer units at the above average prices.

              The following table illustrates the Dollar Cost Averaging Process:  

  Year 1

  Year 2

  Year 3

Year 4

  Year 4

Investment ($)

   1,000

   1,000

   1,000

  1,000

  1,000

Unit Price Paid ($)

       10

         4

         6

         5

       12

Units Purchased

      100

      250

      166

     200

       83

Units Purchased To Date

      100

      350

      516

     716

     799

Average Cost Units to Date ($)

       10

   5.71  

    5.81

    5.59

    6.25

Average Price Units to Date ($)

       10

       7  

    6.66

    6.25

    7.40

 

That is, 799 units have been purchased over the investment period at an average price of $6.25 whereas the average price per unit over the same period is $7.40.    Also the investor has paid $5,000 over the period whereas current realisation value is $12,000

 

CONCLUSION  

****  SET UP AN INVESTMENT PLAN AND INVEST SUMS ON A REGULAR BASIS.  

****   IF UNIT PRICES GO DOWN YOU WILL BE PURCHASING UNITS AT CHEAPER PRICES.  

****   IF UNIT PRICES GO DOWN AND YOU ARE IN DESPAIR WITH THE PRICE DON'T TERMINATE YOUR INVESTMENT UNLESS YOU HAVE RESEARCHED THE INVESTMENT AND HAVE A TOTAL LACK OF CONFIDENCE THAT THE PRICE WILL RECOVER.

 

WEALTH BUILDING PRINCIPLES -  BUY LOW, SELL HIGH

                All investment markets move in cycles.    Investors shift their capital as opportunities appear then disappear.  

              At the peak of the market cycle speculators with a short term investment objective dominate the market.   Activity is intense with speculators buying and selling to make quick capital gains.     Prices rise as more and more investors motivated by greed enter the market.  

              The boom does not last and when the demand lessens and there are more sellers than buyers the market drops and prices fall.  

              Most investors hold off buying until they see others buying and sell when others are.      They  rely on emotion rather than knowledge and  have a greater chance of suffering a loss as market values fall.             

 

CONCLUSION  

****  DON'T GET SWEPT UP IN THE EXCITEMENT CAUSED BY A SHARE WHICH HAS ALREADY RISEN DRAMATICALLY IN PRICE OR AUTOMATICALLY SELL WHEN THE SHARE PRICE HAS HAD A MAJOR DROP WITHOUT RESEARCHING THE SHARE.  

****  IF YOU DO YOU MIGHT WELL BE BUYING HIGH AND SELLING LOW.

 

 

WEALTH BUILDING PRINCIPLES -  RISK AND THE IMPORTANCE OF DIVERSIFICATION

RISK AND RETURN

                Risk in investment terms is the possibility that the expected return will not be realised.

              A general rule of thumb to investing is the higher the return the higher the risk.

              Investment assets can be broadly classified in terms of risk as follows:

 

Risk Level

                           Type of Investment

        9

High

Futures, Options

        8

Highly geared Commercial Property, Second Mortgages

        7

Mining, Oil Exploration

        6

Collectibles

        5

Gold, Silver

        4

More speculative Shares, Low geared Commercial Property, Highly geared Residential Property, First Mortgages

        3

Sound Shares, Managed Funds, Low geared Residential Property

        2

Commercial Bills, Local Body Stock, debt-free Commercial and Residential Property

        1

Low

Money Market funds, Treasury Bills, Bank Deposits, Government Stock

 

Thus, applying the risk/return relationship to the above table it can be said that investment in shares carries a greater risk than investment in bank deposits but that, conversely, likely return will be higher.

 

INVESTOR'S PERSPECTIVES

              The perspective of the rational investor is to:  

- maximise return.

- minimise risk.

 

DIVERSIFICATION

               Diversification means investing investment money over a number of different classes.   By doing so investors can take advantage of the potential benefits offered by higher return/ higher risk assets while balancing the overall risk in their portfolios.

              A well balanced portfolio would have investments with varying degrees of risk, depending on the circumstances of the investor.  

              For example, the following Table is an indication of the possible investment asset mix for different situations (excluding the personal residence):  

Category

Circumstances

High Risk

Shares, Managed Funds

Property

Fixed Interest

Young Person with no dependants

Probably will take a relatively high risk level in return for high returns

10

60

20

10

Newly married couple

Invest in a house so likely to have minimal external investments

5

55

20

20

Middle Aged with Dependants

Has 20-30 Years to retirement so will still have limited exposure to risk sectors 

5

45

20

30

Approaching Retirement

Becoming more Conservative

30

20

50

Retired

Preservation of Capital is paramount

10

20

70

                Furthermore, it is advisable to spread money:  

(a)  By Country- 

Usually when one country's share market falls, another country's share market is rising.   By diversifying your investment across several countries,  you are not exposed to the share market performance of any one country.  

(b)  By Industry-

It is important to avoid relying on any one industry.   Try to spread you investments over a wide range of industries.  

(c)  By Company-

Within any particular industry there are winners and losers.

(d)  By Currency-

You face the potential for significant losses if all your investments are denominated in the same currency.

   

CONCLUSION

****  DON'T PUT ALL YOUR EGGS IN ONE BASKET  

****  SUCH ACTION COULD RESULT IN TOTAL LOSS OF CAPITAL

IF THE INVESTMENT FAILS.  

****  DIVERSIFY YOUR INVESTMENT PORTFOLIO BETWEEN INVESTMENT  TYPES IN ACCORDANCE WITH YOUR CIRCUMSTANCES.  

****  FURTHER DIVERSIFY YOUR INVESTMENTS BY  COUNTRY , INDUSTRY, COMPANY AND CURRENCY.  

****  MANAGED FUNDS ARE AN EXCELLENT INVESTMENT VEHICLE FOR DIVERSIFICATION  AS THEY OFFER THE ABILITY TO DIVERSIFY YOUR PORTFOLIO OVER A NUMBER OF INVESTMENT TYPES AND AREAS AT A  COST MORE AFFORDABLE THAN DIRECT INVESTMENT INTO A DIVERSIFIED PORTFOLIO.

 

 

WEALTH BUILDING PRINCIPLES -  REPAY DEBT EARLY, OR START SAVING?

              There is no right answer to this question, but the following is a logical procedure which in the long run will make you financially better off:  

(a)   Pay off debts in the following sequence:

- first- high interest personal debt which is not deductible for income tax purposes e.g. credit cards, store charge cards, hire purchase.

- second- personal housing loans which are likely to be at a lower interest rate than the above.

e.g. if you had a $100,000 mortgage at 9.0% for 25 years and you increased your mortgage payments by $100 per month you would pay off your mortgage 7 years earlier and save $37,000 in interest costs on the mortgage.

-  last- business debt as interest on this can be claimed for taxation purposes.

(b)    You should consider starting a retirement savings scheme while you are still paying off the mortgage.  By doing so you are:

- getting into the savings habit.

- building up your knowledge of savings and investment options so you'll be better prepared to decide how to invest your savings when the mortgage is repaid.

- not only will you end up with a mortgage free house but you will also have a nest egg to use for further investment or consumption.

TAX PLANNING POINTS FOR THE PRUDENT INVESTOR

SPLIT YOUR INCOME

Under current tax legislation increased income is liable to a higher rate of income tax.  To counteract this give consideration to the name of the person you put on investments on which interest and dividends are received .   For example it would be advisable to put these in the name of a non-working spouse if the other partner is working.   If the working spouse is earning an income with a higher marginal tax rate this is likely to reduce the family income tax liability.  

 

INVEST IN ASSETS WHICH HAVE TAX FREE GAINS

Property offers the following benefits as an investment vehicle:

(a)  Any capital gain achieved is not taxable under present legislation.

(b)  Only rental income is regarded as assessable income.    All expenses incurred in earning that rental income can be claimed as expenses to establish profit/loss.

(c)  Highly geared property whereby interest paid on loans is in excess of rental and results in a tax loss means that the investor can offset this loss against other income, thus reducing the marginal rate of income tax payable.

Shares also offer capital gains which are not assessable to the non share trader.  

 

INVEST IN ASSETS WHICH HAVE TAX-PAID GAINS

These investments pay the appropriate rate of tax on your behalf, and credit you with the bonuses or earnings that are calculated after the tax paid by the fund is taken into account.

Thus you are not required to declare that income in your Income Tax Return.   Examples are Insurance Bonds and Superannuation Funds.

 

MAXIMISE YOUR TAXABLE DEDUCTIONS AND MINIMISE THE DEDUCTIONS THAT ARE NOT TAXABLE

Loans and Credit Card balances which are not business related offer no tax benefits and should be paid off quickly and before business related loans on which the interest cost can be claimed as a deduction against business income.

 

IF IN BUSINESS EMPLOY THE FAMILY

If in business employ members of your family who have a lower overall taxable income.   You must be able to prove to the IRD that the members are carrying out work for the business.    You will save tax at a higher marginal rate than the family member will pay, due to the low income rebates that can be claimed.

 

IF YOU PURCHASE PROPERTY CLAIM APPROPRIATE DEPRECIATION RATES AS AN EXPENSE

Break the purchase price down into asset type on the purchase agreement- a number of the improvements can be claimed at a higher depreciation rate than the building.

 

SUPERANNUATION

               Superannuation Schemes are intended to provide long term investment and financial security.

               Their features are:

(a)  the contributor makes a regular (usually monthly) payment.  

(b)  this payment can stay constant, or be increased at the investor's discretion or by a percentage each year.

(c)  the investor's contributions are locked in for either a pre-determined period, or until a certain age is reached (usually retirement age)

  (d)  as such the scheme gets the investor into the forced savings habit.  

(e)  the regular payments are put into a pool of funds which is administered and managed by a professional funds manager.  

(f)   the regular nature of the payments means dollar cost averaging benefits.  

(g)   the investor can choose where to invest his money among a number of funds.   These are unit linked and the value of the scheme is directly linked to the value of the units.  

(h)  gives the benefits of diversification to the investor.  

(i)   income tax is payable direct against the Scheme and amounts withdrawn are tax free in the hands of the recipient.  There is no need to include proceeds in your Tax Return.  

(j)   Superannuation should be regarded as a long term investment proposition, as in most cases entry fees are taken out of contributions early in the investment period which means that rapid accrual of termination value does not occur until late in the investment period.

 

MANAGED FUNDS

               Managed Funds enable investors to make lump sum investments and withdraw the proceeds quickly.

            Their features are:

(a)  Don't require large sums to enter as is the case with other investments e.g direct property.

(b)  Gives the benefits of diversification to the investor.   The pooling of capital among investors enables a managed fund to diversify into various assets which an individual investor of limited capital cannot afford.

(c)  Variety of objects-   there are a wide variety of investment sectors and types available- the investor can choose the fund depending on objectives.  

(d)   Professional Management-  a professional fund manager is responsible for the investment decisions and day to day running.  

(e)  Time and Knowledge, Ease and Convenience-  a Managed Fund is ideal for investors who lack the time or confidence to make their own investment decisions. 

(f)  Low risk- Managed Funds generally have no debt and therefore have lower risk than most public companies.  

 (g)   Ready Access to Funds-   Units can usually be converted back to cash at short notice (within 14 days on average), although some property trusts have a much longer redemption period.  

(h)   Switching Between  Funds- this option is available.  

(i)  Performance Information-   Units are valued regularly and prices available quickly.  

(j)   Competitive Costs-   the up front fee and the ongoing management charges compare reasonably well with direct investment into the markets.

(k)   Insurance Bonds, a type of Managed Fund, are taxed in the hands of the insurance company.    Therefore no income needs to be included in the investor's tax return.  

(l)   Managed Funds should be regarded as medium to long term investments and are particularly suitable for:  

-  someone intensely involved in money making opportunities.

-   investors wanting to relieve themselves of the demands of managing their own investments. 

    

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