5342121

With the current media hype around “economies” and “sovereign debt” and the like it’s not surprising many are talking about reassessing “risk”.  I must admit to often finding it amusing and sometimes distressing how often I hear of people reassessing risks after the “something bad” has already happened.

Focus on the right risk – DO IT NOW!

Having grown up in sunny Queensland (explains a few things?) I’m somewhat perplexed by the recent reports I’ve read regarding the “rediscovered value” of the traditional “Queenslander design” home. Essentially a squarish house built on stilts, often with a veranda or deck covering the bulk of the perimeter.  This design became immensely popular in the sunshine state due to their simple but efficient design – great ventilation underneath means a cooler home and no flooding and faster drying out after the frequent and significant downpours.  “Under the house” also provide ample opportunity for hanging the washing etc during those frequent “wet weeks”.

Stilts also mean the house can be easily levelled on any slope and even picked up and moved relatively easily to another location (in fact for our first family home after moving north we did just that).

Now I read that following this year’s floods (which we were told couldn’t occur ever with Brisbane’s dam, and certainly not anytime soon after years of drought), this traditional format is now (again) being seen as the best design for up north, especially in flood prone areas!  Really?  You don’t say!

The simple fact is the risk didn’t change, we just chose to ignore it until we were reminded.  Instead we focussed on the cost of housing, the increased upkeep costs, the proximity to the city or a range of other “potential sacrifices and compromises” we inevitably face when buying a home.  Practical, tried and tested Queenslanders were replaced by slab based southern styled Estate homes and McMansions with their “modern” look, complete with air conditioners and dryers.

So what’s this got to do with Financial Risk?

Well nothing really (unless you live in a flood-hit area of Queensland) but is an example of where the lack of experience with risk and perhaps more importantly understanding the true purpose, resulted in some seemingly obvious risks being left exposed, whilst ultimately less important issues were given priority.

It is certainly ideal to have all the lifestyle features you value in your family home – after all, you’ll hopefully spend a lot of time there so you want to be happy.  As with many things in life however we can’t have everything and therefore compromises are inevitable and choices must be made.  The problem comes when we don’t fully understand the true impact of these compromises and in particular the real risks we face.  Some may be unlikely but their effects are devastating and therefore must take priority over small increases in pleasure or function.

So with this in mind I thought it appropriate to look at some of the top Financial Risks people face and what to do about them.

Top Financial Risks

Emergencies

Almost always the start of financial trouble is an unforeseen emergency which whilst often small in size becomes the tipping point.  Access to a “rainy day” is a critical part of any plan.  Just important is a small surplus to allow this pool to be rebuilt as it is likely to rain more than once in your lifetime.

Less likely but potentially more devastating is expenses due to major medical illness.  By age 85, one in two (that’s half!) Australians will have had cancer, with around 114,000 new cases in 2010.  Fortunately more than 60% of those diagnosed survive at least 5 years after diagnosis but not surprisingly this can put a serious hole in your financial plans.

Tips#

  • Always maintain access to a cash reserve – at least a few thousand dollars
  • Make sure you have some surplus cashflow (after savings and investment commitments)
  • Maintain reasonable level of Trauma Insurance for everyone in the family 

Protect your cashflow

In periods of increased market volatility many people become keenly focused on the value of their investments.  Whilst this may seem logical, as we’ve mentioned more than a couple of times, “it’s all about cashflow” and therefore this is what actually needs protecting.  If the earnings of an asset continue to rise over time, it will most definitely be worth more in the future, when it pays more income, than it is now.  Therefore the best and only real way to protect capital is to ensure income will be greater in the future.  Earnings growth drives capital growth – NOT the other way around.

A quick look at most families Real Balance Sheet shows the most valuable Assets is the 1 or 2 income earners.  Let’s compare the potential losses associated with a 35 year old major income earner ($100k pa):

  • Vehicle written off                                        $50,000?
  • Home contents lost or destroyed             $100,000?
  • Home (building if destroyed eg fire)          $400,000?
  • Lost income if can no longer work        ~$6,000,000[1]

Given the value of future earnings it’s insane there are still so many people without adequate Income Protection Insurance.  To replace this 35 year old’s lost earnings you’d need around $1.75M today.  Even at $60,000 per annum you’d still need over $1.0M.  That’s the real Financial Value of an individual as a financial asset and you just don’t leave an asset that big exposed.

Even if you’re retired and no longer have any earnings to protect, you can still be exposed.  Many a retirement has been significantly altered by the incapacity of a son or daughter-in-law.  Ensuring your children are properly covered isn’t just responsible parenting, it’s sensible retirement planning for you as well.

Tips#

  • Focus on the value of the cashflow your Assets are producing – If the market price is too low, consider buying more, if it’s too high considering swapping for something better priced
  • Review your Income Protection at least every 3 years – if you don’t have any GET SOME!
  • Unless you want to fund their retirement to – make sure your children and their partners are insured

Summary

As I’ve mentioned in recent months, the earnings of many good companies around the world are in good to great shape and as such the real value of their shares is much higher than current market values.  Since real value is what ultimately matters, anyone with a properly structured investment portfolio should ultimately be well protected.  Of far greater concern is the protection of the most significant cashflow source – the income earner.  Too often this is exposed and the results can be far more devastating and permanent than any sharemarket “crash”.   Companies are still making profits so cashflow will continue regardless of any “crash” – if you can’t work cashflow WILL stop!

It’s heartbreaking when people come to us for advice on “what to do now” when they really don’t have the financial resources to deal with misfortune.

It is so relatively easy and painless to make sure this doesn’t happen to you or your family.  If you’re not sure please, let us prevent it rather than try to help you deal with it after the fact.  We certainly hope it doesn’t happen to you, but unfortunately, with the number of people who receive this newsletter, many hundreds, if not thousands will experience misfortune and it doesn’t have to ruin anyone’s financial future.

 

[1] Total future earnings

Matt Battye

Matt Battye

CEO, Financial Adviser

Analysing what can seem to be like complex issues, Matt is effective in using analogies to better explain scenarios and truths to the rest of us. This is what Matt enjoys – educating clients on the truths and debunking the commonly held (wrong) view.

Share This