Thanks to the coronavirus pandemic, people's financial lives have been turned upside down. If this seems like uncharted territory, that is because it is. The pandemic brought the global economy to a halt, and salary cuts and job losses have reduced household incomes. So, what do we do? If your finances have been hit hard, here are a few simple steps to get you back to the basics of financial planning.
Work out your net worth
The starting point for any form of financial planning is knowing what you are worth now. In a nutshell, net worth is the difference between all that you own (your assets) and all what you owe, (your debts or liabilities). Knowing your net worth is critical as it helps you evaluate your current financial health.
If your assets exceed your liabilities, you have a positive net worth. Conversely, if your liabilities are greater than your assets, you have a negative net worth. Negative net worth does not necessarily indicate that you are financially irresponsible; it just means that — right now — you have more liabilities than assets.
Reviewing your net worth over time helps you determine where you are and provides a reference point for measuring progress towards your financial goals.
Budgeting is boring, but it is important to prioritise financial goals coming out of a pandemic. Covid-19 has changed the world in many ways. Personal and household finances have been thrown into chaos. Many people may have had to dip into emergency funds, retirement plans and possibly even taken on debt for various reasons.
Creating a budget is the first step to rebuild or revisit your short- and long-term financial goals to ensure you’re setting yourself up for a future of financial stability.
The lockdowns world over has taught an immense lesson on limiting expenses. Now that a lot of us realise we can spend lesser, a new spending plan with allocation to discretionary expenses is important. This could bump up the savings, which can help in creating an emergency fund.
One of things the pandemic bought to the fore is that an emergency fund is essential to ensure people are not caught out financially. Standard advice says an emergency fund should hold three to six months of expense, given that the circumstances are not normal, it would be wise to plan for a 12-month horizon. Build it over a period, start with a three-month plan where you initially contribute higher amounts and then build towards a larger amount.
Cover your risks
As important as the emergency fund, a hedge to cover your risks is equally important. A life and health cover with critical illness cover is a necessary investment. If the pandemic has taught us anything, it is that safety isn’t expensive, it is priceless. There is no point having a long-term investment plan, if you have no way to hedge against risks.
Therefore, it's important to build up your savings, and protect yourself through hedging your risks, before you even consider goals like retirement. At the very least, you should be insured against:
• Critical illness
• Total & Permanent Disability
• Personal accidents
• Death (this protects your family, if you are the sole breadwinner)
Reviewing your assets and liabilities will help create a plan to pay down debt. When you crunch the numbers down, it is easy to see that it makes financial sense to pay down certain debts. If you are paying more interest than you’re earning in interest, then you are losing money. It is important to identify the kind of debt you are dealing with. Money you borrow to buy a home is considered ‘good debt’, while some others such as credit card borrowings are considered ‘bad debt’ as they come at a very high cost. From a financial perspective, it’s smart to pay off your highest-rate bad debt first.
Reset your portfolio
One of the basic tenets of a financial plan is to identify your goals. Goals form a very important aspect of financial planning from a short, medium- and long-term perspective. One needs to factor in inflation to arrive at the amounts one may require in achieving these goals, especially important for the medium- and long-term goals. Simply put, inflation measures the rate of price rise per annum. If the price of food, fuel, clothing and housing are growing very fast each year then it means that your income will be able to buy less of the same thing. Alternatively, your income will have to grow faster than inflation so that at least your standard of living can be maintained
No one-size fits all
It is important to remember that financial plans are tailored to individual needs and there is no "one-size-fits-all" approach to goal setting. Second, financial planning is an ongoing process; many things may happen between today and your retirement. Your portfolio of assets - and long-term financial goals - may have to change. Factors such as marriage, becoming self-employed, litigation, or an economic recession are all milestones that directly impact your financial plan. During this unprecedented time, there may be an opportunity to revisit and adjust one’s short- and long-term financial goals to ensure you are setting yourself up for a future of financial stability.
Multiple sources of income
There are multiple benefits of having alternate income streams: income diversification; more financial options; faster way to achieve financial goals, be it debt reduction or retirement goal – it is a step forward to achieving financial freedom. The income investing strategy involves putting together a portfolio of assets specifically tailored to maximise the annual passive income generated by the holdings. The biggest advantage of opting for this strategy is that you provide yourself an additional source of income. The one notable disadvantage is that you forego the benefits of compounding interest because earned income is paid out instead of reinvesting
Stay calm and invest
In times of market crisis, investors behave differently, and inherent cognitive biases is observed which often lead to certain decisions. Sometimes, even the most seasoned investor could panic and be at loss for what to do. However, instinctive reactions do not always make for sound financial decisions. It is important to keep a cool head when the market is volatile and avoid being distracted by your emotions.
It is best you work with your financial adviser, read relevant market information, review your portfolios in an objective, unemotional and unbiased manner, and consider rebalancing accordingly.
- The writer is the Managing Director, Regional Head, Wealth Management for Africa, Middle East & Europe at Standard Chartered Bank
Standard Chartered Bank’s recently released its Investment Personality Study 2020 that talks about how individual personality traits can impact investment decisions and outcomes.