30 Apr Why on earth do I need a financial planner?
Let’s face it the thought about sitting down to discuss things such as investments and pensions is hardly something anyone of us really looks forward to and is hardly a topic of conversation with your friends.
This originally started out as an article about How To Become a Millionaire. But who cares about that?!
You see, despite the fact that I am a financial adviser I don’t really care about money and therefore aiming for a figure such as a million is irrational.
Why? What money can do for you is far more important than the money itself…. I am much more interested in how you plan to spend your money and what’s on that bucket list!
What I am going to cover is why it can benefit you including:
- What is Your Number
- Building a plan
- Achieving a plan
- The 8th Wonder of the World
- How to get free money – yes, you read that right
- Paying yourself first!
All of which can help you become a millionaire if you really want to…
What is Your Number?
What is “Your Number”? This is a number that is unique to you. It is the amount of cash you need to be able to access to allow you to cover all of your spending without having to work another day!
For example, if you were retiring tomorrow what income do you need to cover your costs?
This doesn’t need to be retirement. It could be, a windfall such as winning the lottery or selling your business. Some people refer to it as “FU Money” as it allows them to walk away from work!
That doesn’t mean they should – we all need a reason to get out of bed in the morning, and as one of my clients recently said to me: “there’s only so much golf you can play!” But what “Your Number” provides is CHOICE! Your choice as to whether to work or not; and what that work is.
To get to Your Number a general rule of thumb is take your expenses and multiply that figure by 25.
So, take your lifestyle i.e. your monthly expenses, your annual holidays, Christmas expenses, eating out etc. Let’s say these costs on average £3k per month, which is £36k a year.
36 x 25 = 900!
If you wish to spend £36k a year you will need a fund of £900k to give you a realistic chance of now running out of money. This is based on academic theory and research and is known as the “safe withdrawal rate” (W. Bengen, Journal of Financial Planning 1994). This theory states that if you take 4% out of an investment portfolio a year it should last a lifetime.
So, we need £900k. How do we get there?
£900k might seem a lot, but this includes pensions, savings, investments, possible release of cash from downsize of a home etc.
Of course, the larger your current lifestyle, the larger Your Number is!
Building your plan
To validate Your Number a good financial planner will review your:
- Lump sums expected
- Tax position, now and in the future
- Debts, including when and how they are likely to be repaid
- Benefits available, including state pension
On top of this, they should be looking at your bucket list and what one-off items you have and ensure these are added in. This could be things such as:
- Pay for children’s education
- Visit Hawaii
- Climb Kilimanjaro
- Spend Christmas in New York
- Watch a Lions test series
We then begin the “project management”. We take all these figures, agree on assumptions such as adding in the cost of inflation, and come up with a figure that accurately reflect Your (true) Number, and plan a course for that.
This plan will include things such as using ISA allowances, pension allowances and other tax-free savings opportunities so that your money is working harder for you and you are keeping more of it to yourself!
This is not a one-time thing. You see life happens. And life is a lot like planning any journey. You programme your sat nav on where you want to get to, but you need to be flexible enough to adapt to changes. Your financial planner should be working with you to help navigate and guide you as life may require the odd diversion.
Achieving your plan
So, back to my original question: How to become a millionaire….
I’ve previously written a blog about this which can be read at: https://osullivanfp.co.uk/how-to-become-a-millionaire/
The reality is most of us could become a millionaire with a bit of time and effort. This helps us to get to Your Number.
Although it requires some effort, this can be helped due to the 8th wonder of the world (more on that later), but the discipline to get there is significantly harder.
First thing we need to do is to save.
But this can be accelerated with free money! Yes, you can get free money – keep reading as I’m not quite ready to tell you about that yet.
The second thing is to cut our spending!
Why? This enables us to do more saving.
For example, do you hit a Starbucks (other coffee shops are available) on your way to work each morning?
Let’s say that costs £3 per time.
That’s £15 per week.
That’s £780 per year.
That’s £31,200 over a 40 year period.
Yes, £31k is far from being a million but we’ve not come back to this 8th Wonder of the World I teased you about….
The 8th Wonder of the World
Albert Einstein is credited with saying:
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
In simple terms, this means earning interest on your interest.
If we go back to that daily Starbucks. If you took that £3 per day and put it to one side, if it made on average 7% annually, after 40 years it would grow to £179,113!
That’s an increase of 5.8x from the £31,200 you have actually saved.
Yes, this is a far cry from being a millionaire, but my first point is you need to save substantially – and to start early. The earlier you start, the less you need to put away!
So how do we get to £1m?
If you saved £500 per month, earning 7% a year you would have £1.029m in 36 years!
You won’t earn 7% sitting in a savings account, but long term this is not an unreasonable figure you could earn if you invested in the stock market! Yes, there’s a risk with this, but there’s a risk with not investing also! A good financial adviser will take time take time to understand you, and help you understand the different types of risk. This article is for education rather than advise so I won’t go into too much detail on that here.
So, to become a millionaire in 40 years you only need to save £500 per month or £6k per year. Only!!
This seems like a lot, but free money can help accelerate this.
Where can you get free money – from your employer!
New pension legislation requires all eligible employees to be automatically enrolled into a pension scheme. You save £3 of every £100 you earn, and you receive an extra £5 to take you to 8% of your salary!
The average UK earnings in April 2019 was £30,420 per year (source: www.ons.gov.uk)
8% of £30,420 is £2433.60! This is a good chunk of the money you need to save, and it can be done without even thinking about – you just need to not opt out of your pension! In other words, do nothing and you get free money!
Furthermore, some employers will also match any additional contributions you make. If you saved an additional 1%, they would match it by 1%! This is literally free money, that you are leaving on the table!
In addition, you also get tax relief on your pension contributions. If you are a higher rate taxpayer this can reduce your tax bill! If you own your business, you can make contributions to your own pension and reduce your corporation tax bill!
All of this is less money in tax, and therefore more money for your future self.
I’ve focused on pensions here, but there are other allowances available which can save you paying tax on your savings or provide tax relief to reduce your tax bill. Making use of all your allowances can greatly reduce how much tax you have to pay, and therefore is money you wouldn’t have without taking the right advice to make use of them all. Free money!
Pay yourself first
So, we know now what we’re aiming for, what we need to save, and how we can access free money. The final piece of the jigsaw is paying yourself first!
For this example, we know we need to save £500 per month. We’ve saved £203 with our pension. We therefore need to save an additional £297 per month. Cutting out your morning coffee is over £60 toward this! Only £237 to go!
Saving an additional £237 per month seems a lot. But let me position this:
- How do you prioritise your spending?
- Direct debits?
- Where are you in the list?
As mentioned, the average salary is £30,420.
This is £2535 per month, which is £633.75 per week or £15.84 per hour for a 40-hour week.
In order to save £237 over a month, you will only need to save £15.84 for 15 days in the month!
We all work hard. Can we not save one hour of what we earn over an 8-hour day for ourselves, on just 15 days a month?
This is prioritising 1 hour of your earnings most days for you and for your future self.
Prioritising yourself and paying yourself first can make Your Number realistic.
Initially this could be diverted to paying off debt rather than actually saving, but this still counts. Once you clear that credit card, loan, mortgage, how much easier is it to save for you?
I am conscious I’ve talked about saving over 40-year period and most of us plan to retire much earlier than 40 years from now. My point is simple – the earlier you start, the easier it is. The later we leave it, the harder we need to work!
Also, you might not need £3k per month to live on! This will make the above easier to achieve. This is based on someone needing to save £1m! If you need less than £3k per month you don’t need to save as much. Although if you spend more you will need to save more!
I’m only scratching the surface in this article. It’s not easy getting to £1m. But it’s not unimaginable either. It requires some thought, some planning and some action.
Working with a financial planner can not only help you to design the plan and make sure more of your money is working for you, but they can also help you with the actions you need to take to make it realistic! The first action might be to pick up the phone….
So, if any of this strikes a chord please feel free to contact me.
The content of this article is for information purposes only.
No individual or company should act on this information before seeking appropriate independent professional advice first
The value of investments can go down as well as up and so you may get back less than you originally invested
The benefits to the treatment of tax will depend on your individual circumstances and may be subject to change in the future