Let’s start at the beginning. The beginning is the end.
At the end of the journey we look at our balance sheet. Our assets vs our liabilities (let’s hope we don’t have any debts at that point), our net wealth or in accounting speak, our equity.
There will be a number and that number is what others will inherit.
The first question you need to ask is where did that number come from? Where did the money come from? If we go back and track the dollars as they entered your life, what will we find? Where did the money (net wealth or equity) come from? The answer is one of only two places:
- Savings (the difference between money in and money out)
- Increase in value of something your owned
Before I go a bit deeper into each of these two points (saving and owning) I would like to tackle the why of it all…why bother…what is the point of accumulating wealth? This borders on a philosophical question, but it is important to focus the mind on the bigger questions from time to time as we get lost in the minutia far too often.
Why accumulate wealth?
My answer (which is an answer and not the only answer) to that question would be: So that we can attain financial freedom. Independence.
What is financial freedom?
When you can generate enough income from your assets (capital) to sustain your target lifestyle. This is income that otherwise would have come into your life in exchange for your time and labour.
There is an important insight here that our financial journey is one that begins with exchanging our time and effort for income to gradually transitioning towards collecting our income from capital. This gradual transition of how we source our income is the essence of financial planning.
What is enough income?
Now that is a good question that I want to dwell on a little.
The answer to this question is very personal and one that is born out of choice.
Do you choose to:
- Live in a Capital City, near the city or far away
- Educate your kids privately or publicly
- Have cheap or expensive holidays
- Buy whatever you want when you want or be disciplined
- Pay for a wide variety of extra-curricular activities for your kids
- Eat out on a regular basis
- Buy new clothes regularly
The choices we make define the level of freedom we have.
Let’s imagine that enough income was $100 per annum and that you could live within that number and achieve your life objectives. If that were the case then you should be able to retire now if you had about $2,500 (assuming a 4% drawdown rate).
Viewed another way, every time we spend money, we are cashing in a lifetime income stream. So every $100 spent reduces or annual income by $4 a year (indexed) forever.
As a general rule, the more you spend the less free you are. If you can define the target income, let’s say $50,000 per annum, then you can start looking at the maths and models of how to generate that and the amount of capital and assets you need to generate that income. If your capital can generate that income in a sustainable, lifetime, inflation linked manner then you are retired.
Definition: Retirement
That point in your life where work is optional. It only becomes optional if you have enough assets that can generate enough income. If you arrive at this point but chose to work then you are doing so for lifestyle reasons and not financial ones.
Here are some core concepts of wealth creation and it’s important to understand them and the way they interact with each other.
Wealth demands discipline
Wealth is created through investing in assets that appreciate over time, and this requires capital. Unfortunately there are only two legitimate ways to access capital – saving or borrowing.
The right decision at any stage of your life depends on your personal assets and liabilities, your goals and your position on the lifetime clock. Making the right decision demands that you sit down and define some clear life goals and a plan that will help you achieve them. Once you have a goal and a plan, it becomes much easier to evaluate the pros and cons of a saving or borrowing decision.
Just having a plan makes you more likely to become wealthy
One of the main differences between financially successful people and the rest is that they have personal goals that are important enough to strive for. If there is a price to be paid, they will pay it in order to reach their objective. At the same time, just wanting something badly enough will not make it happen. You also need a plan that will help you reach those goals.
An effective financial plan is like a bridge that will take you from where you are now to where you want to be, except for one vital difference. Instead of being fixed and immobile like a real bridge, a financial bridge has to be flexible. The reason for this is simple. When your life or the outside world changes, your goals may change too. If they do, the plan has to be adjusted to take the changes into consideration.
Time AND Timing are important
“The great French Marshall Lyautey once asked his gardener to plant a tree. The gardener objected that the tree was slow growing and would not reach maturity for 100 years. The Marshall replied, ‘In that case, there is no time to lose; plant it this afternoon!’” John F. Kennedy
Buy quality assets at fair value (timing) and let time do the rest. Most of the wealth I have seen clients accumulate over the years took a long time to arrive. You will rarely see anyone that bought an asset at a very bad time and still came out with a good gain. It is not fair to say that time or timing is the only thing that matters. They both do.
It’s not effective unless it is tax effective
It is certainly true that the tax burden on wealthier Australians has eased considerably over the last couple of decades, but it is still there and, in a tightening fiscal climate, it could rise again.
While it may be fair that those who have more pay more, there is no need to pay more than you have to. Seeing a financial adviser ensures you are fully aware of the tax implications before you make a decision.
There Is No Miracle Cure
Successful financial planning is always personal and individual. If you could achieve it just by applying certain formulas then you would fire all advisers and do it all on a computer.
Good plans shape good decisions. That’s why good planning helps to make elusive dreams come true. Lester R. Bittel
At the same time, you should appreciate that there is no standard prescription for wealth creation. Wealth creation is a bit like practicing medicine and has a couple of things in common. A successful outcome depends on accurate diagnosis and appropriate prescription and a cure cannot be effected without the cooperation of the patient. You can tell a heavy smoker he is courting death and advise a nicotine replacement therapy to help him quit, but you can’t force him to follow your advice. You can take a horse to water..
In the same way, a good financial adviser will take a careful case history, help you define and rank your personal goals and prescribe a plan or strategy that will enable you to achieve them, but none of this will be effective without your commitment to the goal and your determination to make the strategy work.
