Have You Checked Your Financial Health?
by Michael Moreau
“WHEN I SEE A PATIENT WITH CHEST OR STOMACH PAINS, A HEADACHE OR EVEN DEPRESSION, I ALWAYS INCLUDE, IN MY ASSESSMENT, QUESTIONS ABOUT HOW THINGS ARE GOING FINANCIALLY.VERY OFTEN, THE REST OF THE MEDICAL HISTORY WILL BE NEGATIVE, BUT IT IS THE FISCAL PROBLEMS THAT ARE CAUSING THE TROUBLE. IN A CASE LIKE THIS, A GOOD FINANCIAL ADVISOR CAN OFTEN HELP MORE THAN A DOCTOR.”
– PETER HANSON, M.D., AUTHOR OF THE JOY OF STRESS
Health is on our minds – exercise, nutrition, weight loss, stress, depression. But how many think of our financial health? Retirement counsellors tell us most people start thinking about it too late to make an impact.
There are seven essentials to consider when examining the state of your financial health. This article discusses three essentials: Do you have clear financial goals? Are you managing your cash flow wisely? Is your investment portfolio well suited to your temperament and comfort zone?
DO YOU HAVE CLEAR FINANCIAL GOALS?
“Life is what happens to you when you’re busy making plans.” The act of putting pen to paper forces an individual to be more thoughtful and specific. Ideas committed to paper can become goals that have substance. What is truly important about money to you and your family?
An in depth answer to this question will reveal your true nature, and ultimately what could be your financial goals. You now need to set a timeframe to achieve them. For example, “I want to retire in comfort” is too nebulous. You must be specific: “I will achieve financial independence and retire at age 63. I will have accumulated enough assets to produce $xx,xxx of annual income in 2004 dollars. This will enable me to enjoy one major vacation each year, three mini trips, support the two of us, and help the grandchildren.” You can visualize that independence, family and travel are clear financial goals. By stating these goals in your financial plan, you will more likely achieve them.
ARE YOU MANAGING YOUR CASH FLOW WISELY?
Wise counsel dating back to Babylonian times states: Live within your means while saving at least 10% of what you earn. Many people feel this advice is outdated. Much of society today encourages consumption in every form. Advertisements encourage us to consume before we have earned or saved, and simply pay it all back next year. The ‘Don’t Pay a Cent Event’ is one example. Other advertisements promote the accumulation of “loyalty points” for what reason? So that our spending habits can be monitored, enabling companies to market their product or service with uncanny precision. We are emotional beings, often influenced to do as we are told; we then justify our emotional decision for instant gratification with logic. However, people who manage their cash flow wisely have strategies to combat the emotional monster within.
What are the results of not having specific cash-flow management strategies in place? According to StatsCan, Canadians are now spending over 100% of what they earn. In other words, each year we are getting deeper in debt and many are finding that increasing debt loads have become financial and emotional burdens.
The current economic cycle suggests interest rates are on the rise. As of this writing, the Bank of Canada had raised its key interest rate for the second time in as many months. Higher interest rates will put ever more pressure on individuals’ cash flow. In addition, if current high real estate values return to traditional norms, much financial suffering will result.
I believe the only way for individuals to control and combat these negative influences is to adopt an affluent mind-set of frugality related to a vision of your future. In other words, do as rich people do. Decide in advance where you want your hard-earned money to go, and constantly remind yourself of your vision of the future and your financial goals.
You will want to read and internalize the messages from books such as "The Millionaire Next Door" by Stanley & Danko, "The Wealthy Barber" by David Chilton, and the classic by George Clason, "The Richest Man In Babylon". In my opinion, these are three of the most powerful yet simple books available to learn about positive spending and the saving habits you will need to enable you to enjoy financial peace of mind.
IS YOUR INVESTMENT PORTFOLIO WELL SUITED TO YOUR TEMPERAMENT AND COMFORT ZONE?
During the past three years, many investors have discovered that their investment portfolio was not suited to their temperament. It is only when there is a major pullback in investment returns that many people spend the time to analyze investment suitability. When your investments are increasing at a record pace of 20% per year, it is understandable to question why there would be a need to diversify. Amateurs and professionals alike were taken off guard when their beloved high-tech investments actually decreased in value. After experiencing the greatest boom in stock market history, they also lived through the greatest bust, the bursting of the high-tech bubble.
The most common investment today is the same as it was a generation ago – a one-year term deposit or GIC. Individuals are comforted by the fact that the actual capital is guaranteed. In turn they pay the price by accepting tragically low returns. While term deposits return capital plus interest, that does not mean they are entirely risk free. If inflation is 2% a year and these individuals get only 1% on a term deposit or GIC, their real interest rate is negative 1%. The purchasing power of their investment is eroding at 1% per year. To compound matters, if a term deposit is held outside of an RRSP, all interest earned becomes fully taxable. At the top tax rate in Ontario, of every $1,000 earned in interest income over $460 dollars of taxes will have to be paid.
Proper diversification is having a selection of different assets – capital guaranteed investment, such as term deposits, government bonds (not Canada Savings Bonds, which are only of value as a cash flow management vehicle), and ownership in companies or equity type, both domestic and international. You need to have the right “asset mix”, which will not interfere with your ability to sleep well at night. This is called the pillow test: If your investment portfolio makes you nervous, then you are exceeding your comfort zone and must make adjustments.
Some investors and advisors believe that diversification is simply having several of each asset type then riding out the storm. I believe in going further, in doing one’s homework by analyzing the investment and its managers well in advance of making any recommendations. It is equally important to monitor the performance and value fluctuations to ensure constant suitability in a client’s portfolio.
When I am approached to provide investment portfolio suitability analysis, I am astonished at the number of times I have found investment duplication in the name of diversification. I call this phenomena “diworsification”. When your investments are increasing and decreasing at the same time, you do not have diversification; you have a horse race.
Michael Moreau, CFP, RFP is a Registered Financial Planner. For comments or article suggestions, contact (613) 725-3447 or service@michaelmoreau.ca. The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
