For years now I have been banging on about the need for proper financial planning. It’s often a lonely experience as the weight of the media thrusts its consumerist propaganda of sod the future live life now buy whatever you want because “you’re worth it”. This kind of reckless spending on the debt fuelled merry-go-round is exactly what got us (and our governments) into the current financial crisis.
In their book “The Millionaire Next Door”, Thomas Stanley and William Danko examine the conundrum of why so many people who live in expensive homes and drive luxury cars are not actually wealthy. I was reminded of this last week when a potential new client came in to my office. I have changed some of the details to protect the innocent and ensure they remain anonymous but I feel a need to share the story and highlight the real issues facing lots of people today; not just people who appear to be in financial difficulty either.
A couple came in to see me, let’s call them Vincent and Flavia for the sake of argument (I’ve obviously been watching too much Strictly Come Dancing recently!). Vincent is nearly 60 years old while Flavia is nearer 50. Vincent has worked all his life in well paid professional positions earning a six figure salary. Flavia has never worked, preferring to stay at home and raise the family who are now self-sufficient.
At the start of the meeting Flavia explained that she thinks they need “one of those financial plan things” as she has only recently found out that they have no plans for the future; and I mean literally no plans for the future. Until this point Vincent has handled all of their financial affairs but he says he doesn’t need to save anything as he isn’t going to stop working. He likes working and will work until he “drops”. In fact, he thinks pensions are such a waste of time that he opted out of his employer’s scheme years ago. The truth may actually be that he is too embarrassed to admit to Flavia that he hasn’t been saving for the future and now realises it may be too late; but that’s a whole other discussion for another day.
After an initial chat to find out what they want their future to look like, we started to build a very rough financial model of their affairs together. We do this in our first meeting with clients to let them experience the difference between true financial planning and the product-focused financial advice they may have encountered in the past. We often find that it is almost impossible to explain Financial Planning but as soon as client’s experience it they just get it.
We started the exercise by entering approximate income and expenditure figures into our financial planning software. I explained that if we both agree to work together we will need to dig much deeper and gain a proper understanding of “what’s coming in?” and “what’s going out?” both now and in the future. However, for the purposes of the demonstration a very rough estimate will suffice.
Next we looked at their assets and entered these into the model. They have a very nice house in a good neighbourhood. The house is worth £750,000. Unfortunately, they still have a mortgage of £675,000 outstanding. Not only that, but the mortgage has been arranged on an interest only basis until the latest age the lender would allow (70). They only make minimum interest payments each month as this keeps outgoings to a minimum and allows them to enjoy a very nice lifestyle. However, the outstanding debt stays at the same level year after year. They haven’t thought about how they will repay the loan when Vincent is 70 and currently have no means of repayment in place at all.
In addition to the house and mortgage, they drive very nice German luxury brand cars with outstanding finance against them. They also sheepishly hinted at “a couple of other loans” but no further details were forthcoming. They dressed very well and obviously spend money on their appearance.
They enjoy nice holidays abroad on a regular basis. When I asked what savings and investments they have at the moment they said, “a few thousand pounds in the bank, that’s it”. Sorry? Effectively, they have no savings, not even a basic emergency fund.
I explained that, although we had only gathered enough information for a very rough overview, their position was clearly not good. They will not be able to afford even a basic standard of living (let alone the standard they have become accustomed to) for more than a few months after Vincent’s income ceases.
I also pointed out that the decision to stop working may not be in Vincent’s hands. How would Flavia cope if Vincent had died yesterday? There is some very modest life insurance in place but it wouldn’t even cover the mortgage let alone future spending. So basically Flavia would be left destitute. I asked if she had ever thought about getting a job but this didn’t seem a realistic option to her. In which case they need life assurance and critical illness insurance (which is likely to be extremely expensive at age 60). Depending on the contract of employment, Vincent may also need income protection insurance as his salary may stop immediately if he suffers ill health. However, every pound spent on insurance is a pound that is not being invested for the future which they also need to fund (and quickly!).
This is probably the worst case of a lack of Financial Planning I have ever seen but it would surprise you how many people who appear wealthy are actually stumbling through life overspending today and ignoring tomorrow. Our whole society has become possession and lifestyle obsessed. We want the latest fashions, gadgets, cars, holidays and houses and we want them now. As Queen once sang “I want it all, and I want it now”. In a little over a generation we have degenerated into a nation that, just like petulant children, feel it is our right to have what we want when we want it and damn the consequences.
I often say that we are in the people management business, not the investment management industry. Financial Planning is really pretty simple but that doesn’t mean it’s easy or that everybody can do it on their own. Sometimes a good financial planner’s job isn’t to sell a fabulous investment opportunity but just provide a simple reality check. Financial Planning isn’t rocket science. At its simplest level it is just a matter of spending less than you earn and saving the rest. As our lives become more complex with families and commitments we will need to think about strategies to protect our current situation and our loved ones such as life assurance and income protection.
Once the basic discipline is instilled and the level of assets increase, we can move on to diversifying risk and creating a suitable investment portfolio to fund our future goals but at the core the basic principles still apply. We desperately need to change our attitudes to consumerism starting with ourselves then our children. We urgently need good financial education in schools but that doesn’t mean that, as parents, we can simply abdicate responsibility. Financial Education needs to be a partnership of joined up thinking. Changing lives and attitudes towards saving and debt will take years, possibly generations but we need to make a start. That is why initiatives like Financial Planning Week are so important.