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Your ‘Funky Financial Framework’ – Blog 184

informed decisions blog

Your ‘Funky Financial Framework’ – Blog 184

13th September 2021

Paddy Delaney

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This piece will be helpful to you if you have any of the following emotions/concerns in regards your personal finances:

  • Not sure if your money is ‘working hard’ (I hate that expression but it summarises a lot for a lot of people!)
  • Not sure should you put money here or there!
  • Unsure if you are doing the right thing with your money

The author of the legendary ‘7 Habits Of Highly Effective People‘, and hugely successful business-person Stephen Covey is usually attributed with the following:

“The main thing is to keep the main thing the main thing”

Stephen Covey

I came across this quote again recently, and I love it, and think you should too! Why? Well, if we live by it, it encourages us to keep ourselves pointed in the right direction, and importantly, to keep our priorities as we want them to be. It can help ensure that we live a life we as few regrets as possible!

There really is no more applicable aspect of life to which this applies than in our personal finances. However, based on my own experiences, our personal finances is the one area in which many people struggle to keep themselves pointed in the right direction. They get distracted, disheartened, confused, disorganised and unsure of what their ‘main things’ are. Personally, I believe there are many reasons for this but one of the primary ones is due to a lack of structure and organisation.

At Informed Decisions we are repeatedly approached by potential clients seeking a MasterPlan to aid their personal finances. Quite often, once we have learned about them, what they really want is for someone to help them become more structured. They want simplicity and help to determine and achieve their ‘main things’.

We love simplicity, and where we are a good fit we gladly help them achieve it. But, for most people, engaging an independent financial planner is probably not necessary. Having a simple and proven structure to apply to their own finances can and will help most people in Ireland. Therefore I’m sharing (and probably repeating!) what I believe to be a perfectly suitable structure for most of us to aspire to, no matter your financial status or stage in life. This will be short, but hopefully sweet for some of you.

In keeping with our desire to create even more acronyms for personal finances, I introduce you to FFF (Funky Financial Framework!) 🙂

The Foundation Of Your Structure – In Your Personal Finances

But first, any structure relies on a foundation to keep it standing, in good weather and bad! So first things first; income! If you living expenses but no income then you’ll not get far right! Whether that income is earned income (PAYE/Self Employed), investment income (dividends/rental etc.) or passive income (Services etc) doesn’t matter a jot; once it is recurring and reliable.

Speaking of reliable, if it is a case that your income were to be significantly impacted were you to become ill or to die, and you have dependents who would need that income to continue, you really ought to have some form of Replacement Income in place. Whether that is using your other assets, or some form of Insurance (Life Cove, Income Protection etc) matters not a jot again, once it is sufficient and reliable.

Ideally, your incomes will exceed your expenses. If they don’t you might first look at ways to reduce your expenses (theoretically the easiest route!), and then ways to increase your income. Personal Finances 101!

Funky Financial Framework – Personal Finances

Below I outline the 4 key aspects (Pillars) of a simple yet proven and elegant financial life. You can of course make it more complicated if you want to, but you don’t NEED to! Indeed, making it more complicated will undo the good work that you do if/when you apply this to your finances. Complexity might seem great and adventurous but you’ll likely be pining to revert to simplicity after a period of time.

Pillar 1:

Call it what you will but a segregated fund that will cover any unexpected and urgent financial need is a must for us all. Let’s take a leaf from Kel Galavan’s book and call this our ‘Rainy Day Fund’. It will likely earn zero interest but it serves a very important role – it allows you the freedom to make full and proper use of your other pillars, without having to look over your shoulder. An accessible deposit/state saving account is usually A1 for this type of account.

How much should you have in it? It is a personal choice really, based on what you feel most comfortable with. A typically guide would be to have between 3months and 12months total living expenses in it. I work with some people who will have somewhere in-between, and others who much prefer to have several years’ worth of expenses in this Pillar. It is a personal choice based on your outlook, and your financial capacity to bear urgent and unexpected need for cash.

One note on negative interest rates on deposit accounts. If you place a significant importance on this Pillar then you’ll view a negative interest charge on this account as ‘par for the course’. You’ll perceive this account as serving an important purpose for you, and you’ll take that hit (I won’t say gladly, but you’ll take it!). Please don’t allow the fact that you might pay negative interest charge as a motivator to expose this Pillar to volatility. While it would be understandable, it would make very little sense from a planning/access/future need perspective. Cutting-off-your-nose-to-spite-your-face kind of a thing!

Pillar 2:

I believe we should then have an allocation to our medium-term future objectives, priorities and hopes. Some ideas you may be aspiring/planning for over the coming 10 years:

  • Pay for a loved-ones education
  • Build/Buy a new home
  • A sum of money to enable you to step back from work without having to draw your pensions
  • Gifting/Supporting loved-ones financially
  • Nursing Home Fees
  • Health expenses
  • Buying ‘that’ Porsche 🙂

If and where that particular outlay is likely to happen within the next 5-7 years I suggest that the cash is kept in non-volatile assets. Particularly so if/when you will need that particular asset at a particular date within that 5-7 years.

‘That’s very conservative’ you might say. And it is! Particularly when you see that, using equity as an example, a well diversified 90% Global Equity and 10% Global Bond portfolio has at least held it value over 90% of all historical rolling monthly periods of the past 100 years!

So a 90% success rate, but what happens if you need to access your pot in totality at the same time as the 10% of outcomes. In that case you’ll withdraw your pot at a loss, and potentially a significant one. Unlike a pension where you are only drawing 4/5/6% per year and the long term outcomes are far more favourable because of that fact, and the duration – with Pillar 2 you’re more vulnerable. If your Pillar 2 timeframe is closer or more than 10 years we can likely afford to be a bit more adventurous, if you really insist!

Pillar 3

For most of us, our longest term investment in our personal finances will be done through our pensions. Last week we wrote about the ‘dangerous middle‘, which can and is very applicable to our pension planning.

Pillar 3, whichever route you take; pensions/property investments/other alternative assets, should be do so with the intention of achieving growth in excess of inflation over the long term. In doing so you will likely need to expose your investments to volatility. This is particularly the case if you want to preserve the purchasing power of your money.

Lets assume that long term inflation will be 2.5%, and that you’ll pay fees in the region of 1 to 2%. Even before tax on growth you need to achieve 3.5% to 4.5% just to stand still! You can see why middle of the road simply won’t and doesn’t cut it for most investors who want to beat inflation, fees, taxes AND achieve some real growth!

The taxation of the asset growth is a key consideration that can and will swing the outcome one way or the other. Nevermind the tax relief you can get on the way into them, the fact that pension assets grow tax free is one of the biggest advantages they hold, yet remains largely unknown and often under-utilised.

The decision of how much to put into your pension should be driven by a couple of factors depending on your situation and personal finances:

  • How much income do you want your pension to provide for you, and when?
  • Fund it accordingly based on prudent and time-tested assumptions!

But in reality the following also come into play for many:

  • How much can you put in tax efficiently personally?
  • Does your business have spare cash that it can avail of Corporation Tax relief by putting into your scheme?
  • When times are good you’ll fund it, when times are tight you won’t!
  • Blog 81 hit a lot of this stuff

Pillar 4

Most of us like to try and squeeze ‘that little bit extra’ from something in our personal finances. We like to push the boundaries, take some big risks, and try to ‘go for more’. I wholeheartedly encourage you NOT to do that with Pillar 1, 2 or 3.

If you feel you simply must ‘take a flyer’ with some of your money, then please restrict that to a small % of your overall pot, somewhere around 5 to 10% ideally. It must be money that you can lose without it having a negative impact on your ability to live the financial life you want, and without getting emotionally scarred by it!

Some unregulated and genuinely risky ideas that people are investing in with their equivalent of Pillar 4:

  • Crypto
  • EII Schemes
  • Structured Property Syndicates sold by Brokers and ‘advisors’ (who typically get a 5% up-front commission of whatever you invest – it being the only reason they might suggest it’s a ‘good idea’!)
  • Buying/Holding individual company shares

I was tempted to leave Pillar 4 out of the FFF entirely but realise it is a part of a lot of our personal finances – and that by embracing it in a controlled aspect of our finances we are both satisfying a want in a lot of us, but also ensuring that the remaining 90 to 95% of our FFF is prudently positioned.

Conclusion

That’s it!

Simple? Yes

Effective? Yes

Proven? Yes

Keeps you honest? Yes

Helps you focus on priorities in your personal finances? Yes

Helps you keep the main thing the main thing? Absolutely!

Thanks for reading,

Paddy.

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