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The Simplest Strategy for Retiring Early

The Simplest Strategy for Retiring Early

Getting to a financial position where early retirement is a real possibility is not as difficult as it may seem. There are three key ingredients to being able to retire early; spending less, saving more and starting to invest as soon as possible. What makes early retirement simple is that there is a logical connection between these three ingredients. The less you spend, the more you are able to save and the earlier you can start to invest. But the real magic lies in the fact that the less you spend, the less money you need for retirement. The more modest your standard of living, the sooner you will be able to retire.

An example shows this quite clearly. Let’s assume Peter and Sarah are a couple aged forty. They earn $95,000 after tax between them and they have a mortgage with repayments of $20,000 a year. They can save $15,000 a year which is initially used to pay off their mortgage by the age of fifty. Once mortgage free, they can invest $35,000 a year leaving them $60,000 to live on. By the time they are 65, they will have investments of around $660,000 (at 3% net return); enough to maintain their income in retirement at $60,000 a year, including NZ Superannuation of $30,000 a year.

Now let’s assume Peter and Sarah can save $30,000 year. They are able to pay off their mortgage by the age of 45 after which time they can invest $50,000 a year, leaving them $45,000 to live on.  By the time they are 56, they will have total investments of around $690,000; enough to maintain their income of $45,000 in retirement. By saving more, they have paid off their mortgage much quicker, allowing them to start investing sooner, and to retire earlier. Simple!

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Financial Planning for Young Singles

Financial Planning for Young Singles

For young singles with a reasonably good income, life is full of possibilities. There is a lifetime ahead with many choices and opportunities along the way and plenty of time to recover from any mistakes made. However, choice can create uncertainty and confusion. It can be very hard to set goals when there are so many possible opportunities and unknowns. A financial plan is a set of strategies that help you achieve goals and without goals, it is hard to plan.

Rather than attempting to plan when there is so much uncertainty, it is better to focus on getting the fundamentals right so that when your goals become clearer, you are in a great position to move forward.

Know where your money goes. Your aim should be for your outgoings to be less than your income. Set up a budget in four categories – savings, your financial commitments (rent, insurance etc), your living costs (food, phone etc) and your fun money.

Set up an emergency fund. The golden rule of personal finance is ‘always pay yourself first’. Set up an automatic transfer so that every time you get paid, money goes into your savings account – preferably at another bank so it is harder to access!

Stay out of debt. Use your emergency fund for unexpected expenses, not your credit card. Save up for what you want to spend money on. It’s easier to save if you have a clear idea of what you are saving for.

Protect your wealth. Get some basic insurance cover for your personal belongings and to cover health costs or loss of income.

Learn how to invest. Get to understand your KiwiSaver as a way of learning about investment so when the day comes that you have a lot of money you will know what to do!

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Personality and Investment Decisions

personality-and-investmentPersonality and Investment Decisions

People who find themselves suddenly having to make significant investment decisions often feel overwhelmed, confused, or even afraid. They fear making costly mistakes which could jeopardise their financial futures. In most cases, fear stems from lack of information, understanding or experience which undermines confidence in making the right decisions. These emotions can bring about the very thing that is feared – that is, costly mistakes. Learning to invest is a bit like learning to ride a bike. When you first get on a bike, never having ridden before, your fear of falling off means you ride slowly with your feet ready to touch the ground, so you are much more likely to fall. Once you learn to proceed confidently with your feet firmly pushing the pedals, you have a quick, smooth ride with a low risk of falling.

Fear can lead to procrastination of decision making, or inertia. The cost of not making an investment decision or delaying it is the opportunity cost, which is the investment return that could have been achieved if the decision had been made earlier. Fear can also lead to panic decisions after an investment has been made, which can result in actual loss or in opportunity cost.

On the other hand, some investors are over-confident which means they take on high risk that can lead to disastrous consequences. Somewhere in between are those investors who stick to a narrow range of investment options they are familiar with and who lack the confidence to step outside that range. This means their investments can lack diversification resulting in increased risk or opportunity cost.

Investors often behave irrationally, without logic or reason, driven  by emotion. In the words of author Jason Zweig, “Investing isn’t about beating others at their game. It’s about  controlling yourself at your own game”.

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Putting Financial Plans into Action

Financial PlansPutting Financial Plans into Action

There is a big difference between knowing the right thing to do and doing the right thing. Just ask anybody who is trying to lose weight or get fit. There are endless books, websites and seminars that provide all the information you need to have the body of your dreams. In the majority of cases, the information does not produce long lasting results. When it comes to getting your financial affairs into shape, it is no different. In fact, some of the worst people at managing money are highly educated, financially literate professional people on high incomes. The principal reason they struggle to manage money successfully is that psychological factors get in the way. Everybody has a different relationship with money based on a host of underlying feelings and emotions. Childhood experiences of living in either poverty or luxury can impact on your relationship with money and whether you value, respect, fear, or even loathe money. Past experiences of significant financial loss or gain can affect your attitudes towards taking financial risk. Personality issues can also have an impact. For example, excessive spending is often an antidote for low self-esteem or depression. Being able to manage your financial affairs well is a combination of financial literacy and fully understanding your relationship with money. Financial literacy alone is just not enough. Once you understand the psychological reasons why you have difficulty managing money you can use techniques to manage them. Set goals for your life before you set financial goals, as a way of understanding your purpose for accumulating wealth. Write down your goals and share them with others who will hold you to account for achieving them. Set up your banking to manage your income, expenses and savings automatically. Changing your financial outcomes means putting your financial plans into action.

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Squeeze Your Budget

SqueezeSqueeze Your Budget

We are at the time of year when financial pressure is at a peak and every dollar needs to be used wisely. Before the mad Christmas rush, take some time to look at simple ways of cutting your costs and tweaking your income to free up spare cash for the holiday period. All it takes is some creative thinking, a willingness to try doing things a different way, and some time spent researching the best deals.

Take a look at your bank accounts. There is a great variety of types of accounts with different interest rates and fees. Make an appointment at your bank to discuss the options available and what would work best for you based on your spending and saving patterns. To compare interest rates and fees between banks, click here.

Consumer has two great cost comparison tools available. At Power Switch, you can find the best deal on power based on your usage patterns and at Tel Me (currently being redeveloped) you can research the best deal for phone, TV and internet. Life and health insurance quotes from a range of major suppliers can be obtained free of charge at Trade Me’s Life Direct website. Before you cancel an existing insurance policy, get advice from a broker.

After your mortgage or rent payments, food is your biggest cost and a key area to focus on for savings. Be clear about needs and wants when shopping at the supermarket. Saving 10% of your food bill can be a significant amount.

Other more creative ideas for saving include making better use of libraries and the internet instead of buying newspapers and magazines, using trainee students for haircuts and beauty treatments, and buying clothes from upmarket fashion recyclers. There is plenty you can do with a little imagination and time spent online.

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Prepare for Working Less

FishingPrepare for Working Less

While most of us say we can’t wait for retirement to be able to do all the things we’ve always wanted to do, the problem is how to fill in the thirty years or so after retirement. For some people, the prospect of giving up work creates a fear of loss of identity and loss of purpose in life, so they keep working well beyond the age when they should retire. This can create a problem for employers and co-workers who have to deal with the drop in work performance that inevitably comes with old age.

Research has shown that retirees who cease to contribute and to be productive and active, die earlier than those who continue to engage fully in society. However, being productive and active doesn’t necessarily mean continuing to work. It’s important to keep all aspects of your life in balance all through your life; that is your finances, home life, health, relationships, leisure time and your purpose in life. If work has taken priority over friendships and relationships with family, it is going to be much harder to fill the vacuum left by stopping work because relationships take time to build. If hobbies, sports and other leisure time activities have always been part of your life, it is easy to spend more time doing these things to take the place of work as a meaningful activity.  A balanced working life makes the gap left by stopping work smaller and easier to fill.

Cutting back on work hours over a period of a few years is a good way to transition into retirement. It allows you to gradually fill your non-working time with other meaningful activities, to adjust your living costs gradually to a lower level of income, and to save more for your later years.

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Peer-to-Peer Lending is Here

AgreementPeer-to-Peer Lending is Here

The core business of a bank is to gather up funds from investors to lend to borrowers. By charging borrowers a higher rate of interest than is paid to investors, the bank makes a margin which covers its costs and provides a healthy profit for its shareholders. The concept of peer-to-peer lending is to provide a marketplace where investors and borrowers can get together directly. That way, it is possible for investors to earn a higher rate of interest than a bank will offer and for borrowers to pay a lower rate of interest. In theory, it is a win-win for investors and borrowers.

Peer-to-peer lending services must be licensed by the Financial Markets Authority and follow certain regulatory requirements. The service is usually provided on a website and operates as a kind of matching system. Borrowers complete an application form online stating the amount and purpose of the requested loan. They must also provide personal financial information. The peer-to-peer lending service performs a credit check and assigns a credit rating to the borrower. Approved borrowers are listed anonymously on the website and investors can then select borrowers to lend to. The investor’s funds can be split among several borrowers so as to reduce risk. Funds are repaid by borrowers directly into the investor’s account.

For borrowers, the key issue to consider is the fees that are charged, especially in the event that the borrower is not able to keep up the repayments. Investors pay a management fee to the service provider and must consider the risk of not being repaid their capital or the interest owing and the risk that they may not be able to cash in their investment before the maturity date of the loan. For further information see information from the FMA here or from Harmoney (the only licensed provider) here.

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Be a Secret Saver

SavingBe A Secret Saver

Financial success comes not from a high income or a high level of education; it comes from the application of just one golden rule. It is that easy, yet that hard. There are five simple words in the golden rule, yet they are the most difficult words to put into practice. Those words are ‘Spend Less Than You Earn’. Some of the most highly educated, high income earners have the greatest difficulty following this rule and, at the end of their working life, find themselves financially far less successful than those on modest incomes who have learned how to put money aside on a regular basis.

The majority of the working population has the potential to save, but whether that is turned into reality will depend on attitudes towards life and money. Saving is a behaviour that is underpinned by psychological factors.

It is interesting that for those who have enrolled in KiwiSaver, the compulsory deduction of at least 3% of their pay each payday has been a relatively painless way to save and, now that KiwiSaver balances are building to quite large sums, the benefits of regular saving are clear to all. Most people are surprised at how quickly their own contributions have mounted up over time. Therein lies the key to how to Spend Less Than You Earn; and that is to be a Secret Saver.

A Secret Saver is someone who sets up a regular transfer each payday into a savings account that is hidden out of sight, out of mind – in other words, not on your list of internet banking accounts and preferably with a different bank than your other accounts. That takes care of the psychological factors. Saving then happens automatically and painlessly and there is no temptation to spend what you can’t see.

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Know Your Rights When Borrowing

CreditKnow Your Rights When Borrowing

Borrowing money is something that is often done at a time when emotions are running high, whether it is the joy of finding a dream home or the desperation of needing money to pay for unexpected expenses. Looking at the fine print of a credit contract can easily get overlooked at these times. It is therefore important to understand your rights under the various Acts of Parliament that protect borrowers. Your principal protection comes through the Credit Contracts and Consumer Finance Act, 2003, which is currently undergoing a major review.

Under current legislation your basic rights include:

  • Creditors must tell you the truth.
  • Any fees including administration and default fees must be reasonable.
  • You have the right to repay early
  • The contract can’t be harsh or oppressive
  • You can cancel in the first few days
  • You can ask to change your payments if you suffer unexpected hardship.

More information on your rights is available in a booklet published by the Ministry of Consumer Affairs called ‘Credit: What you need to know when borrowing money or buying goods on credit’, which can be downloaded here.

The Consumer Credit and Financial Services Law Reform Bill, which has now gone through its third reading in Parliament, introduces a wide range of changes, including:

  • Introducing a Responsible Lending Code for lenders
  • Better disclosure of loan terms and extending the ‘cooling off’ period for borrowers
  • Lenders must provide free of charge their standard form contract terms and costs of borrowing
  • Preventing goods from being repossessed unless they are specifically identified in the credit contract
  • Licensing of repossession agents and employees.

It is hoped that these changes will prevent unscrupulous lenders from preying on desperate people.

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Be a Confident, Objective Investor

confidenceBe a Confident, Objective Investor

The key to being a successful investor is to learn to overcome the emotions of fear and greed and make sound investment decisions based on objective analysis. Fear can lead to financial loss through missing out on opportunities to make a good return and through panic which can result in selling investments at the wrong time. On the other hand, greed can result in financial loss through poor analysis of the risks involved. Good investment decision-making requires objective analysis of potential risks and returns with a balanced view that is neither overly optimistic nor overly pessimistic.

Objectivity starts with determining your goals and objectives and the time frame for achieving them. If you have long term investment goals, don’t get distracted by short term changes in the market. Your strategy may need occasional fine tuning but if it has been well thought out, you shouldn’t need to make major changes.

Review your attitude towards risk and ensure your investment strategy is a good fit. When things are going well in investment markets it is easy to take on more risk than you should. Find the right balance between risk and return so you can achieve your goals while taking an acceptable level of risk.

Stay diversified. Markets can change quickly, and moving all your investments into one asset class increases your risk. Evaluate all the options you have. This might mean getting more information from an expert who you trust. Stick to the hard facts such as you would find in an annual report or investment statement and consider the trustworthiness and track record of the people involved.

Confident investors have a long term plan that they stick to; they do their research, they aren’t swayed by emotions such as fear or greed, and they are successful at building wealth.

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