From this weekend’s Australian Financial Review (a newspaper aimed at high-income earners, business executives, and wannabees such as myself =P): a series of case studies with an accompanying article about executives getting their financial affairs in order. They make me so proud!
The site is paywalled, but I thought you may enjoy reading a selection of the best case studies so I typed them up. I made plenty of comment on them in discussion with family, but felt you might appreciate having the opportunity to tear them apart yourselves. =)
Note: "super/superannuation" refers to retirement savings accounts in Australia.
[In the article]
[A financial planner] tells a wonderful story of a career couple who came to see him five years ago. Between them they earned $550,000 a year gross. Of their $350,000 after-tax income, their expenditure was $280,000 – spent on renting a prestige home, a full-time nanny, au pair, full-time cleaner, gardener, pool-cleaner and entertainment. [They wanted to buy a $2.2 million home, so] they were prepared to make the necessary sacrifices – renting in a much cheaper suburb, getting rid of all the staff thanks to the wife going part-time and agreeing private education would be high school only for their kids. They cut their expenses to $175,000 a year, saved the deposit and now live in their dream home.
I mentioned this to my mum, who promptly noted that the au pair was most likely eye candy for the dad… and the pool cleaner eye candy for the mum!
Case Study 1: Lawyer trapped in a spiral of hard work and high spending
Alan, 44, is a partner in a law firm earning more than $750,000 a year. His wife, Sarah, is the chief carer of their three children, aged 10 to 15. The couple has a 50 per cent mortgage on their $3 million home, $350,000 in super and other investments of $280,000. Their net worth is $2,135,000, about $1.6 million less than it should be based on his income and age[,] says Justin Hooper of Sentinel Wealth.
Although Alan first sought financial advice on whether to borrow in and out of super to build more wealth, his real concern was despite being in the top 1 per cent of earners he felt trapped working an 80-hour week to finance a big mortgage and private schools.
Even though he didn’t feel his family were big spenders, there was no surplus cash and he was worried he wasn’t building up investment assets. Motivated by providing for his family, he’d always believed money would buy freedom and was happy to work hard and make sacrifices. But the payoff was less time with family, which he countered by splashing out on holidays and purchases.
Solution The first step in giving him back a sense of choice was to look at a few scenarios – ranging from losing his job (which really scared him), dying and being disabled, to how to get to financial security as quickly as possible. This way he knew exactly what would happen in any of these situations, as well as how much he’d need to accumulate by age 55 to retire.
Six months of transactions from his bank accounts were analysed to show exactly how much was being spent across different categories and the impact “one-off” spends were having on his wealth creation. Then he got his basic ducks in a row via updating his will, trimming some unnecessary death and trauma insurance, beefing up disability cover and cutting premiums by 30 per cent by using his law firm’s group policy. He was paying almost 2 per cent in fees on his two super funds, so rolled them into one. He switched his mortgage, paying 0.5 percentage points less. And he started co-ordinating his investments as one portfolio, with a clearer strategy. Targets have been set up for June 30 each year for his super, debt and investment assets.
Case study 4: Barrister wants a new home
Paul, 55, is a barrister who earns $600,000 to $900,000 a year. The family home is worth $2.5 million, with $1.1 million owed on it. Paul and his wife, Anna, have about $900,000 in super and he puts household expenditure at about $300,000. They want to upgrade to a larger home, likely to cost about $3.5 million.
Paul wants to know how many more years he will have to work to finance the move. But it also transpires he is a nervous investor, having made two previous investments where almost all the capital was lost. And while he has a belief that “bricks and mortar is best”, he doesn’t want to tie himself to many years with a very high home loan.
Solution When Paul and Anna discuss their finances, it’s also evident they have different beliefs around money. Paul believes you have to work hard for money, you have to be careful with it and the sharemarket is very risky. Anna feels money can easily be earned so will always be there.
What they shared was the need to provide their family with a good home and enough resources for everyone to reach their potential. But Paul’s stress was because he couldn’t bring himself to trust advice.
“He wanted desperately to upgrade to the new home but didn’t want to have to work for too many years,” says adviser Justin Hooper. “He knew that he needed to maximise the return on his investments and he suspected that this would require an element of gearing which on the face of it seemed like a good idea anyway. But because he had previously lost money through investments, he was petrified to take risk and was very worried about how it all would work.”
After doing the numbers, the couple faced a few choices around going ahead with the more expensive home. For Paul to retire as planned at 65, the family would have to cut expenses by 20 per cent after that; or he could retire at 67 and expenses would need to be cut by only 10 per cent; or Paul would have to carry on working until 70.
Having such clear-cut choices gives Paul a sense of relief as he knows what the choices will be. The couple decide to go ahead with the new home.
Case study 6: Actuary worried about business draining healthy nest egg
Actuary Michael is in his early 50s and is an owner in a private consulting firm. His investments are worth more than $10 million and he has no debt on his $4 million home. His children are 23 and 21 and his wife works for charity.
Although he is financially astute and well-organised, he is concerned at how much his family is spending and wants to refine the administration and organisation of his financial affairs. He put his household expenditure at about $180,000 a year.
But he’s also really concerned about his consulting firm and wants to ensure that no matter what happens to the business, he and his family can retain their standard of living.
Much of his wealth is invested in high-risk assets and the business will potentially require capital injections in the near future. Michael was very concerned this may jeopardise the financial security he has created for his family.
Solution To help Michael plan ahead, a tool was put in place to track and categorise household spending. A decision was made to divide his assets into two pools – one “low risk” as a backup and the other “high risk” for longer-term investment. Plus, three scenarios were prepared to analyse the financial impact of a big blow to his business.
• Death/disability: it was found he had more than enough insurance in place so he and his family would be able to cope financially.
• Grey swan (his business slowly dies): given his small client base and concerns about larger firms competing, he decided that if the revenue reached a certain level, he would be able to achieve his financial objectives if it was sold at that point. He set a maximum drawdown for further investment in the business. But to reinvigorate the business and keep revenue growth, he has employed experts and developed various tools, adviser Justin Hooper says.
• Black swan (his business immediately collapses): thanks to dividing his assets into two pools, it’s clear to Michael the pool of “low-risk” assets will be able to sustain his lifestyle until the age of 66, after which he would have to dip into equity in his home. He also knows he would have to cut expenditure if this happened or find another source of income.
An important finding in tracking household expenditure is while Michael believed it was $180,000 a year, it was more than $300,000. The family has since become more aware of spending. “Up to this point, they had no limits on spending and whatever they needed was provided,” Hooper says. “The kids have never needed any perspective about the family’s finances and they had been provided with endless cash when requested.”
Enjoy!