Tag Archives: debt

Your greatest financial risk is not financial; it is physics!

Over the years as we have chatted to clients about financial planning we have settled down to the “big 5” risks that everyone faces and the resulting financial (and emotional) risks that they present to the person and their family. Simply put, these are (in no order of importance):

  • Dying too soon
  • Living too long
  • Disability
  • Funds for emergencies, and
  • Debt

A lot of the work that we have done with clients has been around identifying these potential risks and then implementing strategies to address them.

However, I have recently become convinced that there is a much greater risk that people face but that is hardly ever spoken about. I also think that this risk is likely to increase as the process of disintermediation increases.

Rightly or wrongly, Albert Einstein is often credited with saying that compound interest is the greatest force in the universe (or the 8th wonder of the world, or some other version thereof). And indeed, compounding is a significant force but I have become convinced that another scientist, Sir Isaac Newton, had much more to add to the debate.

Indeed, the “biggest” force that haunts people is to be found in Newton’s First Law of motion (you should have paid attention during science lessons). Newton One states that “a body will continue in its present state of rest (or motion) unless acted on by an UNBALANCED external force.” This is known as the rule of Inertia…or the tendency to do nothing or remain unchanged.

Simply put, we are all subject to Inertia and will continue to do the same things over and over unless we come into contact with an unbalanced external force. And that’s why people have personal trainers to hold them accountable to exercise and get them fit, that’s why we have seen an increase in the demand for life coaches and it is also the role of the financial planner.

Don’t get me wrong, I have no issue with people doing their own financial planning and/or investing. The problem is that they don’t! How else do you explain the father of 2 young kids who has no will 10 years after they were born, or the divorcee who has not changed beneficiaries on her life policy (or updated her will) or the employee who has not yet started saving, or the entrepreneur who has never submitted a tax return? I could go on…

The cold hard truth is that we are often our own worst enemies when it comes to things financial and it is my strong opinion that we all need an unbalanced external force in our lives to get us out of our inertia. As long as Newton’s First Law of motion holds, there will always be work for financial planners and for that I am very grateful! We have an incredible privilege as we help clients identify and manage their financial risks and then keep them accountable to address them.

 

 

 

Thanks to the regulators!

Just finished reading a book called the Money Secret by Rob Parsons http://www.themoneysecret.info/aboutrob.asp

There is no real secret – mostly it is just good old common sense with the bottom line being that your income needs to be greater than your expenses…but what was interesting is that it is a book written from a UK perspective which is unusual in that most of the finance books are written out of the US, so it gives some interesting insights into the debt problem in the UK.

We all know what a mess the US consumer is in and how much debt there is in many of the European countries too but it was also interesting to see how bad the situation is in the UK and just how much reckless lending there has been there…the stats are frightening (see below for some of them).

Which got me thinking again about the National Credit Act in SA and about what an excellent piece of legislation it is. It might have frustrated some people who have been trying to finance assets but on the whole it has protected us from ourselves (and the debt industry) and has also shielded us from a lot of misery and pain that is the result of over-indulgence in the rest of the developed world.

So well done to the regulators – take a bow on this one and may this piece of legislation go from strength to strength! Now we just need to start getting access to better information such as that available in many other countries (see below).

Taken from CreditAction.org.uk

Total UK personal debt

Total UK personal debt at the end of April 2010 stood at £1,460bn. The twelve-month growth was 0.8%. Individuals owe more than what the whole country produces in a year.

Average household debt in the UK is ~ £8,761 (excluding mortgages). This figure increases to £18,252 if the average is based on the number of households who actually have some form of unsecured loan.

Average household debt in the UK is ~ £57,915 (including mortgages).

Average owed by every UK adult is ~ £30,228 (including mortgages). This is 126% of average earnings.

Average outstanding mortgage for the 11.1m households who currently have mortgages now stands at ~ £108,809.

Britain’s interest repayments on personal debt were £67.9bn in the last 12months. The average interest paid by each household on their total debt is approximately £2,695 each year. According to PwC the average household will need to spend approximately 15% of net income purely to service the interest payments arising from this debt.

Average consumer borrowing via credit cards, motor and retail finance deals, overdrafts and unsecured personal loans has risen to £4,573 per average UK adult at the end of April 2010.

Today in the UK

  • The average household debt will increase by £0.10 today (it grew by £11.11 a day in January 2008)
  • 391 people everyday of the year will be declared insolvent or bankrupt. This is equivalent to 1 person every 51 seconds during the working day.
  • Citizen Advice Bureaus dealt with 9,562 new debt problems every day in England and Wales
  • The average cost of raising a child from birth to the age of 21 is £26 a day.
  • 1,000 people are seeking some form of formal debt rescheduling every working day.
  • 230,137 unsolicited telephone calls made to UK consumers daily by debt management and personal loan companies
  • In the last 12 months consumers saved an average of £2.76 every day
  • 2,000 Consumer County Court Judgements (CCJs) were issued every day in the first 3 months of 2009
  • 107 properties were repossessed every day during Q1 2010
  • Unemployment increased by 764 people every day during 12 months to end March 2010.
  • 1,940 people reported they had become redundant every day during 3 months to end March 2010.
  • 273 young people (18 – 24s) have become a NEET (not in education, employment or training) every day during the last 3 months.
  • £378,100,000 is the amount that the Government Public Sector net debt (PSDN) will grow today (equivalent to £4,376 per second).
  • £121,640,000 is the interest the Government has to pay each day on the UKs net debt of £893.4bn. This is projected to be £114m a day (£41.6bn) in 2010 – 2011 financial year.
  • 203 mortgage possession claims will be issued and 158 mortgage possession orders will be made today
  • 363 landlord possession claims will be issued and 238 landlord possession orders will be made today.
  • The UK population is projected to grow by 1,178 people a day over the next decade
  • 21.9m plastic card purchase transactions will be made today with a total value of £1.05bn.
  • 8.1m cash withdrawals will be made today with a total value of £530m
  • The average car will cost £15.13 to run today

Ignorance is not bliss!

There are many reasons that people get into debt, usually they can be categorised into one of the following three:

  1. Ignorance,
  2. Indulgence, or
  3. Poor Planning

Debt is often the symptom of some “other” issues but that is the subject for another post. In this post I want to look at the first category: ignorance. This is where someone has no idea of the real cost of the debt. For example, few people stop to think that the total cost of all the interest payments on a million rand house over 20 years is over R2.3million rand – R1.3million of that is interest!*

The National Credit Act has made it a lot easier for people to know the full cost of a financed purchase as the total cost of the item being purchased has to be displayed. This includes the interest, finance charges and even insurance charges. So if you are buying a car and financing it, you must be shown the full costs of financing it over the period for which you have opted and even advertisments are supposed to show this information (take a closer look next time you see one).

But one of the areas that has fallen through the cracks is the cost of having debt while trying to save at the same time. Consider the following fairly typical example:

  • Client A has a current account which is in overdraft of R7000. At the same time he has R11000 in a bank savings account just to see himself through any financial emergencies.

While the principle of an emergency fund is an excellent one, what he has not realised is the cost of keeping money in it while he is in overdraft.

Typically banks now charge a monthly fee for the “privilege” of having an overdraft facility on your account. One bank that I contacted today charges R57 per month for this (that’s R684 per year!). At the same time they levy an interest rate of 16% per annum on overdrawn accounts. On R7000 that amounts to R1120 per year – so the total cost of the overdraft is R1804 per annum.

Now at the same time, the positive interest that they pay on R11000 in a savings account is 0.25%, or R27.50 per year (this is criminal). So the real cost of this financial compartmentalization is R1776 per year! Of course the bank know that the client is wasting money and if you ask them, the would probably advise against doing this kind of thing but then again, if you dont ask, they make more money and that’s what they are there for.

So my advice is to use the money in the savings account to pay off the overdraft and then use the money you were paying into the overdraft to build up the savings account again. And better still, use a money market unit trust account instead of a bank savings product – you will get about 6.5% interest per annum (Capitec bank offer 7% on balances under R10000).

* interest rate of 10% per annum.

Unbelievable – is this a disaster in the making?

A total of 10.75 million consumers are in arrears, according to the Credit Bureau Monitor for the fourth quarter of 2009 – an increase of 160,000 from the previous quarter.

I read this yesterday and it seemed too bad to be true so I did some investigating and found the actual report http://www.ncr.org.za/publications/Credit_Monitor/CB%20Monitor%20-%20December%202009%20Q.pdf .It is worth reading but is somewhat depressing…a few things stand out for me. There are a total of 18.07million credit active consumers on the credit bureau’s databases in SA and of these, only 40.5% (7.3million) are up to date with their credit payments (see pie chart below). Almost 60% of credit is at least 1 month in arrears.

Picture1

The table below summarises the situation in SA very nicely…

Picture3

Picture2I am sure that there will be people somewhere who will be able to put a positive spin on this but we also need to remember about all the adminstered price increases that are coming into effect as well – electricity, rates, fuel, water – to name 4 and there is no doubt in my mind that things are not looking rosy for consumers and already (financially) stressed households.

So from a financial planning side, the old adage remains true – get out of debt before you invest!  Things might be manageable while interest rates are low but they are not going to stay low forever so use this opportunity to get rid of your debts and then make it a priority to stay out of debt.

Dilbert on Finance

The Dilbert cartoonist, Scott Adams, earned a MBA from Berkeley, worked at a bank (got held up twice at gunpoint), and is worth millions. So we presume he knows a thing or two about money. In an interview with the Akron Beacon Journal, Adams says he read about a dozen personal finance books and began working on one himself. However, he found it all boiled down to these nine points and he “couldn’t figure out how to fluff it up.”

1. Make a will.

2. Pay off your credit cards.

3. Get term life insurance if you have a family to support.

4. Fund your 401(k) to the maximum.

5. Fund your IRA to the maximum.

6. Buy a house if you want to live in a house and can afford it.

7. Put six months expenses in a money market account.

8. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement.

9. If any of this confuses you, or you have something special going on (retirement, college planning, a tax issue), hire a fee-based financial planner, not one who charges a percentage of your portfolio.”

If we adapt these to South Africa they might  read something like this:

1. Make a will (you are going to die one day and the consequences of not having one if you have beneficiaries is too great to contemplate).

2. Pay off your debt including your credit cards and home loan.

3. Get life insurance if there is financial risk at your death (i.e. you have a family to support or debts that need to be paid including estate duty).

4. Fund your pension fund to the maximum (that the company allows).

5. Fund your Retirement Annuity to the maximum (if you dont have a pension fund).

6. Buy a house if you want to live in a house and can afford it. I guess the same logic would apply to buying a car – if you can afford it.

7. Put six months expenses in a money market account (once you have paid off your debt).

8. Take whatever money is left over and invest 70% in an equity based unit trust or exchange traded fund (etf) and 30% in a bond fund or 100% into a balanced unit trust fund and never touch it until retirement. As South Africans, probably at least 20-30% of this should be offshore (i.e. out of SA).

9. If any of this confuses you, or you have something special going on (retirement, college planning, a tax issue), hire a fee-based financial planner, not one who charges a percentage of your portfolio.”