How should you start your investment journey? What comes first? Is personal finance an itemized list? The answer is in the affirmative.
Personal Finance is about planning, keeping to that plan, and adjusting if necessary, to meet a predetermined financial goal. Whilst no one can predict the future, we can plan for it, and hedge against unforeseen circumstances.
So let’s use a couple – Mr and Mrs James as a guide. They are married, both employed and have a 2-year-old daughter Hawa, and they want to plan for their financial future. What are the steps? What should they/you do first?
First, do an internal audit of your present financial situation, write down your income. Income can be passive or active. Write down expenses, expenses can be one-off or recurring. Next, write down assets and liabilities; assets can be income-generating or non-income generating. Liabilities can be interest bearing or non-interest bearing.
What is important is to have this information, you don’t have to analyze it; just have the information as complete as possible, with dates, interest rate earned or charged. These are the source documents the financial planner will use going forward.
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So key deliverable from you at this stage is your Statement of Networth which has your income/expenses/asset/liabilities.
Next, get advice; get a financial planner. This can be a human or even artificial intelligence robot advisers like the Betterment®. Your adviser will take your cash flow and asset statement you have done and add new information including:
- Your investment objective: Why are you making this plan? Retire well? Save for school for child? Short term returns? Long term capital appreciation? What will you do with investment returns? Withdraw? Reinvest it? What is your expected target return?
- Your risk profile: What’s your view on volatility? Can you ignore short term volatility to gain long term asset appreciation? If you lose 25% in investment value today, will you sell? Hold? Buy more?
- Investment horizon: How long is your plan? Do you want to stay invested for five years? Ten years? When will you need your principal sum back?
- Do you have any constraints? Are you an ethical or green investor?
- How often do you want to review your portfolio?
It’s important you discuss and agree on these with your financial adviser; the answers constitute your “constitution” of investing. The answer will also introduce discipline to your investment process. These help your adviser build a profile and then give you an investment plan that includes an asset allocation statement. Asset allocation is the key determinant to investment success. It matches your investment expectations to available asset classes.
Key deliverables from this stage will be an investment Plan with an asset allocation schedule. The schedule should list assumptions the plan is based on. This is important because you will amend the schedule based on changes to the assumptions underpinning the asset allocation schedule.
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Next, even before investing a kobo in the Asset Allocation schedule, we have to ask three questions and make plans for them.
- How are we protecting Income?
- What’s our debt situation?
- Any plans for unforeseen expenses?
What happens to a debt or asset allocation plan if income is impaired? To be specific, if a parent dies, what happens? Death is a financial event; it has a serious effect on projected income, hence, that income must be protected. How is income protected? By buying life insurance. Thus, before proceeding with an Asset Allocation plan, the first thing to do is buy Life Insurance. Life Insurance protects income earned NOT life. I advise clients to purchase life insurance cover of minimum five times their annual income and consider life insurance that has an education element attached to it. Allianz has such a product. This is very important if the owners of the plan have dependents.
When I advise clients, I always focus on the Networth statements that score liquidity. Liquidity is how much the client has in net debt and expenses. If the client’s liquidity position is negative, then the plan is no longer an investment plan, but a debt reduction plan. The objective of debt plans is not to pay down 100% debt before investing but to create liquidity from available income and assets to make debt manageable. Debt can be managed and captured in the Asset Allocation schedule. Clients should not invest for returns until we address interest cost drag on liquidity. Simply put, why invest in bonds paying 12% when your credit card interest rate is 20%?
An Emergency Fund is simply three to six months non-discretionary expenses saved in cash or near-cash deposits. This is important because the asset allocation plan will require consistent financial commitment in investing, and the emergency fund acts as short-term protection to our plan. Take for instance a medical emergency; we will not want the investor to sell down his investment for this important cost, thus he taps from his emergency fund.
Implement your plan
Once you have satisfied the life insurance, emergency funds and debt, start to implement your plan to meet the asset allocation schedule. It is important to be religious in implementation. Pay yourself first with automatic deposits from your bank to investment plans. Be constant and seek managers who will charge lower fees. Fees and Inflation will remain the key dangers to your plan. You can’t control inflation but you can control fees.
A N100,000 portfolio that rises 20% means you earn N20,000 but if you pay 2.5% in fees, it means you pay 13.8% of your gains in fees. However, A N100,000 portfolio that rises 20% means you earn N20,000 but if you pay 0.5 % in fees, it means you pay 2.8% of your gains in fees.
Last point? Always watch your portfolio, review as appropriate.