There are three levels people adhere to when it comes to managing money, writes Charlie Weston, which level do you live by?
FEW people really track their finances to see where all their money goes.
That’s why, here in Ireland, we have a much lower rates of financial awareness compared to our Scandinavian neighbours, according to personal finance expert Frank Conway.
But tracking our money can be a lot easier if we just employ a few simple tricks and then do a little bit of personal money investigation for a few months, he says.
How we spend our money is just an extension of the type of lifestyle we really want, constrained only by the income needed to fund it.
And that income matters, a lot.
Some people, if they had an extra amount of money, perhaps €500 or even €1,000, might live it up and buy a really nice leather handbag, or trip away or new set of furniture for the living room, Mr Conway, the editor of Irish Finance Review, says.
For some families, the constraints of income are enough to dampen spending on the desirables. For others, credit can fuel a lifestyle that is false and costly.
So, how much will your lifestyle cost you?
Throughout your life, you should factor for three primary expenses: home, family and retirement. For each item, there are key financial filters that will help you evaluate how to factor the costs and plan for them to ensure you achieve your goal – those are needs and wants.
Put simply, a need is a must have, a want is a nice-to-have.
Throughout time, humans have mixed, mingled and confused the two, resulting in confused finances and drained bank accounts, Mr Conway says.
“If we look at some real-life examples of needs and wants, I use the example that a finance professor used in my undergraduate days which he called ‘The Hierarchy of the Displays of Wealth’.
“It goes something like this: people that earn money, or come into money for the first time, have a tendency to wear their wealth.
“In other words, they buy some really nice clothing as it is the fastest and cheapest way of projecting success.
“This may be all that the person doing the displaying might own, but to them, it is a critical part of their public profile. I call this person Showbiz Jane.”
The next level up on that hierarchy is where that person will drive their wealth, Mr Conway explains.
“Cars are a little more expensive than clothing and this person is likely to squeeze every penny from their budget to buy that image. I call this person Flash Harry,” Mr Conway said.
The next level up is that couple that live in their wealth.
They will buy the maximum house they can afford, and leave as little money as possible for other important financial goals (like saving, investing and putting some money away for retirement).
As long as this couple can put on the show, live in the nice house, drive the flash car and wear the designer gear, to them, little else matters, especially the future.
Mr Conway says: “They live in the now, they spend for the now. I call them the Hollywood Duo.”
On the opposite end of the scale are those that display none of their wealth.
To them, planning for savings, buying a home (not a statement) and planning for life needs are what matter to them.
There are four pillars that people stick to when building personal wealth:
• Buying a home
• Having adequate insurance/protection
• Establishing a rainy day fund
• Saving for retirement.
They do this because they know that in the long run, financially speaking, they are on their own. They know that the State and their employers will not be funding them in their post-employment years and the burden of financial responsibility has been shifted on them.
For families everywhere, understanding what type of life they can endure, to achieve the type of life they want when they stop working, is a crucial piece of work. For example, working back, using income today, evaluating all of the costs, evaluating them using the needs and wants filters, and working out any additional income that can be saved will provide an important starting point.
But, it is the micro-analysis of the essentials that is critical. For example, one may need a car to get to and from work but could costs be pared down?
A new car can cost €25,000 in after-tax income when finance charges are factored in. But perhaps a €5,000 second-hand car can do the same job, and the other €20,000 could be invested tax efficiently with a company pension scheme.
With tax relief of between 15pc and 30pc that could be worth between €70,000 and €80,000 when the pension investment is carefully managed.
The same applies to a home. Financing over a shorter loan term will mean higher monthly repayments.
But in absolute terms, the savings on interest payments on a €300,000 property could be as high as €70,000 or €80,000, where the loan is repaid over 15 years as opposed to 30. The same applies to fairly modest pension investments. Lower fees can yield hundreds of thousands of extra euro.
For many families that are prepared to track their finances and be a little more frugal now, but understand the concept of low fees, short-term finance, and master needs before wants over their entire life, they will be well on their way to a financially stable one.