Where to start: Making a strong base plan
Starting with a strong plan in mind is likely to help you achieve the best financial outcome. Before you decide how you want to invest your money, you can start by considering your current goals and priorities. What are these and what would you like to achieve with your money? Maybe you have a home loan you’d like to pay off or perhaps you’d like to buy a property - either as an investment or home upgrade.
This first step shouldn’t be rushed and will quite likely take longer than expected to come to a decision. This is particularly true if you’ve unexpectedly come into a large sum of money. How you spend this money might not be something you’ve ever considered before. Once a strong base plan has been set in place you can work with your adviser to ensure you’re making the most appropriate investment decisions for your situation.
I once had a client who was 62 years old, single, and had recently received an inheritance. She was the recipient of a disability support pension and had no superannuation fund in place. She came to me with the plan of investing her inheritance in a high-interest savings account or a term deposit. She didn’t need access to her inheritance in the short term as she was able to live off her government pension. Although she had a seemingly appropriate plan of action, after assessing her personal circumstances, she left with a completely different strategy.
We discovered her initial investment plan would result in her disability support being cut off. Had she left the inheritance in a bank account or long term deposit, her assets and income would have been means tested, no longer allowing her to qualify for Centrelink financial support. I advised her to make a non-concessional contribution to her super, triggering the bring forward rule and allowing her to retain her full pension for another 3 years until she turned 65 - gaining an additional amount of approximately $67,000 in pension. This strategy allowed her to achieve a higher long-term return as compared to retaining the funds in a bank account or long term deposit, and made it possible for her to gift some of the money to her only daughter to help out with her mortgage and other commitments. She gifted $10,000 to her daughter at the time, no further assets were passed on but I informed her of the gifting rules and limits.
How to make your money last: Select a variety of assets
Earlier in my career I had a client win a large sum of money from the lottery, for this specific situation I advised a mix of diversified investment options to achieve the most appropriate outcome given his risk tolerance. Diversification when investing is a good option, so as not to put all your eggs in one basket. This can give you a degree of protection if one of your investments goes south.
Here is what we decided upon, keeping in mind these investment options suited my client’s situation and aren’t necessarily the right choice for others:
- Managed funds within investment bonds - these suited his plan for his children’s future, including schooling or first home support
- Regular super contributions to start preparing for his retirement in addition to the minimum super guarantee charge (SGC)
- Separately managed account (SMAs) with a regular savings plan to invest outside superannuation to grow his wealth and benefit from franking credits to minimise tax
- Planned expenses such as a kitchen and bathroom renovation and upgrading the family car
- Allocate more cash into an interest bearing account to meet his preferred level of cash reserve
Each investment vehicle has a purpose depending on your financial situation and what you’re hoping to achieve. Defensive assets, for example - fixed interests, bonds and cash investment - can provide you with stable returns, with lower volatility and can be alternatives to cash in today’s low cash yield environment. Exchange Traded Funds (ETFs), on the other hand, can provide you with opportunities to trade flexibly, achieve diversification at lower costs as well as tax benefits. Shares in Australian and international markets are another common option. This strategy has the potential to grow your investment in capital and income over time despite greater volatilities in the short term.
How much is too much, when it comes to splashing your cash?
To best answer this question, it’s worth considering your long term future and working your way back. Ask yourself, when do you plan on retiring and how much do you hope to retire with? By considering your retirement plans, you can gain an idea of how much you’ll need for a comfortable future and therefore how much you have left over for today. Once this has been established, you can begin considering your short and medium term financial goals - these could be anything from paying off a debt, sending your children to private school or renovating your house. It quickly becomes apparent how much you have left to spend today.
Warnings and cautions: What to avoid
Unfortunately, every now and again you come across a situation where a client hasn’t been able to accurately plan their wealth. I’ve seen this happen before and find it’s most likely to occur when rash decisions are involved.
I once met with a client who, after receiving a large inheritance, quickly made the decision to pay off their home loan, as well as purchasing an investment property using the equity available in their home. What they had failed to consider were the tax implications and ended up paying a significant amount. The tax was from the inherited property and the client used up most of their cash paying off the home loan and putting down a deposit for a new investment property. The client ended up having to borrow money from family temporarily to pay the capital gains tax (CGT). The cost of buying and maintaining the investment property was also significant and prevented them from using their newfound wealth for other financial goals.
Seeking advice from a financial adviser can help you understand your options and make informed decisions. By avoiding any rash decisions driven by emotion, you can settle on the best outcome to suit your overall financial goals - while getting the most bang for your buck!