Liam Croke: Comparing yourself financially to others

Whenever I take on a new client we sit down and discuss their financial situation.

Whenever I take on a new client we sit down and discuss their financial situation.

For the initial assessment we look what the client has in savings and what will be there for retirement and so on.

Invariably I am asked the same question by the majority of clients and that is: “How am I doing compared to others just like me?”

Although it is not advisable to compare yourself with your peers it is a practice that feels perfectly normal.

Research has shown that we base our self-esteem on how much money we make compared to others. However, many people I meet think they are doing something wrong with their finances because they see people who might live near them, who might work with them or who might be related to them appear wealthier and much better off financially than themselves. This belief is held due to the possession of a bigger house, a bigger car, or more expensive clothing by those perceived to be well off, but, I would say in almost 100 per cent of cases the opposite is true.

There are two female clients of mine that I advise. One lady drives a relatively new Lexus, she is dripping in jewellery and habitually attired in designers clothes.

The other lady is of a similar age, her mode of transport is an eight-year-old Fiat that lost a hubcap some time ago. She is always well presented albeit her clothing sports no obvious labels.

On first glance Lexus Lady appears successful at handling her money. After all she drives the car and wears the clothes that only the wealthiest can afford. There is a good possibility that you may even be envious of her position. However, on closer inspection of her car you would notice that the tax disc has expired.

Should she tell you her story and why she calls to me, it is because she is four months in arrears on her mortgage and is desperate to find for a solution for her financial ails and worries.

Fiat Lady, in stark contrast, is seeking advice on how her €100,000 on deposit can work harder to furnish a better return.

Our perceptions of financially successful people appear to be based on what they possess and it is a dangerous business to compare yourself with them as it could lead to the idiotic practice of what is commonly referred to as: “Keeping up with the Jones’s.”

Unless you know for an absolute fact that your neighbours or friends have stashes of cash sitting in their bank account, don’t assume you know their financial position. You don’t. You know only your own status.

Having said all of that, it is a good habit to occasionally check and benchmark your financial position against those of your peers. Those people who are of similar age, similar income and so on. The purpose of this exercise is for you to see what is working for them, what they are doing and if you need to spring into action in relation to your finances. There is also the possibility that it might show you how well you are doing.

There are best practice guidelines for comparing yourself to those who you want to be like and I will look now at how much money you should have in an emergency account, how much you should have in your pension and how much you debt you may have.

First, let’s look at how much money you have in your emergency fund that can be called upon if you lost your job. Alternatively you can call it your “go to hell” account, and this fund can be used should you ever decide that you hated your job enough to tell your employer to go to hell.

Ideally that amount in this type of fund is as follows:

Six months of your seven biggest monthly expenses.

This is the optimum amount you should have and this is the amount that those you aspire to be like have.

Secondly, let’s ask how much you should have in your pension fund?

This is a great question to ask and this is one area where you can legitimately compare yourself against your peers. I recommend that people accumulate a fund based on their age and linked to their salary.

There is a simple method which can be used to calculate the ideal pension fund. It is based on replacing 67 per cent of your current salary inclusive of the annual state pension.

Age Fund amount

35 1 x annual salary

45 2 x annual salary

55 3 x annual salary

68 4 x annual salary

Thirdly we will look at how much debt you have. It is not strictly total debt but what is known as revolving debt. The recommended level of revolving debt is 20 per cent or less of the total amount of debt available to you.

Let me explain what revolving debt is. Assume you have a credit card limit of €5,000 and an overdraft limit of €2,000 and between both you owe €3,000. Based on these amounts your revolving debt is 43 per cent. €7,000/€3,000. In this instance you should pay down your credit card and overdraft to no more than €1,400 which is 20 per cent of the amount of credit available to you.

I tell my clients that it doesn’t matter what everyone else’s finances look like, it’s what your finances look like and what you choose to do about it that matters most.

It starts by being proactive and getting what I call a personal financial check-up and that starts with knowing where you are right now. Just like loosing weight, you need to weigh yourself first because otherwise how would you know if you’re heading in the right direction if you didn’t know your starting weight.

The same principle applies to your finances.