Making Cents: Take 'site' of your own finances

A LinkedIn post caught my eye a couple of weeks ago and it came from Peter Mallouk who is a very well respected and very well-known financial adviser who is based in the United States.
Along with running a very successful wealth management firm, he is also a lawyer and has co-authored two personal finance books with motivational guru, Tony Robbins.
And when asked about Mallouk, Robbins said, he’s an impressive guy, even by my standards. He is, by all accounts, the epitome of excellence in the wealth management world.
So, when I see something written by Mallouk, I take notice, not because of what Tony Robbins said but because of the opinion I’ve formed of him myself from reading and listening to him over the past decade.
Anyway, the headline from Mallouk’s post that got my attention was:

Becoming financially independent, the basics.
I read on and liked what I saw, which is why I wanted to share it with you.
And there are four areas Mallouk said people need to focus on and I re-arranged the order in which he wrote them so that I could form a word that we could remember easily, and that word is:

SITE
And each letter refers to the first word of the area we need to focus on i.e. S refers to Spend.
Okay, here goes those four areas Mallouk believes we should spend our time and attention on:

Spend less than you make – hold off lifestyle creep.
Lifestyle creep is also known as lifestyle inflation and very simply it occurs when a person starts spending more money when they start earning more.
And that’s because as their income changes they give themselves permission to spend more. The problem is that after a couple of months they can’t readily identify where that extra money is now being spent and they begin to wonder how they survived before their income increased.
And lifestyle creep does exactly what it says it does, it creeps up on us and the signs are there for all to see. For example, if your savings rate has remained stagnant even after a few years of salary raises and bonuses, that’s a sure sign that you are a victim of lifestyle creep.
Which all feeds back to the point of spending less than you make because if you spend all of your income each month there’s no way you can achieve any of your short or long-term financial goals.
So, please try and live below and within your means and spend less than what you make.
The key to financial success is trying to widen the gap between your income and your outgoings and saving the difference.

READ MORE: What is doom spending?

Invest wisely
My first piece of advice to anyone is always the same and that is, if you can’t explain the account you are proposing to invest in, in less than 20 seconds then I’d say don’t invest in it.
And you should always ask yourself what is the worst that could happen? And make sure you know the answer to that question before you invest in any account. And understanding the potential return is only half of what you need to know before making any decision around what account is best suited for you.
I think one of the reasons why people leave money stagnate in bank accounts earning next to nothing is a fear of losing money and that puts them off investing. When people hear the word risk, they associate it with losing all of their money which of course doesn’t have to be the case.
Which is why taking time out to understand what investment risk actually is or finding someone who can tell you is important because it could lead you to earning much higher returns, whilst enjoying a great nights’ sleep in the process.
And when it comes to taking on risk no matter what I or others say, you’ve got to weigh up the potential reward and the potential loss and then ask yourself - is it worth it?
Let me give you a quick example of what that might look like:
If, for example, you invest €10,000 in an account that carries a 95% capital guarantee, the maximum risk to your capital is €500.
If the account returns 3% per year, compounded over a 5-year period, the interest would be €1,616.
So, risk = €500 loss
Reward = €1,616 gain
If you left the same amount on deposit in a bank, your risk/reward scenario would look like this:
Risk = €649 loss (this is the amount your capital will reduce by, if the annual gross return is 0.25% and inflation runs at 1.5% pa)
Reward = €0 gain
As you can see, the monetary difference in loss between both scenarios is just €149 and the gain is €1,616. So, are you willing to risk a loss of €149 for a gain of €1,616?
And maybe you’re not and maybe you are, you decide.
There are lots of other things to consider before you invest as well i.e. your time horizon, what the purpose of the funds are for, where the funds came from in the first place and what your level of investment knowledge is.
And you can run all sorts of calculations and carry out all sorts of risk profile questionnaires, which are a very important exercise by the way, but for me any investment must also pass the good nights’ sleep test as well.

Time matters – start as early as possible.
Time does a number of things but the most important one from a financial perspective is the compounding effect it has on the amount you save each month.
And if you were in any doubt about how important it is, let me run some numbers by you.
Let’s assume someone is saving €200 per month, earning an annual return of 5% over a 25-year period.
If they were offered an extra 10%, that could be applied to (1) the amount they either save or (2) to the annual return or (3) to the length of time they are saving, which 10% would create the biggest impact on their final fund value?
And here are the results:
1. Savings – an extra 10% means that €200 now becomes €220
@ 5% x 25 years = €131,558
2. Return – an extra 10% means that 5% now becomes
@ 5.5% x 25 years @ €200 pm = €128,996
3. Time – an extra 10% means 25 years now becomes 27.5 years
@ €200 x 5% = €149,044
Time is the big winner of these three variables, but unfortunately people delay either starting a pension or a savings account because they think they can catch up at a later date by increasing the amount they contribute each month or by trying to get better returns but there’s a much easier way they can build their savings and that’s by starting earlier.

READ MORE: Stop, start and continue to your goals
Earn more
Your career is where most people get the vast majority of their income from, which is why you should never stop focusing on your personal development, so you can maximise your earning potential.
And let me tell you about Jessica, because I think her story will explain this point better than anything else I say.
When I met her she was 27 and was earning €34,000 which was about €2,400 after tax each month.
And 40% of this income was going on rent and 20% on food and 15% on savings, so 75% of her income was going on these three areas. And she wanted to save more but there was only so much she could cut back her spending by before she reached a point where she simply couldn’t reduce it anymore.
And tinkering around with making small changes to the amount she was spending on clothes, transport, entertainment etc. wasn’t going to move the dial much and she was young and wanted to live a little and she was absolutely right.
So, my advice at the time to her was to make herself more valuable to her employer because the only way she could increase the gap between what she earned and what she spent was having a higher income.
And she reconnected with me last week telling me the good news which was she had been promoted and her new salary was going to be €47,000.
She took my advice on board 12 months’ ago and she did become more valuable to her employer and in doing so her income is going to increase by a net €776 per month.
It means those three outgoings I referred to now account for 57% of her new monthly income.
So, she was able to get the numbers to change places – old expenditure was 75% of income whereas now it is 57%.
What it means is that she’s going from a breakeven scenario which was, I better watch what I spend every day, to worrying much less about money and actually carrying a very healthy monthly surplus.
And this extra money means she can probably bring forward buying a house as she’ll accumulate her deposit in a much faster time, if she decides to buy a house that is. She may not buy for a while but having that extra money just gives her options that’s all.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie