Financially sound decisions for 40-somethings

Liam Croke

Reporter:

Liam Croke

This is the second part of the article, I wrote about last week, and I have three more financial mistakes to avoid when you’re in your 40s.

Mistake number three I notice with some 40-year-olds is that as they become more conscious of retirement (its not being that far away in their opinion), they adopt a much more conservative approach to investing, particularly with their pension.

I met a 47-year-old women in early June and she had accumulated an excellent amount in her pension fund. She was fearful that what happened to pension funds in 2008/2009 might happen again. And she still has the memory of what it did to her father’s fund when he was just two years from retirement.

She didn’t want the same thing happen to her so she decided to protect what she had, and invested everything into a cash fund.

The amount she was saving and had saved to date was hard earned and she didn't want to put it at risk. She thought that by putting her money into a fund that guaranteed her capital, she was protecting it against what might happen to stock markets around the world.

While her intentions were good, she wasn’t, in fact, protecting her money at all. She was still putting it at risk - more than she realised.

I worked out that investing in a fund that probably had a management fee of 0.5%, and if inflation was running at an average of 1% over the next 18 years, the value of her fund when she was 65 would have depreciated in value by c. €28,582. That’s a drop of nearly 25% on what she started out with.

Investing too conservatively in your 40s means you lose out on considerable growth until you reach retirement age. You may still have 15 or 20 years until you begin to take benefits from them so you shouldn’t play it too safe.

Yes, there will be years where your fund will go down in value, but over time, your fund if even only partially invested in equities will outperform returns if invested in cash, and by a considerable margin. Remember, there has never been a 20-year period of negative stock market returns whereas cash loses value year in year out due to inflation.

Sure, seeing your fund drop by as much as 30% will have an impact on you. But if you have time on your hands - and in your 40s you do - stay calm and don’t make the mistake others made in 2009 when they transferred funds into cash and missed out when the markets recovered. The S&P for example has tripled in value, since its low point in March 2009.

So, if you are worried, consider what your appetite for risk is, what fund you need to accumulate, and finally the time horizon you have left before you begin to take benefits from your fund, and then change your asset allocation i.e. the amount you invest in each asset class (equities, cash, bonds etc.) to reflect this.

A quick rule of thumb that might help is to consider the Rule of 100 when it comes to how much of your pension fund should be invested in equites, which suggests the amount should equal your age minus 100.

Another mistake people make is giving up saving altogether; they think it will make no difference as they don’t have enough time.

Just because you are in your 40s and for example, never saved into a pension account, doesn’t mean you left it too late to save either.

You can achieve a lot in 15 or 20 years. If you are a 40-year-old for example and save €250 per month which could be just €150 after tax relief, at 65, you could have €203,699 in your fund assuming a return of 7% each year.

The state pension will provide you with an amount of money each week that will barely provide for basic needs. Forget about going on holidays or going out for a nice meal each week, or paying for private health insurance which will probably be beyond your reach.

You need to supplement your income and every little amount you can pay yourself will help, so it’s not too late

Another mistake I see 40-year-olds make, is in the area of personal insurance.

When it comes insurance, most people think of health and life assurance but one of the most important insurances you will need in your 40s is one that protects you in the event of suffering a serious illness or disability that prevents you from working.

I say this because statistics will show you that the average age a person takes benefits from a serious illness policy, if they have one, is at 49 (Source: Irish Life) and according to Friends First, 46% of their claimants of income protection policies are under 50 years old. Alarmingly, women on average, are 45 when they need to make a claim.

If you have income protection cover through your employer, then great. Just check the details though because it may only last for six or 12 months before it stops and if it does you need to consider making provisions yourself.

There are other danger areas 40-somethings are prone to making mistakes in as well that I haven’t mentioned, like overspending, not having a financial plan, getting into a comfort zone at their place of work and not exploring other areas of opportunities or developing their own career, not diversifying i.e. everything they have is in one company stock or in property etc. and they have to be cognisant of them as well.

Liam Croke is MD of Harmonics Financial Ltd,

based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie