What Would You Do With A Lifetime's Income In One Day?
Seeing the future will impact your view of today. Thinking about and planning for the future can have a strong impact on our spending, saving and investing behaviour.
Imagine getting paid your entire lifetime's salary on day one. Let's say you are 25 year old and you have arrived on day one of your first real job. It's not a bad job and it pays pretty well, say $60,000 a year.
Your employer really believes in you and wants you to work for the company for the next 40 years, and has decided to pay you your entire 40 years’ salary on day one as a show of good faith.
So you are handed a cheque for $2.4m, you think about it for three seconds and you decide to accept. The deal is done. But remember, this is all you're ever going to earn, not a penny more and not a penny less.
Before we go any further I want to also assume that we live in a world where there is no inflation. This will keep the maths and ideas linear and simple. So you would earn $60,000 today and also $60,000 40 years from now.
So what do you do now?
Once you get over that first partying impulse, the reality of the situation would begin to dawn on you. You would start thinking about how to make sure that the $2.4 million actually does last you for the rest of your life, even if you live to be 95.
Then it dawns on you that the $2.4m is not all yours, you need to pay taxes totalling c. $500,000 leaving you with $1.9m.
Your employer also put 9.5% into super for you leaving you with c. $190,000 after tax in super.
So let’s pause for a moment, you have $1.9m cash in the hand and $190,000 in super and you have 40 years to get through and another 30 after that.
Here are a list of questions you need to contend with:
• How much am I going to spend on a home?
• If I am going to borrow money, how much do I put aside for interest?
• How much do I put aside for general living, educating kids, travelling?
• How much do I need to put into super? I know that $190,000 is not enough!
Some general points will start to dawn on you:
• If you spend $1m on a home there will not be much left for all the other things?
• If you don’t top up your super fund, you will not have anywhere near enough for the 30 year stretch between 65-95.
• If you don’t take some risk and try to get a decent return on your capital, even what you earn might not be enough.
It all makes sense so far doesn't it? But here's the thing. You will probably earn over $2.4m in your lifetime. The difference is that it will be paid to you in dribs and drabs every month instead of as a lump sum. In easy monthly instalments!
The following table outlines different income ranges against different timelines with resulting calculations all after tax. So someone earning $100,000 pa gross for 20 years will net after tax $1.4m and so on.
|$60,000 pa||$80,000 pa||$100,000 pa||$120,000 pa|
In our hypothetical, with 40 years to go you had 480 monthly pay checks. That’s it. It is useful to thinking of what you earn as a finite resource, something that can and will run out. Seeing it that way helps to more accurately value it.
The big question remains the same though: how do you make sure that the money you earn in your lifetime will stretch to cover all the things you need and want over the years, and still finance your life when you stop working?
Spend, Save or Invest?
Every day of your life is full of trade-offs between spending and saving.
We must spend money, not just to live, but also to have a quality of life. By contrast, what we save can be invested. So how do we know what to spend and what to save and invest? And what to invest it in?
The only way to work that out is to know what you want out of life financially. In other words, to have a financial goal and a plan to get you there.
"We teach children to save their money as an attempt to counteract thoughtless and selfish expenditure. That has value. But it is not positive; if it does not lead the child into the safe and useful avenues of self-expression or self-expenditure. To teach a child to invest and use is better than to teach him to save." Henry Ford
There are three reasons why having a financial plan can give you a much better chance of getting what you want out of life.
First, the plan is personal. It's all about you. The things that are important to you. What you want to do with your life.
Second, the plan gives you a goal or goals, something to save and invest for. A reason not to spend the money, but to make it work for you instead.
Third, a plan doesn't just define a goal that is important to you, it sets out a practical path to achieve it.
Once you've written down your goals, a lot depends on you.
Circumstances such as your age, your income and how much money you owe or have saved are all important. But it isn't just a matter of how old you are and how much you have. It's also a matter of what is in your head. Attitudes to risk often depend on the kind of people we are. A risk averse person could be 20 years old and cautious.
The important thing to note is that you don't have to take huge risks to create wealth. Not with time and compounding returns on your side.
Not an easy do-it-yourself option
There are two things that make do-it-yourself financial planning difficult. One is that it is almost impossible to look at ourselves objectively. The other is the sheer complexity and range of options available to us.
A financial planner will spend a lot of time understanding you and your long term needs. (Most of us are so tied up with the decision making that carries us from month to month or year to year, we find it hard to make decisions that will affect us 10, 20 or 30 years into the future).
"Planning is the process of preparing a set of decisions for action in the future, directed at achieving goals by preferable means." Y. Dror
And once you've agreed on your financial goals, your time frame and the resources you are prepared to commit, a financial planner will make the decision easier for you by only presenting those investment options that are relevant to your plan.
As a result, you are always in control, and always making informed investment decisions, no matter how time-poor you are.
Finally, a financial planner will review your plan with you on a regular basis. There is no such thing as a 'set it and forget it’ financial plan. Your goals, needs, health and family commitments could change from year to year, and if they do, your financial plan must respond.
One of the questions a financial planner might ask you is what you would do if you were paid your whole life's salary on day one instead of receiving in drabs and drabs over 40 years.
The answer could change the rest of your life.
Frank Paul is Chief Operating Officer & Head of Advice Services with Spring Financial Group. Frank has over 20 years' experience in financial planning and investment advisory.
|Frank has extensive experience in private client advising and the management of financial services operations. Frank is actively involved in the recruitment and management of advisory personnel and heads the advisory panel. He holds a Master of Commerce (Financial Planning) and a Dip. Financial Planning and has authored literally dozens of financial education publications.|