Wealth Planning - Baseline and Personal Ratios

In the heady days of 1998 to 2007, like so many others with paper profits, my appetite for investment debt was immense.

April 2008 came along - Oh dear. I was just planning to remortgage the investment properties and cash out almost enough to pay off the entire mortgage on our home when ………..WHAM ………….. the banks stopped doing what they had done so well for a decade – lend any property investor 85% or even 90% of the VALUATION of the property.

So like others who had learned the No Money Down method of multiplying investment holdings, I ploughed into multiple purchases in 2007 without any serious planning of the debt repayment schedule.

“Price inflation will take care of that……….. prices will double in ten years …………. I only have to collect sufficient rent to cover mortgage interest, management fees, insurance and (an underestimated) contingency for repairs and maintenance”.

Base rate was 5.75%. Cash flow was zero. Sound familiar? I broke my own investment rules built up over twenty years. I had to go back and continue consulting and work for my living. I felt sorry for myself. Well we survived, and that MoneySavingExpert budget planner was one of the first things I revisited.

By that stage, property was only one of three businesses we had nurtured over the past fifteen years, so the UK banking crisis did not impact us as much as I thought it might. But it brought me back to basics. As Robert Kiyosaki, the author of the famous Rich Dad, Poor Dad series of books, so eloquently puts it

“an asset is something that puts money in your pocket, and a liability is something that takes money out of your pocket”.

I had to go back and relearn that in a hurry. No matter where you are in the investment cycle, it’s always good to know your baseline, and to continually reassess your goals. Part of the correction process we went through in 2008 and early 2009 was to look at our personal expenditure, which had grown by over 100% in the last 10 years. Though that rate of growth is, in my opinion, the same as real inflation, I had become slack on the cost side of the equation as the income side had increased dramatically.

Recall that I had said that one of the ratios I have used for 20 years was to ensure that 10% of your earned income was to be invested. Another way of stating this is to say that your personal budget should ensure that you spend no more than 90% of your income on all personal expenditure. If you have completed a first pass of the budget planner, and find that your personal expenditure is more than 90% of your income, you will never become wealthy unless you either increase your income (preferred), decrease your spending (recommended) or plan a combination of both (the perfect plan)

Some other ratios I have used throughout the last twenty years, but not applicable to individuals with net debt,are:

Maximum percentages of net equity to allocate:

•  25% to principal private residence
•   5% to personal cars
• 10% to cash, jewellery / precious stones & metals
• 20% on individual investments

This was purely a personal decision when I finally came out of net debt twenty years ago, but I have stuck with these ratios since then.

Some additional ratios more recently used in balancing allocations of income:

•  30% of total income spent on essential costs
•  30% of total income spent on optional costs
•  30% of total income assigned to investments
•  10% of total income assigned to charitable causes

 Note that if total costs currently exceed total income, it is advisable to allocate time to charitable causes instead of income.

 Your first pass personal budget will be nowhere near these ratios. However, when you have identified essential or irreducible costs, it’s much easier to analyze the optional, investments and charity costs to adjust your expenditure budget to ensure there is more than zero for investment.

A word of caution.

 Financial security precedes financial independence. Your first goal is to make sure that you have three months expenditure available to you quickly should you need it. An example is an unexpected loss of primary income due to illness or job loss, or an unexpected and large bill. That doesn’t mean you need to keep three months cash available, but it does mean that you should aim to have a facility that allows you to quickly make use of funds for unexpected events. An example would be an offset mortgage.

Some useful links to get you on your way to increasing your income and reducing your outgoings are:

•  How to get a pay rise

http://www.thisismoney.co.uk/payrise

•  50 ways to save money

http://www.thisismoney.co.uk/50-ways

In the next article, we will discuss goals and plans – first pass, and introduce a Terms of Reference template in which the goals, long term plans and short term actions required to achieve the plans can be logically written and broken down into manageable lumps to achieve those goals.