Scott Kingsley, Senior Wealth Advisor
In order to achieve long-term financial security, it is vital to have a long-term financial plan in place. This will be supplemented by short-term financial targets, which will be the stepping stones to long-term financial goals. However, it is just as important to recognise that short, medium and long-term financial goals can be adjusted over time. Life doesn’t remain static, you may have noticed!
To put this into perspective, ask yourself the following question unless you know your long-term financial destination, how will you know when you have arrived? To paraphrase a famous question.
When we talk about long-term financial planning, this could be anything up to 50 years and above. It is vital to have a long-term goal, but you will need to have short-term milestones along the way. Research shows that those with plans they are actively working towards are ten times more likely to succeed than those with no goals. It comes down to focus, maintaining a long-term view with short-term targets, which create a sense of achievement.
For many people, there is a natural pull towards living the best lifestyle today and worrying about retirement and later life tomorrow. After all, someone in their early 20s may find it challenging to appreciate income requirements in retirement. While it is essential to recognise that we work to live, not live to work, there must be a balance. We must live within our means while also appreciating long-term income requirements.
For example, the earlier you start paying money into your pension fund, the greater the potential for long-term capital growth.
Compound returns make a massive difference to pension assets. Check out the following scenarios:-
Annual capital growth: 4%
Annual pension contributions: £4000
Duration: 20 years
Total contributions: £80,000
Pension fund value: £123,877
Overall return: 54.8%
Compare this, now, to significantly reduced pension contributions over 30 years. This shows the power of cumulative returns:-
Annual pension contributions: £2125
Duration: 30 years
Total contributions: £63,750
Pension fund value: £123,948
Overall return: 94.4%
This is why many financial advisors recommend their clients start making pension fund contributions as early as possible. The second person achieved the same pot by investing less for longer, contributing £63,750 against £80,000, a saving of £16,250. That £16k would have been handy in daily life.
You can bend and shape this example however you like, really. Anything from “the longer you save and invest the more you stand to make”, to “it’s rarely too late to catch up, but it’ll cost you more each month”!
When looking at long-term investment in a vehicle such as a pension fund, it is crucial to recognise the spectre of inflation. In essence, inflation eats away at the value of your money year-on-year unless you make adjustments. So, for example, over a 30-year period, assuming inflation of just 2% per annum, £100 would need to have increased to £177 to maintain spending parity. Frightening!
So, I’d suggest increasing your pension fund contributions at least by inflation each year. This also creates the added benefit of enhanced compound growth. Going back to the examples above:
Initial contribution: £4000 per annum
Additional inflation-linked contributions: £17,000 over 20 years
Enhanced return less additional contributions: £5,800
Return: 34.1%
Initial contribution: £2,125 per annum
Additional inflation-linked contributions: £22,487 over 30 years
Enhanced return less additional contributions: £11,500
Return: 51.2%
While not the easiest of subjects to discuss with friends and family, inheritance tax planning should be an integral part of your annual financial review. This takes in various topics such as:-
Many people make the mistake of retaining as many assets as possible and then distributing them upon their death. Some countries offer an array of annual allowances, which may allow you to gift a certain amount of money to friends and family each year. This reduces the value of your estate upon death, minimising future tax liabilities and provides a tax-free means of providing for friends and family before your death.
For many people, their pension fund is the most tax-efficient vehicle and very often a means of reducing/avoiding capital gains tax. In addition, while the situation will vary between countries, many governments encourage long-term investment through additional tax incentives. Utilising these allows you to minimise your tax liabilities as you approach retirement.
Mortgage finance
For the majority of people, an investment in their family home will be by far and away their most significant outlay. Yet, while we all strive for that dream home, you must be sensible about mortgage debt. In the aftermath of the US subprime mortgage crisis, regulators introduced stricter mortgage affordability tests. Incorporating several scenarios as a means of stress testing personal finances, the idea was simple, avoid high-risk mortgages.
While the previously tight regulations surrounding these mortgage tests have been eased in some countries, individuals still need to appreciate the risks. In recent times we have become accustomed to historically low interest rates, although this is starting to change. Many who stretched their finances on much lower mortgage rates may struggle with interest rates set to rise for the next year or so. It is important to take advice on variable and fixed-rate mortgages as a means of taking advantage of the forecast change in interest rates in the short, medium and longer term.
Repatriating funds
More and more people are now moving overseas to achieve their career goals and maximise their income. While some may remain overseas in retirement, others prefer to repatriate to their former homeland in their later years. However, you must take financial advice on repatriating funds and assets as there may be specific tax liabilities. Consequently, if you are looking to return home during your retirement years, you may need to start planning many years in advance.
As we touched on above, your short-term targets and long-term goals offer a form of guidance concerning your finances. Sometimes life throws us curveballs: unemployment, increased expenses or, on the flip side, enhanced income from an unexpected source. Remember, nothing is set in stone, and you may need to adjust and adapt your financial goals in the future.
While every financial advisor should carry out a review at the start of the relationship, it works best if you keep them aware of any significant changes in your life that could impact your short, medium and long-term finances. For example, there may be ways in which they can reduce your short-term tax liabilities and increase your net income or make adjustments to your long-term plans.
While enjoying the moment, it is also crucial to appreciate medium to long-term financial requirements and take action on issues such as pensions and even inheritance tax. In addition, those who recently took advantage of low-interest rate debt may soon struggle as interest rates turn upwards. In this scenario, it may be possible to lock in lower rates in the short to medium-term, allowing you to pay down debt before returning to higher rates.
Your annual meeting with your financial advisor should not simply be a case of ticking boxes; all parties should be proactive with full disclosure. This is the only way that your advisor can provide the best advice possible regarding your short, medium and long-term financial targets. While subjects such as pension funds and inheritance tax may seem irrelevant in your younger years, time quickly catches up!