Financial Planning News: 08 Mar 2010
Spending up big was all the rage in the noughties but attitudes are changing, say the experts.You've got to hand it to the banks...
. A few years ago they were extolling the virtues of borrowing and living on credit. Now one bank has a marketing campaign based on the idea that "Saving is the new spending" and another is urging customers to sign up for "FebuSave", a month of fiscal fasting.
Is this marketing hype or is saving really back in fashion? According to the Australian Bureau of Statistics, the banks may be on to something.
Household savings were about 10 per cent of after-tax income until the mid-1970s, when they began to slide until they hit negative territory between 2003 and 2005.
Then in 2006 the savings rate became positive again until it hit 4.5 per cent of disposable income in 2008-09.
In other words, in the mid-noughties households spent more than they earned. Interest rates were low, share and property markets were booming and home owners and investors felt they were invincible.
In that environment, lenders were encouraging people to borrow to the hilt to spend on lifestyle and a new wave of "sophisticated" investments, many of which included some form of debt.
Then it seemed to dawn on people that the party was too good to last and, beginning in 2006, they started keeping a bit of cash in reserve.
By the time the crash finally hit Australian investors in 2008, cash was staging a comeback.
The chief economist of CommSec, Craig James, says household savings increased in the past 12 months with good reason.
"People are deciding to leave money in the bank for longer because of the attraction of term deposit rates. The sharemarket's improving and lending rates are up, so people are more likely to be saving rather than spending," he says.
With the financial crisis and the orgy of debt that precipitated it still fresh in everyone's mind, it is worth asking how much we should save. The answer depends on your age, stage of life, income and attitude to risk.
Most Australians in the full-time workforce are already saving 9 per cent of their salary thanks to compulsory super but financial experts suggest we need to save closer to 15 per cent of salary to afford a comfortable retirement.
While building long-term wealth is the ultimate goal of saving, it is not the only consideration. Savings can be used to fund the deposit on a house or major purchases such as a car or a holiday without the need to go into debt. They can also be used in an emergency, to tide people over if they lose a job or need urgent repairs to their roof.
An adviser at Centric Wealth, Greg Pride, recommends a cash buffer of $5000 or 5 per cent of your investible assets, whichever is the greater.
"You forgo [a higher] return but you are buying flexibility with that cash. Flexibility and long-term return are at opposite ends of the spectrum," he says.
Pride explains that money invested in your home may provide a good tax-free return over time but you can't sell it quickly if you want a holiday.
Conversely, you can get your money out of a bank account today but the return is mediocre and income is taxed at your marginal rate.
"Having a lot in cash feels safe but with tax and inflation you might lose money, if not remain standing still [over the long term]," he says.
But when the going gets tough, as it did during the financial crisis and will again, cash is king and it's good to have a decent stash set aside for emergencies.
A senior financial planner at Platinum Strategies, Daryl Smith, says young adults should begin by saving a deposit for a home in a high-interest savings account or short-dated term deposits. Once you buy a home, you need to build up a cash reserve to cover four to six months of living expenses.
A financial adviser at Lachlan Partners, Jamie Nemtsas, says as a general rule of thumb, people should have an account with three months' living expenses in it as an emergency cash buffer.
For the average couple with two kids this would be about $15,000.
Nemtsas recommends people channel at least a portion of their savings into a home loan with a redraw facility. However, he suggests choosing a redraw you can't access over the internet. The rationale is that if you are forced to go into a bank branch or use the phone and wait 24 hours for your cash, you are less likely to withdraw it for spontaneous purchases (see Page 8).
A director of WLM Financial Services, Laura Menschik, recommends saving one month's living expenses and putting it somewhere accessible. That could be in an online savings account with a higher interest rate than an everyday transaction account but that is a matter of personal preference.
"It gets back to peace of mind. Everyone needs some way of getting to emergency funds. It could be a credit card, an equity line-of-credit or money hidden in the closet. Everyone has a different way of dealing with it," Menschik says.
The size of your cash hoard and where you choose to save it will depend on contingencies you need to cover. Some things, such as illness, redundancy or a period in hospital, may be covered by insurance or your employer's sick leave provisions.
Menschik says savings for a holiday or school fees could go into a term deposit timed to mature when the funds are needed (see Page 6 for rate).
While a certain level of cash is desirable, Pride says people should make a rational decision about where to channel their savings, not just an emotional one.
Many Australians today can look forward to living to 90 or beyond but few have enough savings to last the distance. The best way to maximise your nest egg once your short-term cash requirements are covered is to direct a portion of your savings into growth assets.
Cash needed to cover all eventualities
Retirees need to ensure they have sufficient cash flow to cover periods when the market dives, dividend or rental income falls and investments fail or are frozen, as happened in the recent financial meltdown.
Daryl Smith of Platinum Strategies advises clients in the pension phase to hold about 18 months of living expenses in a cash management account and term deposits with different maturities.
"Over the last 18 months [that cash] has probably been a godsend because they haven't had to sell down assets to fund their pension," he says.
Jamie Nemtsas of Lachlan Partners gives the example of a self-funded retiree with $700,000 in super earning $40,000 a year. "If your income drops 50 per cent as it did last year then cash becomes important," he says.
He recommends putting aside three years of living expenses in cash and term deposits.
So, in the example above, he would suggest putting $40,000 in a cash account that can be accessed quickly, $40,000 in a two-year term deposit and another $40,000 in a three-year term deposit.
"You need to plan not just for cash you have on hand but cash for next year and the year after as well," he says.
SOURCE: Barbara Drury - Sydney Morning Herald
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