If people are too dependent on the fortunes of a single asset or their lifestyle is propped up by borrowings for example, the appearance of wealth can be quickly shattered.
Many home owners think they are wealthy, but they are possibly asset rich and cash poor, and in some cases struggling to meet their recurring expenses. They are also vulnerable to falling property prices in the short term and rising interest rates in the medium and longer future.
Not being able to repay credit card debt each month is often the first sign that your personal cash flow is in trouble. Being unable to manage a financial emergency without increasing debt or being forced to sell an illiquid asset is another concern.
All investors should ask the following questions to ensure they are building good quality, sustainable wealth.
Does your income exceed spending?
Do you save money each month?
Do you pay the full amount off credit cards monthly?
Are you investing appropriately for your circumstances?
Is your portfolio diversified?
Do you have adequate insurance?
Is your wealth accessible if needed?
Can you cover unexpected expenses or loss of income over the next two years?
Are you on track for a comfortable retirement?
Have you consolidated your super accounts and checked its performance?
Do you have a will and other estate planning arrangements in place?
The way to build wealth is to spend less than you earn, save the difference and do something meaningful with the money saved. This could include making extra repayments on the mortgage or making regular deposits to an investment portfolio.
Any investment strategy should be appropriate for a person’s stage of life and circumstances. An appropriate strategy for a 30-year-old will look very different to one for a 50-year-old.
Time frames also impact strategy. For any time horizon over five years, consider investing in a portfolio with a higher allocation to equities and property. These asset classes provide the opportunity for capital growth and higher yields but also come with more short-term volatility.
However, if you are investing for a period of five years or less, there is not the benefit of time to ride out short-term market volatility so a portfolio predominantly invested in cash and fixed interest assets may be more appropriate.
You can be asset rich but cash poor when too much of your wealth is tied up in illiquid assets, such as direct property or unlisted shares. This can leave you exposed if your income circumstances suddenly change and you can’t easily extract cash from these lumpy assets to cover living costs.
It is also important to consider how assets are held, as this can make a significant difference to tax paid. This could mean investing savings in the name of the lower income earning spouse or putting more in superannuation.
Finally, having adequate insurance and estate planning arrangements in place will ensure your wealth is protected and a legacy passed down to future generations.
Michael Hutton, head of wealth management, HLB Mann Judd Sydney