One wrong decision can put your financial future at severe disadvantage.
I see it all the time – people making not just financial faux pas but money mistakes of the magnitude that will drastically impede their future financial security.
Are you? Here are the five-biggest inhibitors of wealth creation.
1. Buying a home without thought to the future. This is the largest investment you’ll ever make.
It also carries massive transactional costs when you buy and sell, such as stamp duty and real estate agents’ fees. When you swap one property for another, you can forgo up to 10 per cent of your proceeds.
You want a home that will suit your circumstances for at least seven years, the length of the average property cycle, to recoup your expenses and hopefully start making a profit. If you’re thinking of having children in that time, they’ll need somewhere to sleep.
The only exception might be if you deliberately buy a too-small place with the intention of building enough equity in it to afford a larger one in a few years and retain the first as a rental. You can sell capital gains tax-free in the six years after you move out, so this can be clever. Read on, though.
2. Keeping savings anywhere but your mortgage. And there’s another key element here – they should be not directly in your mortgage but in an offset account attached to it. These accounts give a dollar-for-dollar reduction in interest on money held in them – if you have a $100,000 loan and $10,000 in an offset, you’ll pay interest only on $90,000.
This is far better than a savings account, on which you’ll earn probably a percentage point less and see that diminished further by tax.
It’s a tax-free, risk-free effective return of, say, 7 per cent; a higher-rate taxpayer would need to earn 13 per cent in an alternative investment to better it. And remember, you’d have to risk your capital to get that.
Save everything into these – for holidays, school fees, renovations, whatever.
You can usually get multiple offsets linked to the same mortgage, so there should be no potential to get the money mixed up. Even get your salary paid into one and think about charging all your expenses to a credit card with a long interest-free period so you can leave it there for as long as possible (incur interest and you’ll cancel out your benefit).
If you are applying the strategy in point one, it’s also vital to make any additional repayments into such an account.
Pay down the actual mortgage and you will only be able to claim tax deductions on your lowest-ever loan balance – it will become useless to you as an investment property.
3. Failing to use protection – insurance, that is. Smart money management is not just about building wealth but protecting what you’ve already amassed. Once you have debts and/or dependants, you need, at a minimum, enough life insurance to cover them.
Your ability to earn money is actually your most valuable asset, so it’s vital income protection insurance would kick in if you could no longer work due to injury or illness.
4. Succumbing to barbecue risk. That hot tip confided while someone flips sausages.
It probably poses the greatest single danger to your prosperity. You never know how accurate the information is and even what’s motivating it.
5. Focusing on the pain, not the payoff. Scrimping and saving is not much fun but it can yield fantastic results.
The trick is to precisely determine what those results will be first. A trip to Fiji. A paid-off house by January 2020. Retirement five years before you can get at your super. Now that’s worth holding some back.