Often, the financial press bears a striking resemblance to the celebrity pages. Articles will talk about how Australia’s mega-wealthy are investing their money and their business ventures.
They make it all sounds so simple, and seeing as you wouldn’t mind having James Packer’s $6 billion net worth (source: Forbes), it makes sense to model your own financial decisions on his, right?
A large part of financial planning is risk management. It’s not the interesting side that gets a lot of press, it’s just making sure that we manage your finances in a manner that prevents unacceptable outcomes.
Risk management for James Packer and you, are two completely different beasts altogether, here’s how:
If James loses 95% of his net worth through poor investment decisions, he really comes down a notch. Can you believe he would be left with only $300 million to fund the rest of his life. This gives James the capacity to take on some really specialised, high risk but high potential investments.
Contrast this with a couple who has accumulated $1 million in a super fund, to provide an income in retirement.
A retiree prepared to take on a moderate amount of risk may be able to draw income from this of $55,000 per year.
If they suffer a 95% capital loss, they are left with $50,000 and a life on the full age pension of about $32,000 per year for a couple. That amounts to over a 40% reduction in their spending ability!
Health & insurance
Suppose James’ health took a turn for the worse. He may be unable to work for a period of months or even years. It would definitely impact on his finances, but if James spent $1 billion of his wealth on medical bills (which would probably buy your own hospital), he could take the remaining $5 billion of his wealth and put it in a term deposit, for a tidy interest income of $200 million a year if he can get 4%!
What about your own finances? I know in my case, I have a home mortgage and business loans. I’m self-employed so I don’t have sick leave, but even if I was an employee this would probably have run out after 12 weeks. So how would I continue to meet my mortgage repayments, pay medical expenses, and ensure that my family could still afford groceries? The answer to this question is my insurance policies would provide me with capital and/or income to help out.
If your net worth is measured in billions, or even millions you may be able to go without cover. If your net worth is not so grand and you have a few years or more of work ahead of you, you need insurance.
Liquidity means having cash available when you need it. On the smallest scale it means having $5 when you want to buy a coffee on the run, or on a larger scale having $40,000 available when you want to buy a new car.
The mega-wealthy have a wide range of liquidity options. Firstly, a James Packer or similar probably actually has millions of dollars just sitting in cash at any one time. Picking up the tab for dinner is not going to cause him a cash shortage. But the mega wealthy will have a wide range of assets and at any one time some of them would be able to be sold quickly and easily, to get cash in the bank if required. Banks would also be falling over themselves to lend money against some of those assets.
For those who are wage earners, or own a small to medium business, there are many fewer sources of available cash. We might own all or part of our home, but it’s our home so we don’t want to sell that. We could have some cash in the bank as a rainy day fund, but there is likely to be a limit to how many consecutive “rainy days” that could stand.
If we are hit with a surprise medical bill, or need to fund an investment, we may be forced to sell assets that we didn’t otherwise plan to, at a price we’re not happy about.
It’s ok to not be one of the mega-wealthy! It’s also ok to read the articles about their finances if you just find it interesting, or if you’d like to dream. It just means you don’t necessarily go about managing your money in the same way.
If anything, planning is more important for the rest of us because we need to preserve as well as grow our wealth.
Do you have a plan that takes into account the 3 factors above?