How to know if you are ready to get advice and the important first steps everyone should take.
The first thing that everyone should understand about their financial situation is cashflow. In essence, this is the relationship between how much money comes in and how much goes out.
Think of your cash savings as a bucket with a hole in the bottom. As you fill up the bucket at the top (income), some of it will leak out of the bottom (outgoings). This could lead to one of two problems. If the hole at the bottom is too big, eventually the bucket will be empty and you might not be able to cover your expenses. If the hole at the bottom is too small relative to the flow filling it up, eventually some will spill over and be lost at the top.
Furthermore, if the bucket is too small, a minor change in the flow could lead to overflow or emptying much quicker than expected, but if the bucket is too big, it is a waste of space and often brings unnecessary costs.
We all need to find a balance-point where the level of cash in savings will stay relatively constant without risking overflow or running dry.
At Black Swan Capital Europe, we normally expect each client to have a minimum of three months’ expenses and a maximum of six months’ after-tax income in easily accessible cash at any one time. Less than this minimum could put you at risk if any combination of financial emergencies hit you suddenly. A loss of income, unexpected repair bill or other personal situation will often require immediate funding with little or no notice, so we need to have cash in the bank ‘just in case.’ If your cash savings are too high, you may be losing spending power due to inflation, in addition to the potential for negative interest rates in many European countries.
If you find yourself in the position that your cash balance is within the ‘3-6 month’ range and increasing each month, that’s great. You need to think about investing some of your surplus in order to meet your financial goals for the future, but don’t overcommit in the early stages. If you are investing a little bit and your cash is still growing, you can always add more to your plans later on. If you commit too much of your cash to the longer term and find your cash gradually disappearing, you may be at risk in a financial emergency.
If you are not sure about your cashflow or you want to better understand how to maximise the value your income provides, some simple budgeting could give a big benefit.
The first key to effective budgeting
If you can’t see where money is coming in or going out, you will never be able to manage it. The great news here is that most banks and card providers these days have their own app or online access, and almost all of these include some kind of budgeting or forecasting function. Log in to your personal banking and look for the function that will let you look forward at upcoming payments. You will normally see a list of regular expenses that you pay every month, along with some expected costs or suggestions based on your spending history. You should also be able to add in other expected costs that are not listed, such as going out, groceries etc.
Once you have a clear understanding of what you are paying to other people and companies, you will know how much is left as surplus income. At this point, you should understand that paying yourself, by investing towards your goals is just as important as paying everyone else and should be treated as a regular expense, not an optional extra.
If your budget shows that your expenses leave nothing left at the end of the month or may even be eating into your savings, you should examine whether this is a short-term issue due to one-off costs or a longer term issue that needs to be resolved before your cash runs out.
A good way to start out is to estimate how much you will have left at the end of each month and then cut that number in half. That number is the maximum that you should be allocating to regular investments to begin with.
If you already have some savings in place, make sure that your emergency fund covers at least three months’ expenses before allocating any surplus to investments.
For new investors, there is always the temptation to follow the latest trend or put your money into what worked well for someone else you know. Just bear in mind that when you hear stories about successful investments, those positive returns have already been made and you may well be too late. Trendy assets can often be high risk and extremely volatile, so if you want to allocate some money to the latest craze, understand that there is the very real possibility of losing all of it.
If you are looking to grow your money over the long term, you first need to identify your targets. This can be difficult at first, especially with the very long term, so break everything down into bitesize slices. Start with the coming months, then years and work towards where you see yourself in the end. Be realistic, but don’t neglect your own dreams and ambitions. Think about locations, relationships, timescales and the things that will make you happy, rather than just numbers and percentages.
When you are ready to start investing, it is important to be flexible so you can adapt to any life changes.
Whilst your goal may be long-term, it is prudent to allow yourself the flexibility to adjust your investment if you need to, without any restrictions or penalties. In most cases, it is best to avoid locking yourself in where you can’t access your money if your circumstances change, or to a long-term commitment. Stay flexible.
Having professional help can always be a boost to your plans, but it must be cost-effective. Any financial professional should be thinking about your objectives first and foremost, so you should understand if you are paying for your benefit or for theirs. Know that even though target-based investing should be a long-term commitment, there is no harm in realising you are not ready just yet. A good adviser will always tell you if you are not quite ready.