This post covers a concept that we speak about a lot with our clients and is one that can have a major impact on achieving your goals and creating a better financial life.
Life can be busy, hectic and we often find ourselves moving from one weekly or monthly deadline to the next. This is true for work, for study and for general household management, paying the bills and managing your finances. Bigger and more important issues tend to get pushed back to “when I have a bit of space” or “when I have more time”.
It is essential to step back from the everyday, get some perspective and integrate what you really want out of life into the everyday.
This is one of the most impactful things we do with our clients.
From a financial perspective this means getting some clarity on your goals: What you really want, how much do you need and converting those to a number. Now you have a target. From here, we can work out how you can achieve it.
The power of 5 years shows that by doing this exercise and starting your plan today, by stopping pushing it back into the future, that in just 5 years you can have a major positive impact on your life.
Let’s go through an example.
A client couple, we will call them Jane and James, want to build a capital reserve but keep struggling to find the time to do it, and to know how best to do it. Their goal is to have €400,000 in 5 years. They have managed to build an emergency cash reserve of €15,000 and have a combination of an inheritance and some bonuses Jane received at work, meaning they have €250,000 in a savings account, but it is earning zero interest. With smart structuring, budgeting and proper financial advice they can do much more. If they leave the money in the bank it will stay at around the same value over the next 5 years, but it will lose its purchasing power by the rate of inflation, meaning they will get further away from their goal. This is because if inflation is 2.5% per year, they are in effect going backwards by that amount. In 5 years their €250,000 will be the same as having only €221,000 today. That’s the negative power of 5 years.
They need to do something better than that. Presuming a diversified mid-range balanced investment earning 6% per annum, in one year it would grow to €262,500. But here is where the power of 5 years is so strong. And it really is a demonstration of the power of compound interest, because compound interest means earning interest on your interest. What would this example be worth in 5 years? On all the above assumptions, it would have grown to €335,000. That’s good but doesn’t get them to where they want to be.
To bring the power of 5 years and the benefits of proper advice and structuring together to achieve a goal, we calculate that they can afford to add to their investment with €2,000 every month. To be conservative and to ensure they maintain an adequate cash reserve though we reduce that to €1,000. With this added to the pot each month and the effect of compound interest, in 5 years, their investment could be worth €407,000. They can achieve their target.
The difference is basing the investment on the goal, rather than the starting point. By looking at every investment as a means to an end, rather than just optimising for today, we can build a strategy that is adaptable and geared towards your individual needs and wants.
The power of five years is a recipe book for your finances with a picture of the cake that you should have at the end, not just a list of ingredients to throw in the oven. The message here is don’t put these hard discussions off. Doing them today, means you can achieve your goals sooner and achieve what you actually want out of life.