Before diving into investing, ensure your financial protection is in place. Discover the essential steps to secure your wealth and build a strong financial foundation.
Image: File photo.
The financial services industry offers a sophisticated array of instruments and products you can use to ensure financial security and build wealth. But what is important is the order in which you use or acquire them – in other words, before diving into the world of finance and investing, you need to get your priorities straight.
This was brought home to me in a recent LinkedIn post by Christo Muller, a financial adviser at Enriching Life Financial Services in Kenilworth, Cape Town. Muller reported on the following client engagement, which, he says, is a relatively common scenario among younger clients:
“A 28-year-old came to see me last month. Good job. Excited about investing. He’d been putting R500 a month into a unit trust fund for six months. He said he felt like he was finally ‘adulting’ with his money.
“Then I asked: ‘What happens if you lose your job tomorrow?’
“Silence.
“No emergency fund. No income protection. No life cover. Just R3 000 in a unit trust fund that he’d need to cash out (at a loss) the moment anything went wrong.”
Muller says this is a “backwards” approach to financial planning: “People rush to invest before they’re ready to invest.”
Investing can only begin once you have your other financial ducks in a row. As Muller says, it’s about building wealth in the right order.
So what, when you’re starting on your wealth-building journey, should you have in place before you can start putting surplus income into long-term investments?
Speaking to Personal Finance, Muller said financial planning rests on two pillars: the protection of wealth and the creation of wealth. He said clients often focus on wealth creation, whereas when you’re younger, protection is more important and provides the foundation for what follows.
At the top of the list of priorities is the health of you and your family, for which you’ll need medical aid cover, and protection for your existing assets, in the way of short-term insurance cover. If you are not protected in these two areas, a large expense can set you back years financially.
However, you’re still not in a position to start investing. There are three other protection mechanisms to put in place: an emergency fund, disability cover, and life cover.
Emergency savings
You need to build up a fund in a relatively low-risk and easily accessible savings vehicle that can cover between three and six months’ living expenses. Depending on your budget, this may take a few years.
“If money is tight, you can build it over a two- to four-year period. But you should try to put in as much as you can, especially if you’re able to put a 13th cheque into it, because it really provides breathing room. Recently, a client of mine was retrenched, and he had six months to look for employment because all his living expenses were covered by his emergency fund. So while it takes time to build, the end result is worth it because of the peace of mind it provides,” Muller says.
Income protection/disability cover
Cover against disability is a vital form of protection, especially early on in your career, before you have begun to accumulate assets. “For young earners, this is more important than life cover,” Muller says. “Under the age of 40, your risk of becoming disabled is higher than your risk of dying.”
There are two basic forms of disability cover, Muller says, and it is wise to have a combination of the two. “Income protection replaces your monthly income on disability, while lump-sum cover can take care of your liabilities as well as any immediate expenses for lifestyle changes, such as for railings in your bathroom, or a vehicle that can take a wheelchair.”
Life cover
Life cover is essential if you have dependants, but even if you have not started a family, it is worth considering in order to cover your debt should you die suddenly. Another consideration is that life cover is much cheaper when you are young.
Muller says his plan with his clients is to structure their life cover so that it falls away once they have accumulated enough wealth to “self-insure”. “For me, I like to think of life cover as taking a line of credit against an investment that you are building. I like to set things up to have an investment running alongside your life cover so that, by about year 20, the investment is worth more than your life cover.”
Building on the foundation
Once the “protection” pillar of your finances is taken care of, you can start investing for the long-term, which may include upping your contributions to an occupational retirement fund or retirement annuity fund and contributing to a tax-free savings account.
“I’m not saying don’t invest that R500. I’m saying make sure you’re not building a house without a foundation. Get the foundations right first. Then build wealth that lasts,” Muller says.
*Hesse is the former editor of Personal Finance
PERSONAL FINANCE