As 2007 draws to a close this is a good opportunity to review how we have fared financially during the past year and what we should be doing to ensure we do better in the coming year. If you are really on the ball you will know the total value of all your assets at the beginning of 2007. All you have to do now is to calculate the value of the assets at the present time and - hey presto - you now know whether you have made a profit or loss this year. If you run a business and keep accurate accounts this is information you will have at your fingertips.
If you don’t keep close track of your personal wealth then to do so could be one of your first New Year resolutions. And by calculating your wealth at the beginning of the year you will be able to repeat the calculation at the end of the year and thus determine if you are richer or poorer.
How can we calculate personal wealth?
The best way is to divide everything you own into three separate asset classes or ‘compartments’. These are:
1) Fixed assets such as land or property and also businesses. Land and property should be relatively easy to value, although to be realistic you should state a value that a willing and able buyer would pay for them today. As for a business, calculating physical assets may be straightforward but measuring intangibles such as goodwill is more subjective. Again, you have to take a realistic figure that you know the business would fetch in a short time if you offered it up for sale.
2) Medium to long term financial assets. These include the current market value of any stocks and shares, mutual funds, portfolios and the surrender values of insurance policies and savings / investment plans. Remember the value of the latter is not what you have invested but today’s surrender value which could be significantly less if the plan has been running only a few years. The value of a defined benefits pension plan may be more difficult to assess, especially if it cannot be accessed until you reach retirement age. If the latter is well into the future it is best ignored for the purpose of this exercise.
3) Liquid assets. These include all your bank accounts, deposits, cash equivalents and money under the mattress. Beer in the fridge doesn’t count!
How balanced are your assets?
Once you have totted up the value of the three asset classes, by adding them together you should arrive at the figure that represents your total net worth. This is the figure you will need to record so you can recalculate at the end of the year again to see if you are richer or poorer after all the efforts you put in during the year.
But dividing your wealth into the three asset classes serves another purpose. How your wealth is distributed can affect your future wealth. For example, if you retain 80% of your wealth in cash deposits you are not going to make money in the long term since the purchasing power of cash diminishes over time. The consequences could be even worse if your cash is in a single currency that happens to be the wrong one. Even the once mighty US Dollar has lost more than 40% against the Euro and other major currencies in a short time. You may also recall 1997 when the Rupiah fell around 80% against other currencies.
If you have 80% of your wealth in fixed assets, such as real estate, you risk cash flow problems and potential losses in the event of a property crash or recession, when there are no buyers around. If your fixed assets consist of a business this can be even worse should events cause a sudden downturn in trade. Bali entrepreneurs who have experienced darker times will be well aware of this.
So how should assets be balanced?
Where financial planning is concerned the conventional wisdom is that assets should be divided as follows: Fixed assets: 10% to 20%, Medium to long term financial assets: 60% to 80%, Liquid assets: 10% to 20%. This guideline should be appropriate for those well into professional or business careers. If your asset distribution does not fit into these percentages then you may want to take a hard look at any imbalance. This may take the form of insufficient or excessive cash holdings, or more commonly an excessive weighting in fixed assets and insufficient financial assets to ensure a secure income in later years.
A common error is for people to put all they have got into a business venture. Great if the business is successful, but dangerous if things go wrong, as they do statistically with the majority of businesses. For many business people in Bali this year has seen a great recovery in fortunes as the tourists flock back. Some may be tempted to expand aggressively. This would be unwise unless ample resources can be channelled into cash reserves and long term financial investments in safe offshore jurisdictions. These should ideally be sufficient to support you completely in the event of business failure. If there is a risk that creditors could pursue you for your personal fortune, it is possible to set up trust arrangements to ensure that external assets are protected from them.
Make sure your most valuable assets are protected
You have probably insured your car, but how well are you and your family covered? All your plans for the future can be in ruins if you suffer an accident or major illness and you do not have adequate medical, disability or critical illness cover. And would your family be able to maintain the same standard of living if you, the breadwinner, were to die suddenly? The turn of the year is an ideal time to reflect on these issues and take action without delay in the New Year to put proper protection into place.
Look beyond 2008
While the end-of-year focus is on making 2008 a prosperous year, don’t overlook the longer term. The actions you take now can determine what kind of lifestyle you will enjoy – or suffer - in your later years. In the ‘good old days’ in the West, an occupational pension scheme coupled with a state pension could be counted on to provide a pension equivalent to around two thirds of final salary, plus inflation proofing. For most people, those days are gone. Few employers can now afford to provide open-ended ‘defined benefits’ schemes. Pensions in future will depend on the vagaries of the markets.
Most expatriates do not even have a company scheme and many have drifted out of their home country state schemes. Pensions in all currencies are at the mercy of inflation which threatens to worsen in years to come with the likelihood of growing food shortages and the impact of climate change.
The solution to the risk of a serious shortfall? – Increase contributions to private pension plans and also invest in solid assets that will hold their value as paper money declines in value.
Ready to make some financial resolutions?
The above should provide you with a fair amount of material to enable you to make a list of things to do to ensure prosperous times ahead, not just for 2008 but the years beyond.
Happy New Year!
Colin Bloodworth
colin.bloodworth@financial-partners.biz
