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Thursday, December 31, 2009

FINANCIAL MAKEOVER

It is the eve of a new year and the norm with many is to usher it in by doing things in a new way. To spend less, to save more, to start a business on the side, to invest and to look for a better paying job are some of the common resolutions that are made about money.

Ironically, the pledges such as to ‘spend less and save more’ will be made over drinks that will still keep coming after the resolutions have devoutly been made and the dawn of the new year that inspired them will be started with a physical hangover that will most likely translate to a financial one.

Financial experts agree that one keep making resolutions year in, year out but meaningful change and progress will only ever come about by making and sticking to them. This is what separates those who make financial breakthroughs and those who keep making half-hearted resolutions.

“It takes working out specific amounts and expenses to make meaningful changes and if one is serious about spending less, for example, they wouldn’t be resolving to do so while continuing to keep the drinks coming,” says Diana Gachukia, a financial advisor with Zenith Capital Advisors.

“And therein,” she says, “lies the difference between a resolution and a decision. New Year resolutions are for most people a tradition, much like counting down the last seconds to a new year and thus the resolve to keep them lasts almost as briefly as the flash of the fireworks that are lit to usher in the new year,” she adds.

Manyara Kirago, managing director of First Independent Advisors, a personal finance advisor, concurs. “After determining one’s financial circumstances, setting specific goals, putting in place effective money management plans including an investment plan and risk management measures, the last step is to put in place an implementation and review programme,” he says.

No day like tomorrow

Most plans fail because they are made for some unspecified time, he adds, such as “when I finish paying my loan or when my salary increase comes through, or when I get that new job; when I get employer housing then I will start saving for a house.”

What happens, he says, is that when the anticipated event comes to pass, the resolution is long forgotten or is again tied to another future event. Reviewing personal financial plans at least yearly is recommended, he advises, but there should be progress to review and assess.

There should be an amount accumulated in a home ownership scheme to meet that goal of owning a home, there should be interest earned from investments that should be re-invested in the same or other investments, there should be a reduction in any debt that was owed, there should be an emergency fund in place, personal risk management in the way of health insurance and no new, unplanned credit such as credit card debt.

Even if these goals haven’t been met yet but there has been consistency, such as putting money into these goals monthly, then that’s a person who has gone past making resolutions and is showing their resolve to put their financial house in order with actions, he notes.

Financial goals and values

Financial goals come from personal goals, which are driven by one’s values. To be attainable goals should be ‘SMART’,” Mr Kirago says. To explain the acronym, goals must be specific, mutual or agreed on by partners such as spouses, attainable, recorded and relevant and there must be trade-offs or prioritisation.

Keeping this in mind, rather than make passing resolutions inspired by the start of a new year, review the following expenses which take up the bulk of income and review how SMART your goals are as relates to them. These will help give you the perfect makeover you’ve been yearning for.


Everybody has to live somewhere, be it rented accommodation or one’s own home. While paying for a roof over the head leaves one with nothing to show for it, one’s own home continuously increases in value. “Even if one has to take a loan or mortgage, when the debt is cleared, one will own an asset whose value will eventually surpass its cost, including any interest paid on the debt incurred to acquire the house,” Mr Kirago says.

Letting go of a prestigious up market address would certainly change most people into home owners sooner rather than later. *Judy, a banker, lives in a one-bedroom apartment with her six-year-old chid on State House Road , which costs her Sh17,000 a month. Her son attends kindergarten nearby at a Montessori-method school that costs her Sh21,000 a term.

A house that costs her even half that amount and a good private school for her son that costs her about the same amount plus a cut in other exorbitant habits like expensive clothes would put Judy on the path to home ownership.

She would have the added advantage of easily being able to secure a loan from her employer, a bank, and perhaps at a more favourable rate, and be on her way to owning a home, one of the most important assets one could own. “Generally speaking, rent should not take up more than 15 per cent of one’s gross income,” Mr Kirago says.

Debt

“Credit is expensive,” Mr Kirago says simply. As much as possible, he urges, stay on the positive side of the capital fence, that is, receiving interest and dividends on investments rather than paying interest and penalties on loans. Limiting your debts so that you never pay more than 36 per cent of gross income towards debt is the general rule about credit, he says. When used wisely, he concedes, it can be a valuable tool for achieving financial goals.

“The basic principle is to use credit as far as you can to purchase only appreciating assets, to finance education that will increase your earning power and to finance viable businesses,” he says. Going for holiday or buying clothes on credit is not good use.”

Credit card debt, which is a form of debt most people incur especially during the festive season, is one that can quickly compound to unbelievable amounts. *Joe, a sales executive with a car sales firm was devastated to lose his job last year when the global financial crisis hit home. New car sales fell drastically and he was one of the ones the downsizing axe fell on in a bid to cut operation costs.

As he tried to find another job and his savings run out, he used his credit cards to get his essentials, hopeful of some leads he had got from friends and former colleagues of getting a job. As he accumulated credit month after month, the amount continued to rise from Sh12,000 in one month to Sh52,000 in four months and continued to rise.

Referring to it as the modern day “Alladin’s lamp” that yields instant cash, Mr Kirago notes that many use the card when they can avoid the expense of interest payable on it and when they can comfortably live within their means, because having a credit card is seen as symbol of success.

Health care

Health is wealth, it is said and that is true. Unexpected serious or chronic illness can leave a serious dent if one is unprepared. It is well worth it to be prepared to face unexpected medical bills through health insurance for yourself and dependents.

Apart from medical policies offered by private companies, there is the national health insurance scheme and the recently introduced national hospital insurance scheme. “Without these, one serious illness or accident can incur such a huge hospital bill that could wipe out savings and investments,” he warns. Do make provisions for such schemes.

Health plan costs vary according to what you are taking cover against. Some offer cover for inpatient services only, some offer cover for both in and outpatient services and others offer comprehensive cover that includes accident scene evacuation, ambulance services, surgery and any medical expenses one would incur.

Basic cover costs from Sh1,000 and is payable monthly such as that offered by AAR medical company and it can also cost up to Sh40,000 per year for comprehensive cover for self and dependents of up to Sh200,000. It also costs less to cover family cover than individual cover .


Education

For those with children, ensuring that you are not paying exorbitant school fees that makes it impossible to save for higher education is one important check to make, he says. “Borrowing to pay primary and secondary school education is a symptom of poor financial planning and one that will impair your ability to pay for their most important tuition fees which is college fees,” he says.

Borrowing Sh60,000 for school fees payable over 12 months at the rate of Sh5,850.50 will come to Sh70,225, which is even less affordable than the Sh60,000 that was initially needed, he says as way of an example. For university or higher education, putting money aside from as early on as possible is the most prudent thing to do, he advises.

Insurance company education policies are one way to go but keep in mind that the interest they earn over the years could be taken over by inflation and costs are likely to have risen from when predetermined the sum to invest towards. Unit trusts and the money market would earn more interest and are reviewed to keep up with current inflation rates.

Transport

A car is the dream of many and in some situations, it can make more financial sense than relying on public transport. In the case of a family for example, where both parents are working and school going children who need to be picked and dropped from school everyday, the total cost of transport for each may come to more than it would cost than fuel needed daily to get everyone where they need to be.

The key is to go for a car that is within your means and not to impress others. “A car is a popular status symbol,” Mr Kirago says, adding that many sacrifice other goals for the status of owning a car. Like all other expenses, try to get the best possible at the best terms possible.

Savings

For many people, saving remains an intention they intend to fulfill when certain things fall into place like a better paying job, a loan is paid or a child is through with school. Spending all that is coming in means not putting any money into acquiring assets and that is through them that financial security is realised.

“When one invests over the long term and re-invests the earnings, invested money grows at a higher rate because even the earnings begin to earn,” he says. “Sh3,000 invested every month for example for 20 years at a rate of 12 per cent return will accumulate to Sh2,997,443.”

Emergency fund

If you don’t have one already, embark on setting up an emergency fund with at least three to six months of living expenses to take care of unexpected expenses without disrupting your life, he says. “A part of this money should be kept in a separate savings account where it is available when needed but where it earns higher than bank interest rates such as the money market,” he says.

After an adequate emergency fund is in place, set aside the same amount or more if you can and investing it in a portfolio that mixes high and low risk investments. From there, aim to acquire assets that can work for you such as real estate, which would cut out the never-ending expense of rent, as well as appreciate in value over time and could bring you income such as real estate.

Investments

“Investing is an important pillar of an individual’s financial plan,” Mr Kirago says. Even if you save but don’t invest, inflation will eat away at your money’s purchasing power, making it difficult to achieve your goals. “Investing is not a preserve for the rich nor is it optional,” he says. “It is for anyone with some resources and some goals to achieve.”


“Develop a personal investment plan, know your tolerance risk and invest accordingly with your goals in sight. Goal-oriented investing means putting money for each goal in an investment appropriate to it,” he says. Money meant for paying for university education in eight years for example, may need to be invested in a different kind of investment vehicle from money meant for a house deposit in two years.

Other expenses

The above are the expenses that take up the bulk of one’s income but there are others such as food, clothing, entertainment and others that need to be taken care of with what is left over. ”The first step in creating a good budget,” says Mr. Kirago “is determining how you are currently spending money.” Do that by noting every single expense everyday for a month and might be surprised to see that you spend a lot without forethought, he says.

The second step to compare actual spending with one’s goals and priorities and the next is to make necessary adjustments to align the two. Cut down on weekends nights out, leave the car home sometimes to save on fuel and parking costs. Don’t buy clothes and shoes on impulse, that flat screen TV or any expenditure that would interfere with the budget. Sacrifice now for the sake of owning that home in future or getting that higher qualification.

The last step is “tracking ongoing spending to ensure that it remains within the limits you have set for yourself,” he says. Do this by recording expenses and comparing these with budgeted amounts, adjusting as you go along, he urges and you will find that once the habit is established, it will become a normal part of your life.

New Year, new financial path

As the year dawns, usher it in with decisive reviews rather than passing resolutions that fade with a return to the old ways of overspending and incurring debt until another year comes to find you in the same or worse financial position. Make this year one that counts, shilling for shilling, in terms of positive personal financial growth.

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