The four rules of money

Article last updated: 20/05/09

1. Spend less than you earn
Spending less than you earn is crucial if you want to accrue wealth during your lifetime. However, it does not mean your average monthly earnings must exceed your average monthly expenditure at every point in time during your life.

Expenditure follows a different pattern, and depends on your stage of life. This can entail:

  • lower expenditure in the early stages of life, reflecting limited financial commitments
  • significant increases in expenditure when children are born, homes are purchased or businesses established and
  • diminishing expenditure toward the end of life as children leave home, mortgages are reduced or paid-off, businesses are making higher profits and investments have grown and are performing well.

2. Protect your capacity to earn

With opportunities come risks. The key is to make the most of your opportunities, while avoiding or at least reducing, the risks that may prevent you from achieving your goals.
Of course, some risks cannot be avoided entirely so you may need to look at transferring these risks to an insurance company. You may consider one of the following types of insurance.

Income insurance
Income insurance can provide you with up to 75 per cent replacement income if a disability, illness or injury prevents you from working. This can go a long way to maintaining your living requirements.

Life insurance
Life insurance is one of the oldest forms of personal protection insurance, providing a one-off cash payment in the event the insured dies.
There are many reasons why you might want to obtain life insurance:

  • to support your family’s life goals after you have gone
  • to pay out any loans (mortgages and personal debt) in the event of your death
  • to buy a full share of a business if your business partner dies (buy/sell insurance), and
  • to pay for your funeral.

Some life insurance plans may include a terminal illness benefit, which provides an advance payment of the total sum insured if you are diagnosed with a terminal illness. Alternatively, the policy may pay the cost of a financial plan for your spouse or other dependants in the event of your death.

Life insurance policies are often flexible enough to allow for increases based on changes in your life – for example, the purchase of a new home, an increase in your income or the expansion of your family. Policies can also generally be increased to accommodate inflation. Many policies provide a total and permanent disability option. This covers you if you cannot work due to a total and permanent disability and need to adjust your lifestyle accordingly.

Unfortunately, when it comes to life insurance, the overwhelming majority of people, particularly the young, are underinsured. While you should guard against over-insuring and you need to be able to afford what you are buying, most people do not hold enough insurance1.

Trauma insurance
Trauma insurance can help you cope financially with the impact of a disability, illness or injury. Trauma insurance is paid as a lump sum and can be used to pay for changes to your lifestyle or for care required as a result of the trauma.

Child trauma insurance
Some insurance policies contain a children’s trauma option. This can cover (often to a set maximum of $50,000) up to five of your children (usually between two and 15 years of age) against certain events.
Total and permanent disability insurance (TPD) covers you for disabilities that totally and permanently prevent you from working. TPD is paid as a lump sum. Many TPD policies pay the benefit after the insured has been totally and permanently disabled for up to six months.

Business expenses insurance
Business expenses insurance can help your business cope financially if you are unable to work and contribute to your business earning an income. It covers:
  • electricity, gas and water rates, general insurance ∙premiums, cleaning, laundry, heating and telephone accounts, leasing of equipment or motor vehicles and dues to professional bodies
  • rent or the regular interest instalment payment of ∙any business loan or mortgage
  • salaries of employees who do not contribute directly ∙to your earnings or your business’ earnings and costs directly related to those salaries (for example, superannuation), and
  • other fixed expenses, property rates for example, ∙that are normal and customary in the conduct and operation of your business.

Few people can afford to insure themselves against all the risks they face in life. However, most of us can insure ourselves against the risks that are more likely to affect us. A good rule of thumb is, ‘protect yourself against the risks you could not afford, if they occurred’.

Putting safety nets in place ensures your capacity to earn is protected throughout your life, and this helps to make your life goals more achievable.


3. Pay off non-deductible debt first
Non-deductible debt is debt that you pay off with after-tax dollars. This means you bear the entire cost of borrowing, including the interest. Unlike tax-deductible debt, non-deductible debt simply costs you money.

4. Make your money work for you
Three common ways to make your money work for you:
  • Invest in shares. Shares work for you by paying you dividends.
  • Invest in property. Property works for you by paying you rent.
  • Invest in a business. A business works for you by generating income.

When you invest your money, consider at least two important investing concepts: diversification and your tolerance to risk.

Diversification
Diversification spreads your risk across numerous financial investments, reducing the impact that poor returns from any one investment is likely to have on your overall portfolio.

Useful site
www.personalinvestor.com.au

1 EXX&R data expertise & research: "Estimates of the extend of underinsurance in Australia" August 2003