How does someone who earns $500,000 a year land themselves in a situation where they are living month to month, with no assets and credit card debt?
That’s the scenario Peter*, a Sydney barrister, found himself in a couple of years ago. When you a regular, high income, “it’s not as hard as you think to fall into the habit of spending everything you earn”, he says.
Eating two to four times a week at hatted restaurants ($30,000-plus over a year) catching taxis around town and keeping a lease car for mini-breaks ($25,000-plus) having meals prepared and delivered ($25,000-plus) hiring a personal trainer for mornings ($22,000) and outsourcing drycleaning home cleaning and gardening ($20,000-plus) add up quickly. (See example at end of article)
Peter is not alone in spending up. A recent MLC survey found most people don’t think having $1 million makes you rich any more, many consider eating out and private schooling essential costs and one in five households with incomes of more than $200,000 report living pay cheque to pay cheque.
It’s not uncommon for individuals who earn a lot to think they are not wealthy, financial planner Justin Hooper of Sentinel Wealth, says. “They say, ‘I know I earn a lot, I know I am in the top half per cent, but I don’t feel wealthy and I am not accumulating assets’. The other interesting thing they say is, ‘I don’t think I have a lavish lifestyle’.”
Indeed, there is a big disparity between high incomes and wealth, say financial planners, who find people who overspend and fail to accrue wealth are often successful business people who are simply time-poor and not cognisant of how much they are spending. They are masters or mistresses of their careers, but not of their wealth. “Spending significant amounts of money is quite prevalent among professionals, particularly in the legal profession,” Hooper says.
Others might assume the money goes on luxury holidays and mansions, but that’s not always correct. Often it’s fine dining, rental accommodation and hired help that are the culprits.
The problem starts early in professionals’ careers, a young legal professional says. It’s the lack of preparedness for substantial jumps in salary. You go from being a frugal university student to earning more than $100,000 and suddenly it’s like you’ve won the lottery she says. And so the cycle continues, until a circuit breaker enters.
For Peter that circuit breaker was being on the cusp of 40. About to have his first child and getting worried phone calls from family. He did his first stocktake and realised some lifestyle changes would have to be made. For others, the circuit breaker might be realising you don’t want to rely on your parents – or children - when you have your own income and so it’s time to build your wealth, Hooper says.
Not using your top earning years to build wealth is an enormous waste of a very valuable resource – a high salary. Fortunately, it’s not too difficult to correct these wealth-sabotaging habits.
Advisers use a variety of strategies to help their clients build wealth, from using spending trackers and secret accounts to disabling internet redraws. Some of the tricks planner Suzanne Haddan, of BFG Financial Services, uses include encouraging her clients to siphon a proportion of their salary straight from payroll into a locked account, or, better still, their superannuation through salary sacrificing. “If they can’t see it, they can’t spend it and they don’t feel like they’re missing out on it, “she says.
For credit cards, she says the limit should be one, with an automatic repayment set up. She also tries to ban advances offered to clients for quickly paying down their loans by removing internet redraw options. “Budget can be a dirty word in the minds of some high-income earners, say Haddan and Hooper and clients sometimes feel they should be rewarded or compensated for their long hours by being able to buy what they want.
Hooper instead prefers to start by tracking spending and then linking it to various outcomes. Some clients realise they are not actually spending more than they should to achieve their goals while others find themselves on “disastrous paths”, he says. “I try to show them what the future looks like through projections if they continue to spend that way, then we set targets linked to goals and objectives.”
Another strategy for building wealth is understanding how to use debt, financial planner Olivia Maragna of Aspire Retire Financial Services, says. “Maximise your good debt (where you can claim the interest expense as a tax deduction) and concentrate on reducing the interest on your bad debt. The strategic use of an offset account can reduce your interest on your bad debt but maintain the principal debt amount, which can potentially be used later on to claim tax benefits from, should you wish to,” she says.
Haddan agrees top earners are psychologically more likely to want to pay down debt quickly than put money into a savings account and says this can be used to their advantage with investment loans.
Financial planner Ben Smythe, of Smythe Financial Management, puts his clients on Xero Cashbook, which he says helps them manage their cash flow and wealth planning more like a business. Xero, which is best known for its small business and accounting functions is linked to bank accounts and credit cards to keep a record of spending. It then categorises receipts and lets the user know how close they are to their spending or saving target. You start by setting up categories, like mortgage, school fees, food, entertainment, and then your transactions start flowing in live and fall into their respective groups. Patterns are then formed to show you where you are overspending and how that will affect your goals.
“It gives them a very transparent picture of what cash flow is available for building wealth,” Smythe says. Once clients are set up on Xero, he puts them on a plan and links it to emotional outcomes, like a family holiday. One of Smythe’s clients Sharon*, the owner of a small business, says the program saves her the three hours that she previously spent on a Saturday morning reconciling her transactions. The main benefit for her is not the financial savings but the time it saves. You also don’t have to have that conversation with your partner about whether those shoes were really $200, because it’s in the budget,” she says.
However, a significant barrier for some prospective users is the fact you have to surrender private bank account details to the cloud. Xero acknowledges these concerns and says though the cloud isn’t totally safe from hackers, there are things users can do to reduce the threat, like multi-factor authentication and installing anti-malware devices. Smythe says he’s never seen or heard anything that would make him worry his clients’ security was being breached. “It’s always a risk with a lot of things, but there’s nothing that makes me uncomfortable (with Xero).”
Xero costs about $50 a month, which for some people might be a fraction of what they would save but for others already wary of spending it might not be worthwhile. It’s available as a free trial through its website. For those who don’t want to pay that there are other free applications emerging for personal wealth management, including PocketBook, MoneySmart’s TrackMySpend and MoneyPad.
Finder.com.au says its searches for bugeting apps more than doubled between December and January, which signifies the growing awareness for these tools.
Apps to budget by:
An example of over spending:
Couple with two children at high school, single income of $400,000
Article: AFR Weekend 12-13 March 2016