What are your priorities

What are Your Priorities?

It has been drilled into us from a young age that if we find ourselves owing money to someone, we must pay that back before anything else. And rightfully so. But as we grow older, we also tend to put debt into this same category. Our minds cannot fathom moving forward in any way until our home loan is gone.

But is this really the best approach to take?

Well to answer that question, there are a number of factors to consider, so let’s break them down and by the end of this blog, you’ll have a clearer picture of where your priorities should lie.

1.     Do you possess a sufficient financial buffer?

A financial buffer is essentially your safety net. It will enable you to maintain your living expenses and financial obligations should your financial situation change, such as a loss of income.

This buffer can consist of available redraw facilities (meaning extra payments made on a loan that can be withdrawn later, if necessary) and/or funds held in offset accounts.

The amount of buffer required depends on the stability and predictability of your income and the extent of your financial responsibilities.

If your income is uncertain, I generally recommend clients to have a reserve equivalent to one to two years’ worth of expenses and obligations.

Otherwise, a reserve equivalent to 6 to 12 months expenses and obligations should suffice.

Typically, one of your primary financial goals is to amass an adequate financial buffer.

2.     Can you reduce your debt before retirement?

The next thing to consider is if you are repaying enough each month to ensure that all non-tax deductible debts, such as your home loan, are completely paid off a couple of years before you intend to retire or reduce your working hours.

You also need to ensure you’re gradually decreasing your investment-related debts to a point where your investments are neutrally geared. This means that the income generated from your investments covers the interest costs. There’s no necessity to eliminate all investment debt before retirement. Maintaining some leverage can be efficient. However, it’s crucial to avoid a situation where your investments become a financial burden in retirement, leading to negative cash flow.

If you’re on course to achieve this optimal level of debt reduction, any surplus cash flow beyond these requirements should be allocated to investments in growth assets.

3.     How responsive is your cash flow to fluctuations in interest rates?

A significant debt-to-income ratio implies that your cash flow is highly responsive to changes in interest rates, a situation that many individuals may currently be grappling with.

The objective is to bring down your debt to a level where your quality of life can be maintained with minimal impact from interest rate fluctuations.

As a general guideline, achieving this entails lowering your home loan payments to a point where they account for less than 25% of your gross (pre-tax) income.

However, like all such guidelines, this serves as a reference point. It’s advisable to assess your actual cash flow situation to gauge its sensitivity to interest rate changes accurately.

If you’ve successfully met the above three objectives, it’s highly likely you should commence your investing journey today.

Ask yourself:

–        Do you have adequate buffers in place?

–        Are you on track to reduce debt by the time you retire?

–        Is your cash flow unaffected by changes in interest rates?

Don’t allow debt to hold you back. Get in touch today to discuss your priorities.

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