A good financial plan prepares for the worst, but hopes for the best. It creates a balance between protecting you should you lose your job or fall ill and ensuring your wealth grows over time. It is a multi-layered pyramid, built on solid foundations but with the flexibility to generate growth once those foundations are established.
It is tempting to believe that long-term wealth is all about having a set amount of money, but the reality is more complex: how you plan to use your wealth makes a difference to how you manage it.
It’s all about timing
Time is important when managing your money. You can usually get a better return on your savings if you are willing to tie them up for longer. With term deposits for example, banks will give you a better interest rate on your savings. Depending on your risk appetite, a long term approach also means you can invest in higher risk assets such as shares because you can ride out short-term volatility.
Why does this volatility matter? The stock market can move around a lot in the short-term. This was seen in 2020, when markets saw a rapid sell-off in response to fears over the impact of Covid-19. The market recovered, but if investors had sold in February or March they would have been nursing losses of 30% or more. This is why stock market investment is not usually a good option where savers are likely to need the money in the short-term.
Having lots of money tied up in cash savings for the long-term is a poor option to build wealth over time. Cash savings should be seen as a home for short-term or emergency money.
At the same time, having lots of money tied up in cash savings for the long-term is a poor option to build wealth over time. With many cash savings accounts paying low or negative interest rates and inflation expected to rise, investors will see the purchasing power of their savings drop over time. As such, cash savings should be seen as a home for short-term or emergency money.
The investment pyramid
It can help to see money as a pyramid. At the bottom, there is rainy day money, a reserve to cover any contingencies – a leaky roof, an unexpected bill – or certain larger spending items, such as a car or a deposit on a house. This should be in cash because you might need to call on it at any time. No savings plan is complete without this in place and it is the foundation for everything else.
It is worth choosing your savings account carefully; although rates are low across the board, they do vary. Pick the right account for you and pay in small amounts regularly, for example by standing order. It can be worth doing this on the day you get paid every month so you don’t miss it.
Once you have this cash buffer in place, you can start looking at longer term savings. This should include some measure of protection for your family in case of a sudden loss in income – illness or redundancy, for example. In practice, this is likely to mean life insurance and retirement savings.
Retirement savings will often start with your workplace provision. In Luxembourg, the social security system provides retirement benefits with two components: a flat-rate amount for those that have accumulated enough years of contributions, plus an earnings-related amount. This is paid for through contributions by employers, employees and the state, and has tax breaks attached. At 24% of wages for employees, provision is high but personal pensions and insurance products are also an option for those who would like to save more. The self-employed have a similar scheme, but contribution rates are lower.
Insurance is a vital part of any financial plan. Many people will have death in service benefit and some sickness cover through their employers, but it is worth checking how much this is worth and whether it would be enough to protect your family. Any shortfall can be topped up with life insurance. Equally, income or critical illness insurance can cover your salary in the event of redundancy or ill-health.
The top of the pyramid
The remainder of your wealth is likely to be directed towards financing other major lifestyle ambitions – your children’s education, a ‘bucket list’ holiday or a second home. The right option will depend on your risk appetite, your knowledge and experience of financial products, how long you have to save and how much you’re willing to put aside, but is likely to include a blend of investment products such as SICAVs, structured products, shares and bonds.
For this part of your wealth, there is more flexibility. You can afford to see some volatility in the capital value of your investment, which means you can direct it towards expected higher growth assets. You will need to decide how much risk you are willing to tolerate, whether you need an income from your investments and whether you have specific requirements for the way your money is managed (such as ethical considerations). Your banker can help direct you to the best option for you – whether that is discretionary management, execution-only or something in between.
In viewing your wealth this way, you can see how savings and investment interact. The investment portion is vital for building long-term wealth, but savers have to get the foundations right before they can start to take a risk with their money. In this way, a well-managed financial plan helps build both security and long-term wealth.
It is tempting to believe that long-term wealth is all about having a set amount of money. The reality is more complex: how you plan to use your wealth makes a difference to how you manage it.