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Personal Finance Strategies in the Context of the Credit Crisis
4th October 2008

Strategy 1 - Pay Down 'high interest' non - tax deductible debt (eg store cards and credit cards).


This strategy makes great sense - and probably should be undertaken with a greater sense of urgency than before.  This is because with the slowing of the economy comes increased unemployment and a tighter financial landscape (for example, perhaps taxes might be raised rather than the stream of tax cuts that we have had over recent times).


Therefore it is important to get rid of the high interest debt burden that takes some money (interest payments) out of your pocket every week.


There is more than $40 billion in credit card debt.  That is more than $2,000 for every man, women and child in America.


Strategy 2 - Regularly Investing in Growth Assets


For most people a long time from retirement, regular investments into growth assets is actually what is happening in their superannuation - their employer contributes 9% of their income and (after 15% contributions tax is taken out) this money is used to purchase investment assets.


Many people also contribute regularly to an investment portfolio. 


This is a great strategy for exactly times like these - when investment markets fall in value and you are making regular contributions it means that you are continuing to buy investments at lower prices - putting you in a great position when markets do rebound. 


Strategy 3 - Borrowing to Invest


Borrowing to invest in any growth assets - property or shares - increases the expected return and the volatility of the portfolio.


While investment returns are volatile, the real volatility of this strategy is revealed.  Whereas share markets have fallen in value by 30%, someone 50% geared into the market has seen the value of their worth fall by 60%.


Borrowing to invest intentionally increases the volatility of an investment portfolio - and should always be used with caution.  It is a legitimate strategy - however there are risks that you must be aware of.


Strategy 4 - Making Additional Mortgage Repayments


This is a sound strategy at any time.  You increase your financial position by reducing your debt, you free up future cash flow because you now have a lower loan and you are on the way to being debt free more quickly.


There are forecasts about property prices falling in value.  Certainly we have seen this happen in the USA.  I don't put a lot of faith in forecasts either way - let's face it the future is unknown - however if property prices did fall then a person who had a smaller mortgage is in a better position to cope with that (for example if they sold their property).


Making extra mortgage repayments ?earns' you the rate of interest saved, likely to be around 9% at the moment - and is tax free.  Getting ahead on the mortgage also puts you in stronger financial shape to weather any increase in interest rates (although at the moment it looks like rate cuts are more likely in the short time).


It remains a sound and sensible financial strategy.  If we do get an interest rate cut next week, and if that cut is passed on to mortgage holders, then a strategy might be to keep your repayments at the same level and pay off more of your loan.


Strategy 5 - Salary Sacrificing to Superannuation


The core of this strategy is that there is a tax saving between taking income, or redirecting it to superannuation as a salary sacrifice.


For the average income earner their tax rate is 31.5%.  The rate of tax on a superannuation contribution is 15%.


So, if you earn $10,000 usually you pay tax of $3,150 and end up with $6,850 working for you.


However, if you salary sacrifice your money to superannuation you end up with $8,500 working for you after paying 15% tax ($1,500).


Keep in mind that you can control where your superannuation contributions go - you can direct these to be made to a cash investment option, a share based investment option or (most commonly) a 'balanced' superannuation fund made up of some shares, cash and property assets.


The strategy still works well despite the current market volatility because the key to the strategy is the saving in tax.  For people close to retirement they might choose to see their salary sacrifice contributions invested in a more conservative option such as a 'cash' option - proving them with greater certainty that their superannuation account is increasing in the lead up to retirement.


Strategy 6 - Income Planning for Retirement


More and more people are using their superannuation assets at retirement to pay them a pension (income stream) in retirement - particularly now that all superannuation withdrawals after the age of 60 are tax free.


For example, a couple with superannuation assets of $200,000 might want to draw on these assets at the rate of $10,000 a year, to supplement the age pension that they would receive (assuming that they are of age pension age).


The best way to plan for this income is to have at least 5 - 7 years of drawings set aside in cash and fixed interest investments.  That way, regardless of how volatile investment markets are (and they are extremely volatile at the moment), you know where the next 5 - 7 years of drawing are set aside.


If the rest of the money is invested in shares and property, these investments would be paying income (dividends and distributions) over time - so they are topping up the cash account.  The income from shares and property tend to grow over time, which helps protect your situation from inflation.