Your ability to earn money is your greatest asset and needs to be protected
RANDS AND SENSE:
By Gavin Van Dyk
It’s a new year and an exciting time if it coincides with starting a career. Earning your first pay-cheque is exhilarating, but at the same time it is easy to fall into the habit of spending it all. Spending your entire salary each month and buying things on credit can be a slippery downward spiral into the dark world of debt.
By following some basic laws of finance, you can achieve financial peace of mind and a more gratifying life.
For most youngsters entering employment for the first time, the most important financial asset for a long time is likely to be their ability to earn an income. This potential for future earnings is aptly called human capital.
While wealth is built through money management, perhaps even more important is the management of your own personal human capital. This can be enhanced through education, training, skills development, and experience.
From a financial planning perspective, your future earnings potential has a significant financial value. It should therefore be apparent that losing your ability to earn – either temporarily or permanently – poses a significant risk to your quality of life. This could come about through illness or disability. If you support a young family, you also need to consider the financial risk to them of your death.
Risk mitigation should therefore form a cornerstone of your financial plan. There are five important factors that should shape your plan:
1. Medical aid: Accidents and illness happen, and the associated costs can be enormous. If you are young and healthy, perhaps a hospital plan may be an economical option. In terms of the ongoing cost of being a member of a medical-aid scheme it is important to remember that they impose a late joiner penalty if you join only after the age of 35.
2. Income continuation benefits: These pay you a regular income if you experience a loss of income as result of disability, injury, or illness. According to your condition, the income can be temporary or permanent, and typically continues to your selected retirement age.
3. Capital disability benefit: This generally pays a lump-sum benefit if you become permanently disabled and are unable to earn an income. The lump sum can be used to settle debts, cover rehabilitation costs and possible modifications to your home or car. A portion of the lump sum can be invested to provide an ongoing source of income for you and your family.
4. Life cover: This pays a lump sum to provide for your family’s financial needs on your death. Generally speaking, you would want it to cover any outstanding debt, provide for your children’s education and cover any shortfall in your family’s regular income.
5. Will: Dying without a will complicates and delays the winding up of your estate and may have unintended consequences. Even if you do not have any dependants, you should have a simple will in terms of which you leave any assets to a beneficiary of your choice.
It is particularly important that the above-mentioned cover, as well as your will, be reviewed regularly or as your personal circumstances change. What may be sensible at this point in your life may very quickly become unsuitable, as your career and personal life evolve – for example, when you get married, have children, get divorced, change jobs or move countries. Your will should be reviewed and updated at each significant stage in your life.
Gavin van Dyk is a Certified Financial Planning professional and director of Fiscal Private Client Services in Cape Town.