Making Cents: Your money questions answered

Question

Liam, I’ve been separated for the past two years, and I have no money left over at the end of each month. In fact, I’m running a deficit of about €600 which I’ve been making up from savings, but they are running very low and I’ve only about two months reserve left and after that I’ve nothing. I need your help please.

Answer

Not knowing what this reader was spending their money on and how much in different areas, I sent him a monthly budgeting tool, so that I could see what he was up against. Not knowing or having this information to hand, would have made it impossible for me to help him.

When you know what you are spending your money on each month, you can make the necessary changes, because you can’t change what you can’t measure. And in fairness he did complete the budget tool in full, warts and all, and this was my response and advice to him.

Four numbers immediately jumped off the page when I reviewed what you sent on, the first being the amount you’re spending on food, drinks, and shopping. It was accounting for 42% of your net monthly income.

Which seemed unusually high, but when I looked at what was behind this number, it wasn’t the amount you were spending on food or lunches, it was the amount you were spending on cigarettes. As you know, or maybe you didn’t until you completed this exercise, they’re costing you €112 per week and because you are buying them from after tax income, they’re really costing you about €12,000 a year.

The second category that was high was the amount you are paying on loan repayments i.e. €623 per month, which was accounting for 20% of your net income. The acceptable % in this category would be repayments that aren’t greater than 10% of your income each month, so it’s twice what is considered the norm.

And the third area that was high as a % of your monthly income was the amount you were paying in maintenance for your two children. The court appointed amount you advised you have to pay was €920 per month which was 29% of your monthly income.

The rest of what you were spending your money on was fine, but these three areas alone i.e. cigarettes, loan repayments and maintenance accounted for 63% of your income so it’s not surprising you’re running a deficit each month.

And typically when you’re running a deficit of outgoings over income, the reason is because you’re either spending too much or you’re not earning enough or a combination of both. And I think the blockage with you is some overspending and under-earning.

You can’t do anything with the maintenance payments and nor would you want to, and you can’t do much with the loan repayments either because you advised that they have already been restructured, so the standout area to spend less on are those cigarettes.

And easier said than done, but it’s the one area you really need to focus on to see if you can reduce how much you’re spending on them.

And reducing this cost won’t solve your cash flow problems either, but it will help.

What you also need to do is earn more.

If you cut back on your cigarettes by a third, you’ll save €152 each month. And if you managed to do this, your monthly deficit would be about €448 and that’s how much more you need to earn each month, and when you account for tax, it means you need to earn about €10,000 more each year.

And can you do this? Can you make yourself more valuable to your employer so that they’d pay you more? Can you work more hours and maybe do some shift work which you said might be available? Are there other employers that would pay you more?

Failing these solutions, you’re going to have to look for a second, part-time job that will pay you €448 each month.

And there’s only so much you can reduce your outgoings by before you reach a floor where you can’t spend any less and I think you’re at that point apart from those cigarettes, but there’s no limit to the amount you can earn, which is why you need to focus on it.

So, the solution to your cash flow problems is to (a) cut down on the cigarettes and (b) earn more and I’m sure it’s something you probably already knew but putting a number on both and knowing what you have to do with each I’m hoping will help.

Liam, I’m 38 and I have €70,000 in my pension fund and I contribute €8,000 per year. My salary is €85,000. The pension fund I’m invested in has produced a return of 3% per annum since I set it up. When I asked about the return with the bank that set up my pension, they suggested that I meet with their pension adviser, and when I did, he said nothing about the return. But he did say I needed to increase my pension contributions by €467 every month to build up a fund that would pay what income he thought I’d need in retirement. I’m not sure why he thought that but if it’s true I don’t have that amount extra amount each month. Your help would be appreciated.

I’m not sure where he came up with that number you need to increase your contributions by either but based on what he’s suggesting, it looks like he thinks you’ll spend about €35,000 in retirement.

And I arrived at that figure based on you increasing your pension contributions as he suggested and that amount together with your €70,000 over 27 years at an annual return of 3% would give you an end value of c. €714,161. And after you take out 25% tax free which you absolutely should, it leaves you with a balance of €535,621 which would pay you €21,425 using an withdrawal rate of 4%.

When you add this amount to the state pension and let’s assume you receive the maximum amount, that gives you an annual salary of about €35,000.

I don’t know how anyone could say whether this number is right for you unless they knew what your current spending habits are like, not to mind what they will be like in 27 years’ time. And if he also doesn’t know where you’ll live, what other sources of income you’ll have etc. it looks like a real stab in the dark but in fairness there are a lot of unknowns about what the future will hold and you need to be aiming towards something, but nonetheless I’d like to know what the logic behind any advice is, rather than just saying increase your contributions by €467.

Anyway, if you stay doing what you’re doing, it looks like you’ll have a pension fund in the amount of €484,822 which is €229,557 short of what this bank adviser thinks you’ll need which is why he’s suggesting you increase your pension contributions by €467 per month. But here’s the thing, he should have given you another solution that would increase your fund size, and it would cost you €0 each month.

And how can you do that?

By focusing on your pension funds’ annual return, that’s how.

A 3% annual return is very low and over the next 28 years you’d expect to earn a whole lot more than that.

Because if your fund earns 2% more, you’ll end up with increasing your fund by c. €229,557.

That’s what you need to be focusing on. When you put the difference between increasing your contributions or increasing your return alongside each other, you’ll see why there must be a big focus on the type of fund you’re investing into.

This is what they look like:

Existing fund + increasing existing contributions by €467 per month + 3% annual return = €714,161

Existing fund + increasing existing contribution by €0 per month + 5% annual return = €714,161

So, I’d say go back to your bank and ask them why they only focused on you contributing more, and why they ignored looking at what needs to be done to increase the annual return on your fund.

Perhaps you’re in too conservative a fund and maybe the fund you’re in will never achieve that 5% return, so what fund or combination of funds would they recommend that will hit that 5% per annum target.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at [email protected] or www.harmonics.ie