Unless you already have enough assets to cover your cost of living (for the long term) then I would argue that for Gen Xers (plus Gen Y and virtually everyone else) the subject of this weeks blog is in fact the most important part of your overall wealth creation strategy…at least for right now.
If you fall into the category of 99% of Gen Xers that are yet to create Financial Freedom, then your greatest asset is not your house or your super balance…your greatest asset is your ability to generate income. Your earning capacity.
It’s crucial to have a strategy around how to best protect your earning capacity (it’s also crucial that you have a strategy to grow your earning capacity through developing your skills & knowledge to be able to add more value to others – but we’ll save that for a later post). You might remember from the “Introduction Part 3” blog on what we at The Practice call ‘The 3 Pillars of Cash Flow’, that this concept is a key part of the ‘Protection Pillar’ – to ensure that you and your family are protected if things don’t go to plan.
Following the ‘Clarity is Critical’ post a couple of weeks back, if you took the time commit your goals to paper, what is the key ingredient that is going to be required to achieve those goals?…it’s cash flow. It all comes back to cash flow. Cash flow is like oxygen. When you have it, you don’t think about. But when you don’t have it, you think about it all the time – and without it, virtually nothing else is possible.
Let’s take a minute to consider just how great an asset your future earning capacity is. As per the below table, let’s say you are 35 years old and earning $100,000 per annum. Assuming you are able to grow your income a bit above inflation by continually getting better at what you do and adding more value, then between now and age 65 you are likely to earn a total of over $6.6 mil. Those are Powerball jackpot numbers. But you don’t need to buy a lotto ticket…you just need to invest in and protect your earning capacity.
So how do you protect your earning capacity?…Through implementing a wealth protection (risk insurance) strategy. Amongst other things, this involves having an appropriate mix of all four types of cover below. Next week we’ll go into more detail, but here’s a brief summary of the four main wealth protection tools to bullet proof you and your family’s wealth creation strategy.
Types of wealth protection cover;
- Income protection – pays up to 80% of your total salary package ongoing if you are sick or injured and unable to work.
- Life cover – pays a lump sum to dependants if a person passes away (ideally enough to clear the mortgage, cover loss of future income and pay the kids school fees).
- Trauma cover – pays a tax free lump in the event of a person being diagnosed with a major illness (around 80% of claims are for cancer).
- Total and Permanent disablement – quite often linked to Life cover and pays a lump sum in the event of a person being totally incapacitated and unable to work again.
An alarming amount of Generation X clients who come to us for initial Wealth Creation advice have a mortgage, a couple of kids, great earning capacity….and no wealth protection cover in place. If the main income earner was to be off work for health reasons for an extended period…or pass away prematurely…then the family would be in severe financial stress pretty quickly. As wealth creation advisers, it would be irresponsible of us to put in place plans around how to best invest clients income, without first putting in place a strategy around how to best protect clients income in the event of being sick or injured and unable to work long term, or passing away prematurely.
Most clients allocate 2%-5% of their (gross) income towards protecting their earning capacity…leaving the other 95%-98% to cover their lifestyle spending, debt reduction and wealth creation plans (as well as of course to pay some tax).
For what’s it’s worth I’m insured to my eyeballs. I’d say don’t tell my wife…but she is too. Whilst I don’t dwell on it too much, it gives me comfort and peace of mind to know that our kids will be well looked after if either one or both of us are no longer around or unable to work long term.
Several of our clients claim on Income Protection and/or Trauma cover on a yearly basis. Whilst an unfortunate situation, it makes me happy that we’ve played a part in protecting their financial future…to ensure a major health problem doesn’t result in a major financial problem. This way they can focus on getting better, rather than worrying about how they will pay the mortgage or feed their kids.
I’ve experienced the benefits of wealth protection cover first hand. Nearly 9 years ago while my wife and I were living in London, I was in a major car accident and unable to work for 12 months while I learned how to walk again from scratch. Thankfully I’d taken my own advice from a few years earlier. The income protection I had in place ensured that the majority of my income still rolled in and I could just focus on getting better. What would you do if your income stopped due to health reasons for 12 months…or more? At that stage of our life, having no income at all for 12 months would have made a significant dent in our finances, and been a major step backwards. Having appropriate wealth protection in place allowed us to get through the year without drawing on savings. This savings was then used to buy a house upon returning from London, and this asset has helped fuel our wealth creation plans ever since.
Importantly, not all wealth protection (insurance) policies are created equal. Many people think they are fine as “I’ve got insurance in my super fund”. However quite often this is bare minimum default cover that is grossly inadequate for most Generation X family’s needs – especially anyone with a mortgage and kids. Also as we’ll cover in more detail next week, default income protection held entirely inside of superannuation is incredibly limited as to when it will and won’t pay out – and in my opinion really can’t be relied upon to protect you and your family in the event of a loss of income due to health reasons. More comprehensive cover is crucial.
Next week (in Protect your greatest Asset – Part 2) my special guest will be Eddie Scalpelli – The Practice’s in house Wealth Protection specialist. Eddie will cover in detail the various aspects you should consider when building an appropriate wealth protection strategy when looking to bullet proof you and your family financially. He’ll also cover a few trips and traps to be wary of along the way.
In the meantime, it’s important to understand what you have in place currently. Do me a favour and pull out your last superannuation statement and any additional wealth protection policies you have in place. Make a note of what wealth protection cover you have. Then make a note of your mortgage, future earning capacity from the above numbers, along with future estimated education costs for your kids. Have a chat between you and your partner. Really discuss what you would both “want” in terms of a financial outcome in the event of one of you being sick or injured and unable to work long term…or passing away prematurely. Then resolve to investigate and implement an appropriate wealth protection strategy. Remember…it all comes back to cash flow. And a solid wealth protection strategy forms the foundation of your wealth creation journey as you work towards creating Financial Freedom.
Matthew Morrison is the Director of Wealth Advisory at The Practice, a Personal Wealth Advisory & Business Advisory firm based in Parkville, Melbourne. Matt along with The Practice team are committed to and passionate about developing & implementing wealth creation strategies for clients to enable them to Fuel their Family’s Future (while protecting them along the journey).
Matt and The Practice team can be contacted via http://thepractice.com.au or (03) 8888 4000.