Financial Pneumonia and the Healing Power of Time

What’s the difference between a financial cold and financial pneumonia?  We all know how this works right?  You overdo things and get a cold or the flu so you take some time out and rest your body and often you will get better quicker.  On the other hand, if you get a bit sick, continue to stay up late, skip meals and make generally dodgy consumption choices, you get run down.  The situation gets worse and eventually results in something more serious and the older you are, the more likely it will develop into potentially deadly pneumonia…..

We were recently asked a question from one of our favourite readers, who likes to be called Cleo (not her real name).  Cleo wrote in relation to one of our posts:

‘So, I understand that the message is “establish your risk profile and invest in a portfolio of assets which fits the level of risk you are happy to accept” but what if you make a mistake and lose money on poor investments – is there room for a “My bad….” and where to from here?’

The answer to Cleo’s question is potentially yes and no.  Like when you get physically ill and need time to heal, finances are the same.  Time is your friend and you need to look after your financial health – the more time you have on your side, the better you are able to recover.  By way of example, let’s assume you start saving $100 per month when you’re 18 and you do this rigorously until you turn 65.  We estimated how much money you’d have accumulated at the end assuming a 10% annual return compounded monthly which is line with the long term average return from the Australian Stock Market.  We also estimated the change in purchasing power (the value of stuff your money would buy at the end) by discounting your investment by a 3% annual inflation rate – again 3% is inside the RBA’s target band for the Australian economy.

Finally, we thought it’d be interesting to see what happens if you had a catastrophic financial event (financial pneumonia) and had to start again with nothing 10 years later.  We rolled the calculations forward in 10 year intervals and increased the amount you save by $100 each time.  The calculations attached are interesting:

Click here to see our calculations

The bottom line is the later you have to regroup after an adverse financial event the harder it is to catch up and later in life it can get to the point where it’s impossible to catch up because you physically can’t save enough.  That said, if you taking action as quickly as possible, the greater the chance you’ll make some form of recovery and that your financial health will be less adversely impacted.  It’s also important to continue to be mindful of the following things:

• Establish your risk profile and invest in a portfolio of assets which fits the level of risk you are happy to accept;
• Understand what you are investing in, the characteristics of the asset class where your money is and the volatility that may go with it;
• Understand the length of the market cycle appropriate to the asset classes you choose to invest in and remember that sometimes you might have to stay in and ride out the low points;
• Use debt carefully and assess the likely benefits verses the impacts it may have at each point in your life if something unforeseen should go wrong.

Wealth information for the iGeneration!

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Dean Johnson