Monday, June 8, 2015

Wealth Projector: The Whole Is (Much) More Than The Sum Of Its Parts

There remains a serious gap in the financial tools available to Australians. To illustrate, consider the following scenario:

"Tim and Jane have a home, mortgage, and growing family. They would like to renovate their home to add room for their new child. They would also like to send their two children to private school one day. Can they afford it?"

This question is remarkably hard to answer. Some of the factors to consider:

  1. Tim and Jane will need to draw into the equity in their home to fund renovations. But how much equity do they have? What year did they buy the home, what is their current mortgage amount, and what is their suburb growth rate?
  2. Drawing into home equity will increase their mortgage repayments. It will push out the age at which they can expect to have paid off their mortage. So what is this new age? And how much are these new repayments?
  3. The lifetime of their new mortgage will encompass their children's schooling. So in the toughest years, when both children are at private school and they are still paying the mortgage, will they be able to keep up with expenses?
  4. If the mortgage repayments extend into their late 50's, will taking advantage of TTR help them?

Factor number 3 is particularly important, because by the time Tim and Jane are in their toughest years it will be too late to change their mind. Tim and Jane need to know now, before they start renovations, how things may look in 5 or 10 years time.

Unfortunately, the existing landscape of financial education tools in Australia does little to help. Yes there are web sites that can look up suburb growth rates, there are sites that can project mortgage repayments, and there are sites that can explore TTR. But it is unrealistic to expect Tim and Jane to combine all these calculations to answer their basic question. Many of the formulas involved interact in subtle ways. And it is easy to posit additional, complicating factors such as: what if Jane wants to stop working for a few years to spend time with her young family? What if Tim wants to pay for professional training courses, and ultimately increase his salary? What if they can expect inheritance one day?

The current gap in financial tools means that many Australians simply have to jump in and hope for the best. As Joshua Corrigan and Wade Matterson, from the Institute of Actuaries of Australia, observe in their paper A Holistic Framework for Lifecycle Financial Planning:

"Current illustration tools are inadequate for helping to make [decisions about the future]... Not only will more sophisticated advisor tools, illustrations, and calculators help to demonstrate value-adding analysis and advice, but the incorporation of such tools within a holistic financial planning framework will help to develop long-term relationships... Technology systems will have a major role to play in helping advisors and consumers to understand and analyse sophisticated [financial] products"

Only by having tools that can consider the whole of a family's wealth and dreams holistically, can we expect to improve the financial literacy of everyday Australians.