Australians need to rethink their approach to financial planning as they face the grim prospect of almost no real income growth for the next six years
The International Monetary Fund’s recent report on Australia’s economic outlook has projected low growth for income each year until 2024. It has forecast that wages will grow 2.1 per cent this year, which is only real wage growth of 0.04 per cent after allowing for inflation.
The IMF says that over the next six years real wage growth will be around 1 per cent or even less in each of those years. This trend is a continuation of the last four years.
Advisers and economists have strategies to help people come out on the other side: create a savings plan and pay yourself first; automate finances for investing; keep debt levels modest; and use the bank of mum and dad.
Head of investment strategy and chief economist at AMP Capital, Shane Oliver, says: “In this environment of pretty constrained wage growth Australians need to be a lot more cautious in terms of taking on debt because the burden of that debt won’t decline as quickly in a world where wages aren’t growing that fast.”
Reserve Bank Governor Philip Lowe addressed this very issue at the AFR Business Summit last week and put it down to the fact that household spending has risen faster than household income.
“It is plausible that, for a time, this didn’t affect people’s expectations of their future income growth; that is the value of their human capital. So they didn’t change their spending plans much, despite their current income growth being weak, and the saving rate fell. However, as the period of weak income growth has persisted, it has become harder to ignore it,” he said.
Millennials cannot rely on a significant increase of income to accumulate wealth and pay off debt, as their parents did.
Perhaps the most controversial strategy for dealing with the income recession is to rely on the ‘bank of mum and dad’ to finance a deposit for house now as they will eventually inherit their wealth anyway.
Baby boomers have lived through the days of high income growth and higher inflation which has given them more of an opportunity to accumulate wealth compared to their children.
“Generally speaking older Australians have benefited from the run up in house prices. Their wealth levels are relatively high and ultimately millennials will inherit their parents’ wealth but with people living longer that may not occur until they are in their 60s so there is an argument that parents need to support their children to get into the housing market,” Oliver says.
However, people should take consideration when taking on debt in a world where wages are not growing as the burden of the debt will not decline as quickly so buying a home may not be the key to accumulating wealth.
Omniwealth financial planner Steven Korner says: “People rush into buying a home because they have been conditioned to, but if someone is being gifted an amount from their parents to buy their home, the main concern is that if they can’t save that deposit on their own they may struggle to keep up with mortgage repayments.”
Financial advisors have several different strategies to accumulate wealth through savings which are particularly useful for people that have difficulty saving a deposit.
An important approach to savings is for a person not to live beyond their means and keep their spending and expenses in line with their salary.
HLB Man Judd financial adviser and client relationship manager, Jess Lewis, says: “Those who struggle to build wealth aren’t those who are on a lower wage (they are actually doing better than those earning more) but those who are living beyond their means.”
To properly understand and control spending patterns, people need to be able to see where their money is going to know if they are living beyond their means. Micro investing app, Raiz, has this functionality through the user’s linked spending account, which shows exactly how much each user is spending in different categories like shopping, transport and bills each month.
Chief executive of Raiz, George Lucas says: “You should always be spending in line with what you earn, however if you’re not then you need to get familiar with having a savings first mindset and train yourself to only spend what is left after saving at least 20 per cent of your monthly income”, said Lucas.
Coming up with an affordable investment strategy is an important part of growing personal wealth. People have a mindset that they need an increase in income in order to invest and this is not going to happen.
Managing director at Fidelity International in Australia, Alva Devoy says: “We need to demystify the view that investing is really complicated and you need a lot of money to invest.”
Beginner investors can start with something as simple as a Raiz account, which rounds up debit card transactions to the nearest dollar and invests the change into a personalised investment portfolio.
Others advisers recommend using low-cost investment products, such as index ETFs for savings.
My Millennial Money podcast host and financial advisor Glen James says: “The number one priority is to automate finances by not necessarily trying to find a bank account with the highest interest but starting to automatically have an amount that comes out of your account every pay cycle to be invested in something as easy as a low cost exchange traded fund or managed fund.”
For those interested in low risk, cash is one of the simplest asset classes and carries minimal risk. Products like RaboDirect’s Notice Saver account allow deposits and does not have a maturity date. The notice period of 31, 60 or 90 days is the amount of time customers have to wait before they can withdraw. Notice accounts give savers the flexibility to make regular deposits but keeps the money out of reach of impulse spending.
After investing, it is crucial to understand and utilise the power of compounding to accumulate wealth. With any investment that pays a return it can be reinvested and doing it earlier will make your money work harder.
Infocus Money Management’s managing partner Bill Savellis says: “When you start saving, compounding allows your money to generate money over time and will end up contributing more to your net worth than you do contributing on your own. The power of compounding is what makes all the difference the earlier you start, the better off you will be.”
There are ways around the income recession and prosper but people need to be prepared to adjust their thinking about money.