Telling people not to overcommit financially seems to go without saying, yet it is still a very common mistake. Most people base their financial decisions on their current situation, and often make commitments that are suitable now – but things change.
Changes to personal and financial situations greatly effect long-term financial commitments, these potential changes are often not considered or seriously underestimated.
Lifestyle changes such as starting a family, getting married or buying your first home, significantly influence your capacity to meet ongoing obligations. All these potentially influence income, expenses and are likely to alter your spending priorities.
There are also likely to be external variations that influence your ability to maintain your investment or to make repayments. A huge risk a lot of us are currently facing revolves around interest rates.
Currently interest rates are at historical lows. Although there are no signs of them increasing soon, it stands to reason that eventually they will return to long-term averages (or above). Too many are borrowing based on what they can afford now, however, those repayments look very different with rates of two or three per cent higher.
The potential for increased interest rates don’t just affect decisions for new borrowings. You also need to be aware that increasing rates will increase repayments on existing debts which reduces cash flow available for investments.
When committing to investments that require a long-term horizon or ongoing contributions it is prudent to address likely changes and how they will affect the capacity to keep the strategy in place.
When clients are in life stages that are subject to major changes, such as young clients and pre-retirees, generally speaking, we tend to recommend strategies suitable for short timeframes that are easy to exit with little risk or cost.
Factoring in potential changes and avoiding over commitment is an important part of tailoring strategies to individual situations and will ensure that the recommended strategies are still appropriate if changes do occur in the future.
