Over the years I have come across many clients who are drowning in debt and seem to be caught in a hole from which they can’t escape.
A significant portion of their income is funding debt repayments, cash flow becomes tight and any unexpected expenses present the potential for further shortfalls resulting in even more debt. It is a horrible position to be in and, for many, they see no way out.
In order to end this cycle, the first step we take is to identify how we got here in the first place. Was it the result of continual over-spending? Was it a one-off event or just not allowing for the unexpected costs that are inevitable in life?
One-off events, such as a period of unemployment or medical situation, unfortunately can lead to debt.
For clients in this situation, at least there are no systemic issues that need to be amended.
In cases like this it we normally focus on a strategy to clear the debt.
This revolves around establishing a timeframe, minimising interest payments and identifying funds that can be directed to the clearing of the debt.
Once complete, we establish a safety net to prevent this happening again in the future.
Continually overspending is unfortunately all too common. Before we address the issue of the debt, we need to correct the underlying problem.
First, we need to identify expenses; most people are not able to accurately account for where the money goes. Once we know what the expenses are we need to separate into discretionary and non-discretionary. The aim is to reduce the discretionary expenses to a point where we are living within our means and then, ideally, in a position to reduce debt and get ahead.
This will involve prioritising what is most important to you and directing funds only at these things. In the event that the non-discretionary spending exceeds income, some structural changes will be required.
People who have overspent over a sustained period of time will need to change their habits significantly. This need not be painful, in many cases there is significant wasted spending that offers little or no improvement to lifestyle.
In the case that the clients are not regular over spenders, but live basically pay to pay, and have not prepared for the inevitable unexpected costs, the actions to get out are similar to above. We need to reduce spending enough to allow for a bit of fat in the budget for when the fridge needs replacing or the car needs to be fixed.
Addressing how a client acquired the debt should allow us to shape habits to prevent it from happening again in the future.
Alex McKenzie, Future Financial Services
Alex McKenzie is a financial planner, and the owner of Future Final Services in Penrith. He is a graduate of Western Sydney University.