Many of our best-laid financial plans got wrecked by COVID-19. Not achieving our financial goals or facing financial insecurity during this period is extremely stressful, but a good financial plan can be adapted to all circumstances.
Since each situation is different, this Wealthy Maths post won’t include a calculation per se. Instead, we’ll be sharing some of the variables you should consider when making the best of a bad money situation.
A recap of the basics
Under normal circumstances a great financial plan includes these elements:
- Spending less than you earn.
- Getting rid of debt.
- Short-term and long-term insurance to protect your assets.
- Accumulating cash to cover your expenses for three to six months.
- Buying broad-market ETFs in a tax-free investment account.
- Investing in a retirement product to maximise tax benefits and protect assets from creditors and ourselves until retirement.
For most people, this foundation is quite enough to ensure a comfortable financial life. However, since many of us have lost some or all of our income due to COVID-19 lockdown measures, pulling through this period with the least amount of financial damage is the new priority.
Dig into that emergency fund
Having a pile of cash during uncertain times can be comforting. With interest rates low, you might be tempted to hold on to your emergency fund, relying on debt instead. However, low interest is not the same as no interest. What we’re experiencing now is the very definition of an emergency and precisely the reason we have this fund in the first place. Even at low interest rates, debt makes whatever you’re buying or paying more expensive than it needs to be. If you needed permission to dip into your cash reserves, this is it. When you go back to your full earnings potential, you can pad this fund again.
Don’t hide from debt
Few things are more terrifying than being unable to repay outstanding debts. Resist the temptation to avoid thinking about debts you’re unable to pay. Many people are unable to meet their debt obligations at the moment, which might be the only silver lining to this crisis. As we explain in this article, you have more negotiating room than you think when it comes to debt repayment. At the moment, your creditors are likely more willing to negotiate than during normal times. Don’t look away.
Payment holidays vs cash flow relief
Many lenders have introduced payment holidays and cash flow relief programmes to help those who are unable to meet their debt obligations. When it comes to home loan repayments, the majority of financial institutions have introduced some sort of assistance mechanism. As with all financial products, however, not all relief mechanisms are created equal.
Payment relief might help you free up some cash to cover your other expenses until you can once again earn an income. However, payment holidays could make your debt more expensive in the long run.
FNB’s cash flow relief programme, for example, covers your bond until the end of June. The bond is still paid, which means it doesn’t extend your bond repayment period or affect your credit score. These three months’ worth of bond payments are basically a new loan for which you pay the prime interest rate, not your usual bond rate. This should be treated as an additional debt, not part of your home loan. This is only advisable if you know you’ll be able to service additional debt once you start earning an income again.
Payment holidays extend your loan period at your current bond rate. While you don’t have to repay your bond during this period, you are still charged interest on the outstanding bond amount. This interest charge gets added to your overall debt. That means you will pay additional interest on the interest accumulated during this period, making your bond more expensive. Use this only as a last resort.
There’s no sense continuing investment contributions if you can’t cover your costs. Not investing might push your financial goals out by a year or two, but it’s preferable to not being able to meet your obligations in the short-term or taking on debt.
As we discuss in this podcast, if you’ve taken a pay cut, reduce your investment contributions by the same percentage as your pay cut. This will free up some cash to cover your expenses in the short-term. It’s also advisable to pause your investments if you are worried about your company’s ability to pay your salary in the coming months. Use that money to pad your emergency fund to see you through a period of not earning an income.
Once your salary goes back to normal, you can return to your original investment amount. You can also invest a little bit more to make up for the months you lost. It might be helpful to view this as a loan you’re giving yourself.
The friends and family fund
Formal debt is not the only way to get through this stressful period. If you need to borrow money to cover your costs, ask friends and family for interest-free loans first. Most of us understand the severity of the situation and those who can afford it might be willing to help out with an interest-free loan until you’re back on your feet. Yes, this is still debt, but it doesn’t cost more than you’re spending.
Wealthy Maths blog
Many of us avoid making financial decisions because we worry that we can’t do the maths. Luckily, there are only a few formulas you need to understand to make a good financial choices. This series of articles is dedicated to helping you understand how to do the calculations for yourself. Once you grasp these simple formulas, you can make better financial choices on the fly.