Avoid the debt trap and save a packet- 1st February 2003

Deborah Cleveland - Australian Financial Review

To reach your goals you need to have something to invest. That means cutting spending so you can save.
Put that credit card away, think again if you're about to sign your life away for that gorgeous car, and reconsider taking an overseas holiday. Because if you're like most 20-somethings, two things stand in your path to prosperity an over-ambitious lifestyle and the borrowing that funds it.
Not understanding debt is the biggest mistake among younger investors, says the managing director of Millennium Financial Services, Laura Menschik. Credit cards are the chief danger. ``By not paying them off properly, people land up having debt upon debt. When only the minimum amount on the card is paid off, the debt accrues interest which carries on accruing interest," Menschik says.
Even more careless than using credit cards for consumer items is paying interest that is not tax-deductible. A smarter move, says Peter Thornhill, principal of investor educator Motivated Money, is to borrow for investment. That way, not only are you investing for your future but getting a tax deduction as well.
For example, when you borrow to buy a property, any interest you pay on the loan is offset against income received from the investment. Also, any leftover interest can then be offset against your total income.
But back to conspicuous consumption even if you're a high earner, things can go dramatically wrong. So rather than borrowing to buy your dreams, say the experts, save for them instead.
Make it automatic, advises Menschik, so you don't even have to think about it. Get your employer to direct some of your salary into a savings account. And if that's not possible, your bank can set up a direct payment facility out of your everyday account into another savings or investment vehicle.
After you've set up the direct debit via your employer or your bank, saving is as simple as working out three goals, says ipac executive chairman Arun Abey.
* Short-term goals: buying furniture and household goods, for example. Abey advises accumulating the money in a cash management trust (CMT) which pays higher interest than an ordinary bank account.
* Medium-term goals: buying a car or saving for a wedding. Look for a fixed deposit account for a one- to three-year term. These offer higher interest rates than a CMT.
* Long-term goals: saving for a deposit on a house or unit. Go for the highest possible after-tax return, says Abey, which will mean investing in growth assets such as shares or a managed fund. Remember, though, that to do this you'll need a horizon of more than five years so you'll have time to ``average out" of your investment as the time approaches to buy your unit or house.
He explains: ``Say you start a managed fund when you're 22 and you want to buy your own home at 30. At 27 you should start to withdraw perhaps a quarter of the investment each year, so you're not too exposed to a big market downturn just before you want to buy your home."
Once you're on track with your plan, increase your savings whenever you get a pay rise. Marisa Broome, principal of wealthadvice.com.au, says: ``We see our clients at the time their salaries increase and we try to get that increase off them into regular savings [with no one missing the difference]."
Broome points to yet another common problem not understanding the importance of cash flow. ``The ease of credit is really hard," she says. ``All the stores are offering 12 months' interest-free and all of a sudden all these repayments hit at one time. Many people overspend relying on their annual bonus but it may not be there."
10 TIPS TO MEND YOUR WAYS
* Avoid borrowing unless it's for investment.
* If you're going to borrow for consumption purposes on a credit card or financing a car understand the terms of your debt. You'll end up paying interest on interest if you don't pay off the card in full each month. And on personal loans, shop around for a low interest rate.
* Don't rely on the inflation-driven growth of property and the stock market, which may have helped your parents accumulate wealth. Thrift and discipline will help you more.
* Start a savings plan now. By putting it off you're wasting one of your most valuable assets time.
* Forget the traditional ``house/unit first" approach it's such a big target that it deters many from even aiming for a shorter-term goal.
* Work out three achievable goals short-, medium- and long-term and how to finance them.
* Have some cash at hand for an emergency or an opportunity.
* Think very carefully before acting as co-guarantor for someone or lending money. If you can't afford to lose the money, don't lend it or guarantee it.
* Beware of an over-ambitious lifestyle spending can easily exceed income.
* Get your employer or bank to set up an automatic debit and siphon off a certain amount of your earnings each fortnight or month into a separate account.


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