2 tips for optimizing your family finances during the crisis

A good manager tries to benefit from every situation. While the last blog was dedicated to saving the family budget, this time we will try to help households emerge from the crisis with healthier and stronger outlook on family finances.

Juraj Hrbatý | Investment academy | 23. April 2020

If you are one of the people who dutifully follow all the current regulations, you probably have a lot of free time these days and wonder whether you could spend it in a better way than just watching TV.

However, in addition to free time, the crisis has brought about another interesting phenomenon – expenses have fallen across the board. I think that many of you have reduced your day-to-day spending by more than a third. Traveling, entertainment, eating out, and various services expenses have fallen; we don’t go shopping at malls nor do we go on vacation, leading to a notably more modest lifestyle.

If you haven’t lost your job and your expenses have decreased significantly, you have probably managed to save a few hundred more than usual in the last month. How to use more free time and saved money for your benefit? We have 2 tips for you.

1. Review your financial and investment assets

Flowers in your garden will grow when you take good care of them and water them regularly. The same goes for your financial and investment assets. If you want your wealth to grow, you need to take good care of it. What you may have found profitable in the past may no longer pay off today. Take advantage of your free time and review your financial and investment assets:

Bank account: look at your bank account balance in the long run. If you have had a large positive account balance in the recent years, keep only a contingency reserve of about three months and invest the rest. Start with a financial reserve (conservative strategy) up to 6 monthly incomes of the breadwinner.

Fixed-term deposit and savings account in your bank: Nowadays, it is a redundant luxury. Most fixed-term deposits earn far below 1 percent, thus with inflation at two or more percent you can buy fewer and fewer things each year. You need to terminate any fixed-term deposits and savings account you might have and move on to instruments that are safe and at the same time yield higher returns than inflation, even after paying all fees and taxes. 

Building savings account and unit-linked life insurance: We will repeat ourselves but, unfortunately, there are still hundreds of thousands of households saving this way in Slovakia. Unit-linked life insurance is the least advantageous financial product that has ever hit the Slovak market, and we dealt with it in this article. If you need the insurance, buy risk insurance only. Building savings accounts used to be more favorable in the past but nowadays you won’t make anything off of them.

Bonds: Corporate bonds have recently been a very popular investment tool in Slovakia, as they offered very generous fixed returns. The bonds have served as a source of capital for companies from the less experienced investors, who are usually unable to estimate the hidden credit risk. For the sake of clarity, credit risk is the risk of a debt default.

Often, bonds are issued by variously purpose-based LLCs without liability. For example, if the offered revenue yield is 7% per year, it will be only 5.7% after tax. You need to consider whether the risk you are taking is worth it. If you still insist on the benefits of such an investment, diversify. Buy bonds of various companies. Invest about 10 – 15% of your investment property in bonds, definitely not more than 30%. It’s too risky.

Mutual funds: Review the appreciation of the mutual funds you have invested in. If you invested after 2003, deduct a 19% tax on your return. See the Key Investor Information document for the mutual fund’s fees and risks. The risk indicator is likely to be on the scale between 3-5 and fees are likely to be higher than alternative solutions, given the current market opportunities.

Equities and ETFs: They rank among the best assets for long-term savings. However, selecting specific equities to invest in is very challenging and this approach carries significantly higher risk due to low level of diversification. 

ETF Index Funds are therefore a suitable alternative – you can buy all shares on the stock exchange in a given index with only one investment. Index funds are very cheap and diversify the risk exposure well. If you hold them for more than a year, you don’t have to pay any taxes on your revenue. ETF Index Funds outperform all Slovak mutual funds with similar risk.

If you don’t own the ETF through, for example, Finax, where we take care of risk management and setup, consider whether the portfolio is properly set up and whether it needs to be rebalanced. You can find more about the advantages of rebalancing here. We have already rebalanced many of our clients’ portfolios after the stock market downturn. However, it is important to pay attention to the tax aspect.

The less you spend the more you invest

There is a relatively large group of people in Slovakia who keep working even during the pandemic. People either have the possibility to work from home or they have to adapt to current conditions in some other way. The wage remains the same, but the other side of the equation has significantly reduced. Since everything is closed, you have nowhere to spend the money.

As I have already mentioned, many of you have seen your expenses reduce by more than a third. A proper manager should not spend their savings on a more luxurious holiday when the crisis is over, but rather invest at a time when markets offer significant discounts.

You certainly enjoy discounts when you go shopping and it should be no different in case of investing. Try to look at the current situation as a spring sale for the winter collection. Whether the discounts will be even bigger, I can’t tell. Anyways, it is exactly the regular investors who can make the most out of the current situation.

If you increase your regular investment over the coming months and the markets continue to decline, you will surely hit the bottom with some of your purchases, and those will appreciate the most. If we are already past the bottom, then your early-month purchases will reach the highest appreciation.

The following chart shows an example of an investment started with a Finax 100/0 strategy in 2006 (two years before the financial crisis) investing a hundred euros per month (orange chart) compared to a responsible investor who invested exactly the same way, only increased the deposits to 200 euros in the twelve months after the stock indices fell by 20% (blue chart).

Warning: All data relating to the historical development of the Finax portfolios is modeled and based on data back modeling. We described how to model historical performance in How do we model the historical development of Finax portfolios?. Past results are not a guarantee of future returns and your investment may result in a loss. Find out more about the risks you are taking when investing.

Responsible investor, who increased their deposits by EUR 100 during the crisis, earned EUR 4330 more after 10 years. Their additionally invested EUR 1200 was appreciated by 260%.

I believe that many of you will benefit from what this blog has to offer and find a way to take advantage of the current crisis to manage your financial savings more efficiently. If you still have a long savings period ahead of you, each euro saved now can be returned severalfold during your retirement.

Start investing today 

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