Arun Abey: When zero is the best place to start

Television's Money Man, who can be seen on Tuesday nights saving families and couples from financial ruin, is a grim reminder that many people could be just one or a few months away from financial ruin if they find themselves suddenly jobless. Their main financial obligations are food, utilities, a mortgage, credit card debt and car loans.

It's also a safe bet that during these uncertain times, low liquidity is not confined just to lower income earners. There's plenty of anecdotal and real evidence that high earners are also feeling the pinch, with financial goals and plans conceived in better times no longer relevant. Lavish debt-fuelled spending can no longer be sustained.

For many it's time to go back to the financial drawing board to practice zero-based financial planning. This means planning for goals without reference to previous assumptions and financial statements. The new plan must take into account current assets and liabilities and expected cashflow in the near term. The lifestyle goals must address present needs and not be based on our personal situation a few years ago. To paraphrase Keynes: "When the facts change, we should change." There are three areas where we need to direct our attention for zero-based financial planning: cash reserves, short-term goals and retirement funding.

Margin of safety
Financial planning norms recommend three to six months of household expenses be held in cash for emergencies. Given the uncertain job market, the first step to a zero-based financial plan is to establish and set aside six to nine months of household expenses in a savings account.

For the family that spends $3000 to $5000 per month, this means at least $30,000 in cash reserves. The challenge for those below the margin of safety is how to raise cash levels in the next few months, without having to resort to borrowing or selling assets.

The immediate future
Short-term goals to be realised in the next three years are most vulnerable to changes in external conditions and personal circumstances. Let's make a list of hypothetical short-term goals:

* Completing the purchase of a new home and commencing mortgage payments in 2012.

* Helping fund a child to university in 2011.

* Upgrading the family car which will require a cash outlay in 2010.

Let's assume that when the original financial plan was constructed in 2007, the home purchase and child's tertiary education were considered to be medium-term goals (between four and 10 years away). A comprehensive savings and investment strategy was the basis of achieving these goals. But three things happened in late 2008:

* $100,000 was lost in failed finance company investments.

* The share portfolio value declined by 20 per cent.

* One of the two partners was retrenched so the family's annual earnings are significantly lower than they were.

Clearly, a major change in the family situation requires a re-evaluation of lifestyle goals. Can the mortgage repayments be assured in 2012? Can the financial assistance to the child be honoured?

A good place to start is by creating a zero-based budget where total income minus total expenses equals $0. In other words, every dollar of income is assigned to an expense (or savings) category.

Using a zero-based budget and dealing with the difference from month to month allows control over every dollar spent.

This process isn't easy. It often requires a drastic change in thinking and behaviour around money, particularly if the outcome is a negative difference between income and expenses.

Often, zero-based budgeting shows a complete overhaul of the financial plan may be in order. Scenario planning for future cashflow and savings capacity will drive the family's ability to retain all their current short-term goals. It's nobody's fault that assumptions have shifted dramatically. The practical thing to do is to restart the planning exercise.

Retirement planning
The plan for financial independence is basic to most people. For pre-retirees who were making progress towards building their nest egg, the market meltdown has been a rude shock or worse. Postponing retirement may be one of the options that has to be considered for some baby boomers who now find themselves unemployed with an investment portfolio that has significantly declined.

A zero-based financial plan may include scenarios of future real returns that are lower than historical averages. A low growth economic environment means low portfolio returns. Not investing at all is not the answer - inflation is bound to return once the recovery is under way.

For the core family wealth, a buy-and-hold approach through a regular investing strategy is a good way to go. No one can prove otherwise until stability returns to the financial system. We must have the belief that life will go on. Diversification works, though maybe imperfectly. Waiting for the markets to recover is a gamble.

I can see regret written on the faces of those who fail to zero-base their financial plan and thereby miss the train. Take three steps over the winter:

* Make a (new) plan.

* Give the plan enough time.

* Feed the plan enough money.

Finally, get good advice: if advice is important in good markets, in tough times it's essential.

Arun Abey is executive chairman of financial planning firm ipac, head of strategy for AXA in the Asia Pacific and a director of the Spicers Portfolio Management advisory board. He is also the author of How Much is Enough? www.howmuchisenough.net