Time to take the acid test

Could you deal with the unexpected? Put your financial safety net through the latest scrutiny from our sister publication, AFR Smart Investor, to find out.

QUESTION 1 Y ES NO

If interest rates keep going up, will you be able to cope?

The economy may be slowing but the Reserve Bank of Australia still has an itchy trigger finger. Australia and New Zealand Banking Group senior economist Warren Hogan predicts rates will rise to 7.75 per cent by year's end, to keep inflation in line.

This means that the average standard variable home loan may reach 10 per cent.

Each 25 basis point rate rise increases your monthly repayments by $17 for every $100,000 borrowed over 25 years.

QUESTION 2 YES NO

Could you get by if you weren't able to work for a period?

Income protection is important for many people because it replaces about 75 per cent of your salary should you be unable to work due to illness or injury.

It is expensive, but make sure it's to age 65; you can cut the cost by opting for a longer waiting period before payments start. And remember, premiums are tax deductible.

QUESTION 3 YES NO

Do you have an emergency fund or account?

Whether it's a run of bad luck or unforeseen legal costs, it's important to have a secret stash of funds. Financial planners advise that three months' wages should be kept aside in case the worst happens.

While interest rates have risen on your debts and loans, banks are also offering more attractive rates on savings accounts - above 8 per cent.

QUESTION 4 YES NO

Are you comfortable with your level of investment debt?

If you went for a high loan-to-value ratio (up to 80 per cent) when the market was booming and rates were low, maybe it's time to decrease gearing or reduce the amount borrowed. Some experts are telling clients to gear down to 50 per cent or even advising zero leverage.

QUESTION 5 YES NO

Would you be able to weather a 30 per cent in equities?

If that would make you panic or sell out, it may be time to measure the volatility of your portfolio.

In recent years many investors have increased their equity allocations. The Australian Taxation Office estimates do-it-yourself funds have up to 70 per cent in equities.

Self-managed superannuation fund experts say it's time to be more defensive.

QUESTION 6 YES NO

Would you be able to survive if a particular sector collapsed?

Not many predicted listed property trusts to fall so dramatically, but after the collapse in Centro Properties' share price, the market ped the sector like a hot brick.

Think about your own portfolio. Thanks to the mining boom, it may be high in resources. And what about banks? Long-term, it's not wise to be too overweight in any sector. Rebalance regularly.

QUESTION 7 YES NO

Are you prepared for a capital gains tax bill?

Rapid equity market decline means many investors have been selling stocks. But after years of double-digit returns, you may have accrued a significant capital gain - and therefore a significant capital gains tax liability.

Although CGT is usually only considered at tax time, you can offset capital gains with capital losses. You can realise a capital loss by selling a poorly performing asset. And, be aware, you can roll over a net capital loss from previous years.

QUESTION 8 YES NO

Do you have private health insurance?

Now that the threshold is higher for the 1 per cent Medicare surcharge, it may seem less attractive to have private health insurance.

However, the Federal Government's Lifetime Health Cover will apply a 2 per cent loading for every year you delay going private after age 31 - up to 70 per cent!

And don't forget that premiums attract a 30 per cent rebate.

QUESTION 9 YES NO

Do you have TPD insurance outside super?

Having total and permanent disability insurance within super alone may cause problems.

For example, a payout under an "any occupation" policy may not be released to the member if the super fund has stricter rules than the insurer.

A crafty way to avoid such problems is to split your cover in two so that you have a proportion outside super and a proportion inside super - which is also tax-free, but only after age 60.

QUESTION 10 YES NO

Have you organised a prepaid funeral?

It's not depressing, it's clever and it's now tax effective. For instance, buying a funeral bond is not considered under the assets test for the age pension by Centrelink. This can save you up to $20,000 per couple.

THE VERDICT

3 NOs - be alert; 4 NOs - be slightly alarmed; 5 NOs - it may be time to look at a worst-case scenario.

DON'T panic if you get one NO answer - but if you have many of them, it may be time to lower the risk rating of your finances. Considering a worst-case scenario can be helpful in devising a strategy to deal with debts and living costs. It can also help you work out if you need more cover in case things go wrong.


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