Fri | Jan 27, 2023
ADVISORY COLUMN: PERSONAL FINANCIAL ADVISER

Oran Hall | Living in a state of financial emergency

Published:Sunday | January 22, 2023 | 12:44 AM

While the Jamaican Government grapples with controlling crime using, among other measures, states of public emergencies, we are faced with another state of emergency which is financial by nature. It has hit us at both the micro and macro levels,...

While the Jamaican Government grapples with controlling crime using, among other measures, states of public emergencies, we are faced with another state of emergency which is financial by nature. It has hit us at both the micro and macro levels, seriously compromising the financial well-being of many.

At the macro level, it is high interest rates, the response of the Bank of Jamaica, BOJ, to rising inflation. The general level of consumer prices has largely been the result of changes in external prices.

First, there was the COVID-19 pandemic, more recently followed by the Russia-Ukraine conflict, both of which have led to a significant increase in international commodity and shipping prices.

These conditions have contributed to countries increasing the level of interest rates to stave off inflation. One consequence of interest rates increasing in countries like the United States is that Jamaicans may opt to invest in US dollar-denominated instruments, thereby increasing the demand for the US dollar and thus causing the value of the Jamaican dollar to fall.

Increasing local interest rates is a means of encouraging Jamaican investors to keep their funds in Jamaican dollars, thus ensuring relative stability in the foreign exchange market. One benefit of this is that the local prices of imported goods and services would be moderated.

The BOJ is expecting its actions to cause savings to increase and spending to decline. People who invest in interest-bearing instruments stand to benefit but the prices of fixed-rate debt securities generally fall in such a scenario, possibly leading to unit values in funds investing in these instruments declining.

This action by BOJ is bad news for borrowers. The cost of borrowing increases, thus making it more difficult to service debts, including mortgages. In this kind of scenario, consumers tend to spend less. Businesses facing higher costs and experiencing lower sales find it more difficult to be profitable and may find it necessary to employ fewer people. Overall, this course leads to contraction of the economy.

Among the negative consequences is a decline in the stock market, resulting in lower prices and lower profits and, often, losses for investors. At the same time, these conditions create buying opportunities for bolder investors.

Inevitably, this state of emergency ends, but no one is ever able to tell the likely end date, unlike government-declared public states of emergencies which have specified end dates.

To increase the chances of coping, individuals may consider investing in short-term interest-bearing securities until the market settles. They may also be more deliberate in how they spend, borrow only if necessary, but not for consumption, maintain their savings programme, including an emergency fund, and upgrade their skills to hedge against job loss.

We have seen that macro issues affect us individually, that is, at the micro level, but there are issues that affect us as individuals that are really the result of our individual choices.

One example is preparing for retirement. According to the Financial Services Commission, regulator of the private pension market, just over 11 per cent of the employed labour force was enrolled in a private pension arrangement at March 2022. This is a state of financial emergency.

This is saying to us that many Jamaicans do not have a formal arrangement in place to provide for life after work, and, considering that prices inevitably increase over time, inflation will make it increasingly difficult for those unprepared for retirement.

Formal pension arrangements provide for pensions savings to be managed by professionals, for income from fund assets to earn income on a tax-free basis, and for 25 per cent of a fund member’s pension entitlement to be paid to the new pensioner, free of income tax.

The self-employed and employed people who are not members of an employer-sponsored pension plan may become members of a retirement scheme. Like members of the employer-sponsored superannuation plans, they can be assured of a steady and reliable stream of income in their retirement years, from the annuity purchased, generally purchased from a life insurance company, for that purpose.

Death often results in a state of financial emergency when adequate provisions are not made for distributing the estate of the deceased. This can be obviated by individuals making a valid will detailing how their assets are to be distributed post death. Additionally, documenting where assets and important documents are, having concrete proof of the ownership of assets, and detailing all debts and receivables can be quite helpful.

With respect to the physical assets that people own, natural disasters do not have to result in a state of financial emergency as insurance can be used to cushion, or even replace, losses.

There are many and varied causes of financial states of emergencies, some of which are not easy to foresee. Nonetheless, regular and careful analysis of a person’s situation, with professional help, if necessary, can reduce or deflect the harm such unfavourable situations may cause.

- Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com