It is probably safe to assume that most people want to save money, while being able to live comfortably. In the cash driven economic hubs of mega cities like Miami and the exciting emerging markets of Kenya, Nigeria and others, the world is driven by the economy that binds us.
Such is true in the relationship between saving and investing. Though very similar, the two differ in key elements. According to Steven Nathan, the chief executive of 10X Investments, who says that these different activities are two sides of the same coin, and that it’s important that you do both.
Saving is consciously abstaining from spending as well as keeping funds earmarked for future use, whereas investing is what you do with money to earn a return.
“When you save money for future use, you put money aside with a goal in mind: that may be your annual holiday, your child’s university education in five years’ time, or your retirement, still 30 years away,” Nathan explains. Your objective is to preserve money.
When you invest, your objective is to earn a return and in turn grow your money, Nathan added.
The constant rise in the cost of living – known as inflation – steadily eats away at the purchasing power of your money. Depositing your money in the bank should at least preserve its purchasing power, but in such a savings vehicle your money won’t grow sufficiently to provide for your retirement, which is why you need to invest in assets that deliver a high real (after-inflation) return over time. A tried and tested way of doing this is in higher-risk assets such as shares, which may prove volatile over the short term, but deliver inflation-beating returns over longer periods.
This is an important message for people who are good savers but poor investors.
Financial planner Natasja Hart says she has come across such people, who have “saved themselves poor” – meaning that they have failed to invest. “I’ve seen it with older people who tend to derive comfort from having easy access to their money in the bank.” But left in the bank, their money has hardly grown and they have lost the opportunity for gains to compound over time.
Nathan says that when you save your money as cash in the bank, the risk is generally very low. “You therefore earn a return that, over long periods, exceeds the inflation rate by only one percent a year. But you can be almost 100-percent sure that when you draw your money, you will receive all that you put in plus any interest that is due to you.”
Share prices, on the other hand, move daily. “You are thus never sure how much money you will receive for your shares until the day you sell them. However, to compensate for this uncertainty, you are likely to earn a real return of six to seven percent a year from a well-diversified share portfolio that is held for many years.”
But how will real growth of six percent a year fund your retirement, you may ask. Nathan says that it works through the phenomenon called compounding.
“Say you deposit the price of a loaf of bread today into an investment account that grows at five percent a year in real terms (six percent a year, net of an annual fee of one percent). After 15 years, your investment should pay for two loaves of bread and after 40 years seven loaves.”
This is the effect of compounding, or earning a return on your return. The longer you invest, the stronger the compounding effect becomes.
Nathan says that the key lesson here is that you should start investing as early as possible, to benefit from the strong compounding effect by the end of a long investment term.
“If you invest your money in the bank, earning a real return of one percent a year, you will be able to buy only a loaf-and-a-half in 45 years’ time. In other words, even if you invest diligently over your entire working life, investing in a low-risk asset class could curtail your standard of living in retirement. That is a much bigger risk than exposing your money to the share market over the long-term,” Nathan says.
He says there tends to be an over-emphasis on saving, when we should be considering long-term returns.
IT ALL BEGINS WITH A BUDGET
A budget is the cornerstone of your financial plan, and the decisions you make daily determine your financial destiny, says Natasja Hart, an award-winning financial planner and the wealth manager at GCI Wealth.
You need to budget to save and invest, Hart says. “Saving and investing amount to paying yourself first, but people don’t think of it that way. When I ask clients what the first line item on their budget is, most people say ‘bond repayments’.”
Although a home is an investment, she suggests to her clients that they put saving for a short-term goal, or a small saving as a reward for budgeting, as the first expense on their budget. “It’s psychological: if you don’t pay yourself first, you can feel negative about your budget,” she says.
Hart tells of how she helped a client overcome her negativity about budgeting. “My client felt very overwhelmed by her financial situation when she came to see me for the first time. She felt particularly guilty about what she spends on coffee every day. She didn’t want to give up her daily coffee, so we made it the number one item on her budget and made it her reward to herself for sticking to the budget. I knew she was going to spend that money anyway, and there was no point in her feeling guilty about it,” Hart says. What was more important was that she had a budget and stuck to it.
By living within your means, you are saving, because of the high cost of credit, says Natasja Hart, a financial planner at GCI Wealth.
If, after paying for the item in cash, you carry on saving the R338 a month to end of the 36-month term, you will have the added bonus of about R4 500 in savings to put into an emergency fund or to invest.
Steven Nathan, the chief executive of 10X Investments, says wealth is not what you spend, it’s what you keep. “When my children have referred to other people as ‘richer’ than us, I say to them: ‘We don’t know that; what we do know is that they spend more than we do.’ In South Africa, we need to develop a culture of living below our means.”
Alternately, not all debt is bad and some is unavoidable. Credit to finance an asset that appreciates in value, such as a home, is “good debt”.
Very few people can pay cash for a property. The vast majority of us have no option but to obtain a home loan. But in order to qualify for one, you need to put down a deposit. The bigger the deposit, the better positioned you are to negotiate with the credit provider for a low interest rate.
According to a press release issued by estate agency RE/MAX this week, in June, the average first-time buyer put down a 20-percent deposit. Considering the average purchase price was about R860 000, that equates to a deposit of about R182 000.
Adrian Goslett, the regional director and chief executive of RE/MAX of Southern Africa, says banks are asking applicants for between 10 and 30 percent of the property’s asking price to qualify for finance.
This can be daunting for any buyer, especially a first-time buyer.
Goslett says the best way to accomplish big goals is by starting small and remaining consistent. “Mountains are climbed by taking one step after another. Even if it is a matter of starting out setting aside small initial amounts, just get started – the sooner, the better.”
He says the best way to set a monthly savings goal is to find the difference between your current rental payment and the estimated bond repayment, which should include other monthly costs such as bond insurance, homeowner’s insurance, rates and levies. If possible, the difference should be set aside as savings.
“The benefits of this strategy are two-fold,” Goslett says. “First, it will build up your savings, and second, it will help you adjust to the cost of owning a property.”
This strategy will reveal to you, as a prospective buyer, whether you are financially ready to own a property and what you can afford. If you are able to meet your savings goal consistently, then you will know you have the budget to buy. If you struggle to meet your monthly savings goals, you might need to adjust your budget and bring it in line with what you can realistically afford.
Goslett says the first place to look for savings is the property you are renting. If your rent is more than 30 percent of your monthly income, it is too much.
“It doesn’t make sense to spend more money on a rental home if it’s holding you back from owning your own property,” Goslett says.
If you’re paying a modest rent, assess your current spending and scrutinise every other expense. You can save by making lunch every day, instead of buying. Or cancel that gym contract and find ways to exercise for free. There are many ways to cut back on spending; it just takes some creativity, Goslett says.