Article by Sue Torr
As with everything in the Information Age, managing one’s finances has become seemingly more complex over the years. In our ten years’ experience of financial planning, here are ten things we believe everyone should know about money:
Although preparing a budget is a relatively easy exercise, deciphering exactly where one’s money is going can be a somewhat more challenging task. The complexities created by credit card agreements, cell phone contracts, data bundles, insurance policies, bank accounts and rewards programmes have made tracking our expenditure at times unfathomable, especially when running debit orders off one’s bank account. As time-consuming as it may be, it pays to set aside time to peruse your accounts and statements with a view to understanding exactly where your hard-earned cash is being channeled.
From the time you first begin working, your greatest asset is your ability to earn an income. Simply put, your income is (in all probability) the primary source of your retirement funding. Over and above a reputable private medical aid, a comprehensive income protection benefit is one of the most useful tools one can employ to protect your future retirement plans. In general, an income protection benefit will pay you 75% of your monthly income in the event of a disability until you reach age 65.
Investing for the long-term involves taking calculated risks which allow you to reach your retirement goals whilst still passing the “eat-well, sleep-well” test. If you’re investing for the long term, accept that the markets will peak and trough many times over the investment period. Staying calm and invested when the markets dip is pivotal to successful retirement planning. On the other hand, taking unnecessary risks with your money in an attempt to get-rich-quickly will in all likelihood leave you retirement-poor. Remember, if it sounds too good to be true, it probably is. As Paul Samuelson once said, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, go to Vegas.”
If you are formally employed, it is likely that your employer provides you with retirement funding through either a pension or a provident fund. If you’re self-employed or do not have company retirement fund, a unit trust-based retirement annuity is cost-effective and flexible vehicle through which to save. Investing through an appropriate retirement annuity allows one to claim up to 15% of one’s contributions as a tax deduction – making it a classic case of “use it or lose it”.
According to a 2012 survey done by Forbes Magazine, job-hopping for Millennials (those born between 1977 and 1997) is the new norm, with the average worker staying in his job for an average of 4.4 years. This translates to between 15 and 20 jobs in his lifetime! Every time a person moves from one employer to another, one has the option to either cash in one’s retirement funding capital or transfer it to a preservation fund. In general, our advice is always to preserve one’s retirement capital. Cashing in your retirement capital involves interrupting the magical cycle of compound interest, which leads us to the next point.
Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount. By way of simplistic example, if one were to invest an amount of R95 per month from age 20, assuming a 10% investment return, you would have R1 million invested by the age of 65. However, if you delay this process and only start saving at age 30, you would need to invest R263 per month in order to achieve your R1 million target. Delay savings even further until age 50 years, and you would need to invest a whopping R2 413 per month to obtain the same investment outcome. We’re inclined to agree with Albert Einstein when he said that “the most powerful force in the universe is compound interest.”
By depositing your savings into your bond, you are in effect receiving the interest rate that the bank charges you on your loan as positive interest on the money you invest. For example, if you have a bond for R1 million, and you deposit an extra R100 000 into your home loan, you are now no longer being charged interest on R1 million, but rather on R900 000. The money you save in interest over the time that you keep the R100 000 in your home loan is the positive interest you are in effect receiving on the money you’ve deposited. As an additional benefit, you can withdraw this cash when you need it without being penalised. Understand how your access bond works and make it work for you!
Life is filled with unforeseeable events which can wreak havoc on your well-intended budget. Repairs to your fridge which is no longer under warranty, essential vehicle repairs the month after your car’s motor plan expires, or a hefty excess which needs to be paid on an insurance claim are just a few examples of costly financial set-backs which, if you don’t have an emergency fund, can lead one down the dark alley of debt. Whether you use your access bond, a simple savings account or a money market investment, set aside enough cash to help you catch those curve balls.
Although relatively easy to use and extremely convenient, if not used properly, a credit card can lead one into debt. To use your credit card wisely, ensure that you always pay your bill on time and in full. Refrain from just paying the minimum monthly amount, and only spend what you can afford to pay off. In addition, make sure you read the fine print to ensure that there are no hidden fees or penalties for things such as cash withdrawals or overseas spending. Link your credit card to your cell phone so that you can track spending and avoid credit card fraud.
The Rule of 72 is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to duplicate itself. For example, the Rule of 72 states that R1 invested at 10% would take 7.2 years ((72/10) = 7.2) to turn into R2. Bear in mind that the Rule of 72 gives a quick rough estimate and that the rule gets less precise as rates of return become higher. But it’s a great tool to use for quick calculations are called for.
Kofi Annan is quoted as saying, “Knowledge is power. Information is liberating. Education is the premise of progress, in every society, in every family“, and we believe this applies to money as much as to anything else in life.
By Sue Torr
Managing Director: Crue Consulting (Pty) Ltd