OPINION: 3 essential terms to know about savings
Here are my top three savings concepts that everyone should familiarise themselves with before they start saving:
1. Savings or investment objectives. In the financial planning world, we speak about the client's objectives - what the money is going to be used for, and when. Financial professionals use this information to advise you on the best solutions and products to help you achieve these goals. Importantly, understanding this yourself is a precursor to making the best possible decision when it comes to buying any financial product.
2. Compound interest. Once you start saving or investing, the money should receive return a return in the form of interest, year on year. Importantly, it receives ongoing interest not only on the actual money you've put away, but also on all other returns/interest received over time. Therefore, the longer you save the more you benefit from this compounding effect.
3. Inflation rate. A widely published economic statistic, the inflation rate represents the increase in the prices of goods and services over time. As an example, bread in the mid-2000s cost between R3 and R4, whereas today it will cost you between R14 and R16. Inflation is a fundamental economic concept, because it impacts the real value of your money in the future and which you need to be mindful about when you are saving. Ideally, when you save, you want the interest or investment return you receive over time to be the same or higher than the inflation rate, otherwise what your money could buy is reducing over time.
It’s equally important to understand the concept of compound interest when it comes to taking out debt - the money you have borrowed to purchase goods or services. This can take the form of a home loan, car finance, personal loans, store cards or person-to-person lending. All this borrowed money needs to be repaid, as well as the interest attached to it.
This is where the compound interest part comes into play - the cost you are paying to the company/person who lent you the money. What do they get out the deal, otherwise why would they loan you their money? For the person who is saving, compound interest builds your wealth over time, but for a borrower it is a destroyer of wealth.
Use Savings Month to reflect on your own financial situation, your goals and aspirations, and if you need to speak to someone about how to start saving or restructuring your finances, contact a Certified Financial Planner to assist you.
Michael Kirkpatrick is a business and distribution enablement specialist at Alexander Forbes.