Saving is putting money aside for future use – or spending postponed – whereas investing is what you do with money to earn a return.
This is the view of 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.
“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 – which is to grow your money, he says.
If you hide your spare cash in a drawer, you are saving, not investing. Left alone, that money will not grow in amount or in value; it will lose value.
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.
We’re repeatedly told that South Africans are a nation of spenders, not savers. Yet a significant number of South Africans are saving by way of regular contributions to retirement funds, unit trusts and stokvels, Nathan says.
Almost 11 million people in South Africa contribute to a retirement fund and these funds have assets worth about R4 trillion. And about 11.5 million South Africans belong to one or more of the 810 000-odd stokvels, which are custodians of an estimated R49 billion. The number of savers excludes the unknown number of investors in the local unit trust industry, which is worth about R2 trillion.
“Stokvels are an interesting phenomenon – there’s one in our office. A bunch of people put in R200 a month, and every month someone gets R2 400. It’s a good mechanism for disciplined saving towards a short-term goal. The loyalty is high and the peer pressure is there to stop anyone from missing a payment.
“But a rand in a stokvel is always worth a rand. You want a rand to be worth more – and that’s the difference between saving and investing. But you need time on your side,” Nathan says.
Alexander Forsyth-Thompson, the head of stokvel investments at Investment Solutions, says stokvels that accumulate money in cash or in the bank have a real opportunity to put this money to better use.
“Investment and burial stokvels are accumulating large sums of money that are severely diminished by inflation when left in cash or the bank,” he says. If groups such as these (only four percent of stokvels are “investment” stokvels) put their money into the right investments, members may have seen their money double, triple or quadruple over longer periods of time, he says.
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.
DEFERRED SPENDING CAN SAVE YOU A FORTUNE
Say the word “save” and increasingly the conversation turns to debt. South Africans can’t save because they’re drowning in debt. But what if we sought to save ourselves from the cost of credit.
If you considered saving as “spending postponed” and got into the habit of saving for what you wanted rather than incurring debt, you could save a great deal.
By living within your means, you are saving, because of the high cost of credit, says Natasja Hart, a financial planner at GCI Wealth.
For example, buying a TV for R6990 on credit over 36 months, will cost you R12 157 in total over the term. Almost 80 percent of that will go to repaying the capital plus interest at 21 percent a year. The rest, about R2 700, will cover costs, such as a R100 fee to initiate the loan and a monthly administration fee of R57, and credit life insurance.
If you put away R338 a month (the average monthly instalment, including all costs, of buying the TV on credit) to save up for the TV, you could buy it cash in just under two years (23 months), assuming you earn interest of 5.5 percent a year on your savings and the price of the TV went up by 6.5 percent a year, to R7 928.
By deferring your spending and saving up for the TV, you would save yourself R4 229 (R12 157 minus R7 928).
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.”
YOUR HOME LOAN IS GOOD DEBT
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.