How to get the basics of savings and investments right
The truth is that the more you earn, the more you will find to spend on.
Here are five hacks from Maya Fisher-French that will help you get the basics right in saving and investing, whether it is to build a defense against a debt crisis, buying a car or home, or to start building your wealth through investments.
① Create an emergency fund
When you are in your 20s, start this fund as soon as possible, even if you start small. This is the bedrock of every good financial plan or budget, Maya advises. Your first step is to have R10 000 and over time build up to at least three months of expenses.
This is what stops you from getting into debt when a crisis like retrenchment, an unexpected medical bill etc hits. Even if you don’t face a crisis it will remove financial stress. If fact, she believes that you should at least have R10 000 in this fund before you start tackling any debts you may have.
An emergency fund should be accessible but not too accessible, to prevent you from being tempted to dip into it.
Maya cautions that you should never rely on your bonus, 13th cheque or the credit on your credit card as an emergency fund.
② Avoid the seduction of credit
Speaking of credit cards, Maya believes most people don’t understand just how long it takes to pay off a credit card.
If you only pay the minimum due on your credit card, you will remain indebted for decades. For example, if you owe R20 000 on your credit card, with an interest rate of 20% and only pay the minimum amount of 3%, it will take almost 25 years to pay it off.
Only paying the minimum on your credit card is just not a good financial choice.
The real cost of car finance is hidden in the fine print.
③ Resist the residual option on car payments
The real cost of car finance is hidden in the fine print. Often the payment period is over six years with a residual or balloon payment at the end. A residual payment is when you agree to pay a final lump sum on the car at the end of the payment period (but for which you will be paying interest on from the start).
If you don’t have the cash available to settle the outstanding debt, you will have to refinance the car, extend the repayment period, which dramatically pushes up the cost of the car. If you choose to do this, it will take 10 years to finish paying off the vehicle.
④ Learn to live like a homeowner
Before you start looking for a property for the first time, first practice living like a homeowner to see if you can really afford to buy a house.
If you are renting, save the difference between your current rent and what it will cost you each month as a homeowner, Maya explains. When doing the calculation, remember to add on all those extra costs like rates, insurance, electricity, and water. This will get you used to live on a tighter budget once you have to pay off a home loan and help you build up a deposit for your first home.
Many young people wonder whether they should pay off their home loan before they even think of investing in other areas.
If you are in a position to pay off your home over two years, Maya says, this could be a smart move. But if it will take you several years, then you need to balance this with investing for the long term to benefit from compounding. Remember your house is not an investment or a retirement strategy, it is a roof over your head. Have a balanced approach and put some extra money into your home loan but also start investing.
Don't leave it too late. The power of compounding and time is what will benefit you in the long term.
⑤ Understand the power of time and compounding
Time is the most valuable asset when it comes to saving and investment, Maya says. And time is the one thing you have on your side as a young professional.
The earlier you start saving, the more money you will have invested – it is not just the money saved but the growth on the funds that you are putting away.
On the flip side, the greatest enemy of time is that dreaded word: inflation. The risk of keeping savings in only a cash-based savings account is that it will not keep up with the rate of inflation (in fact, cash may deliver a negative real return over a longer-term).
Investing in the stock market, either directly or through a well-chosen fund, should yield a real return. However, you have to mitigate risk and take a long-term view when you start this journey.
The power of compounding and time, when you’re in your 20s and 30s, is what will benefit you in the long term. Don’t leave it too late.
About Maya Fisher-French
Maya Fisher-French, former stockbroker and now SA’s leading financial journalist, is the author of Maya on Money. She contributes to City Press and hosts Money Matters on eNCA, where she shares personal finance advice.
This article originally appeared in A Quick Update, an Investec newsletter, in December 2019.