As the year unwinds and we head into the holiday season, I know what you are thinking. Now is the time to spend and spoil yourself for a year of hard work - however this time of the year gives you a chance to take a moment and think about savings and ways you can invest your hard-earned money.
Saving vs Investing
One reason you should be saving is it allows you to spend more in the future. Saving is delayed spending to fund near future expenses and short term goals. Investing is aimed at growing your wealth by investing in income-generating assets allowing you to accomplish bigger life goals in the long term future. The question should you save or invest, is the choice between what you want now and what you want in the future.
Save to spend
To save you have to spend less than you earn. The difference can then be saved in a safe place for upcoming events like a wedding, deposit on your first home or an emergency fund. Your savings need to be easy and quickly accessible as savings are normally for goals you want to tick off the list in the next 1 – 3 years or unexpected expenses. Because of the shorter savings period, the savings growth will be lower compared to a long term investment but the growth will be stable and predictable. Savings is a great place to park your money for a while but if you leave your savings for too long you might find that you can buy a whole lot less in the future due to the eroding effects of inflation. To get inflation-beating returns you need to invest.
Invest to grow
At some point, all of us want to stop working or maybe become our own boss. By investing you are buying assets that can generate an income in the form of interest, dividends, rental income, and profits. To earn an income you invest in bonds, stocks, property or business. The cost of higher long term investment growth is short term uncertainty as economic conditions change and prices move up and down over the short term. With a longer investment period, you get higher returns because of the power of compounding growth over time. Investing requires patience and tolerance as your investment might be locked up for a long period as wait for the magical effects of compounding to grow your assets.
Why you need to save and invest
To illustrate the case that you should save for the short term and invest in the long term to let's compare an R10 000 investment in a savings account at an annual interest rate of 6% to the same investment in a local share portfolio over the past 3 years. After 3 years you would have had R11 910 in your savings account and your share portfolio would have have not grown at the same rate as the market has barely moved over the last 3 years. However is we extend the investment period to 20 years the money in your savings account would be R32 071 compared to R105 450 in the share portfolio at an assumed growth rate of 12.50%. That is why you need to both save and invest, save for easy access to your money and invest for long term inflation-beating returns.
The savings and investment plan
You can turn spending into saving by deciding what your goals and planned expenses are for the next 1 – 3 years and what you want your life to look like in 10 or 20 years. Looking at your short term goals start by saving 10% of your income towards an emergency fund big enough to cover 3-6 months' worth of expenses. You can use a savings account or a money market unit trusts fund to store your savings. Once you have sufficient savings in place you can start investing. Depending on your goals you can start investing in your child's education or your retirement. For long term investment, you can use tax-free savings accounts, low-cost property unit trusts or retirement annuity funds.
The great thing about savings and investing is you don't need to earn a certain salary to start, anyone can do it and you can start today. The goal of saving and investing is to put enough money away so you can spend without going into debt and have enough assets to be financially free. If you are planning on starting, why waste time? There is no time like the present.