Everyone knows that saving money is a good idea. But what is the best, most practical way to go about saving money, and how should we prioritise settling our debt, saving for shorter-term goals and investing for the future?
At the second Nedgroup Investments Take 5 webinars, Maya Fisher-French, independent financial commentator, outlined her best practical tips to an effective savings plan.
For helpful tips and some examples on how to practically prioritise settling debt, savings and investments, listen to the conversation on Google Podcast, Apple Podcast or Spotify. You can also watch the webinar on YouTube.
Know your net worth
A realistic view of your financial commitments and position, will help you calculate how much, if any money you have available for saving. The first step is to draw up a list of your assets (how much you own) and your liabilities (how much you owe). This will reveal your net worth. The goal is to have a positive net worth – and to increase one’s net worth over time.
Harness the power of time
Thanks to the enormous power of compounding, time really is money when it comes to saving and investing. Starting just a few years earlier can make a huge difference to the amount of money that you end up saving in the long term. But, while you might have every intention of saving, if you are committed to monthly payments this can be easier said than done.
So, how can you become a better saver and investor?
1. Avoid the anti-wealth trap
If you spend all year on credit and use your bonus to settle your debt, and then start spending again on credit, relying on your bonus to settle it - you are likely falling into the anti-wealth trap. This means you are not increasing your net worth over time. Instead, aim to settle your debt each month so you cannot spend more than you have. If you are unable to settle your credit card debt at the end of each month you are spending beyond your means.
2. Set clear savings goals to stay on track
Goal: Create an emergency fund
Focus first on building an emergency fund with an initial lump sum of approximately R15 000 – then set aside a portion of your bonus to continue contributing to this. The need to have this kind of buffer is never been more apparent than now when we are seeing the effect of the Covid-19 pandemic on many people’s livelihoods. Ideally this fund should be around three months living expenses.
Goal: Reduce debt (start with short-term which is the most expensive)
Once you have this structure sorted out, focus on allocating a monthly amount and a percentage of your bonus to reducing your debt – particularly any short-term debt like store cards. Eliminating what looks like relatively small monthly payments on your store cards each month is a ‘quick win’ and will free up a surprising amount of money each month that you can then reallocate towards paying off other debts like a personal loan and credit card obligations. Each time you pay off one of these debts, you are adding money to your monthly budget and getting a mental boost that keeps you disciplined in your savings. Importantly – this will only work if you close these accounts or reduce your credit limits as you pay them off.
Goal: Use your bonus wisely
Any financial windfall like an annual bonus is a tempting scenario where we tend to imagine big purchases or even just settling a large debt up front. However, there are ways to use one’s bonus in a highly effective manner that will lead to much a better financial outcome in the long-term. Wherever possible, use your bonus not only to settle debt, but also to start creating wealth – by investing.
Goal: Start a TFI
One tip is to use a bonus to pay off some debt as well as paying for an investment at the same time. This is because even a small amount invested each month will benefit from the long-term power of compounding. A powerful investment to start with is a tax-free investment – your investment will grow over time and you will not pay any tax on interest, capital gains or dividends. It really is a no-brainer.
Goal: Start allocating towards retirement
While retirement seems like a long way off for many people, the power of compounding overtime is once again at play here. Use this to your advantage. Do an assessment and allocate a portion of your monthly salary to contribute to retirement. Even if this amount is small while you are initially focusing on clearing your shorter-term debt, it creates a good savings foundation and you will be able to increase your allocation once you have paid off your more pressing debts.
Goal: Create a buffer by allocating more to your mortgage
If you can afford to, pay 10% extra on your home loan. This will act as a buffer from future interest rate increases (which will happen) and it will enable you to pay off your mortgage much sooner. Furthermore, by building up some equity, you have further protection should you experience financial distress.
Choose investments wisely
It’s important to focus both on settling your debt and investing for the future. When it comes to choosing an investment make sure that you are informed about your choice – and that you are diversified in your allocation. Choose investments that give you exposure to a mixture of asset classes, investment styles and geographies. This means doing your homework and investing with a reputable asset manager. Talk to your financial planner who can help you choose investments that best suit your financial situation and needs.