8. How to save
Question
I follow your column every week and am very interested in all the investment advice. However, my question is how does someone like me, who does not have a large sum of money to invest, go about accumulating a good nest egg for the long term? How do most of your clients get into a good financial position?
Answer
Many years ago, I read a book called “David Copperfield” by Charles Dickens. In it, Mr Micawber gave David the following advice:
“Annual income twenty pounds, annual expenditure nineteen nineteen and six , result happiness.
Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery”
This pearl of wisdom lies at the heart of why some people are wealthy and others are not. You need to spend less than you earn and to spend when you have the money, not before.
Over your lifetime you will earn a finite amount of money. If you spend most of this money on interest payments, you will be poor.
Most people end up spending far too much of their money on interest repayments like car loans, clothing accounts and credit card debt. If you can drive that beaten-up car for a couple of extra years or resist the urge to buy the latest clothes on credit, you can turn this equation around and get your money to work for you. Living within your means and building up savings when you are young will result in a lot less money being spent on interest payments and more being used to generate wealth.
The first step towards accumulating a good nest egg is to live according to a budget. You need to know how much money is coming in and how much is going out. You must ensure that what is going out is less than what is coming in.
The next step is to pay yourself first. Just as work expands to fill up the time available, so does your spending expand to use up all the money you have. If you invest before spending, you will get used to living on the lower amount of available money.
By living according to a budget and paying yourself first you, you will ensure that you are well on the road towards getting into a strong financial position.
You now need to choose what you are going to invest in.
Tax free investments
My starting off point is usually a tax-free savings plan. The big advantage here is that all the growth inside the investment is tax free and all the proceeds will be tax free. You are allowed to invest R3000 a month with a maximum of R500 000 over your lifetime.
I did a calculation that if you invested R3 000 a month you would hit the R500 000 investment limit in 14 years. By then, the investment should be worth around R1 million tax free in today’s money, depending on the portfolio you selected. You can now sit back and watch the investment work for you.
You can invest in a tax-free plan in several ways. Many of the local banks offer tax free savings accounts. This is convenient and safe, but the returns are not that great, especially if you are investing for the longer term.
Many of the unit trust companies offer tax- free plans with low minimum premiums. If you have more than R1 000 to invest, you may want to look at investing via one of the investment platforms. Here you will have access to a wide range of investment portfolios and wrap funds.
Once you have exhausted the R3 000 a month limit for tax-free funds, you need to look at other options.
Endowment policies
If you are paying more than 30% in tax (around R30 000 a month in earnings), you may want to look at making your investments through an endowment policy. The big advantage here is the investment is taxed at a rate of only 30% and 12% for capital gains which is less than you would pay in your individual capacity. The downside is your money is not as accessible in the first five years as it would be under the other instruments. Be careful of some of the “old school” endowments which have high upfront costs and limited flexibility and investment choice.
There are many portfolios to choose from and this can be daunting. I would recommend that you chat to an investment specialist. They are regularly updated on what is happening in the economy and how the different investment types are expected to perform over the next 12 months. They will help you choose the most appropriate portfolios.
To become wealthy, you need to live within your means and invest wisely. If you get into the habit of saving before spending, you will find a level of financial freedom that will allow you to have so many more life choices.
Kenny Meiring MBA CFP ® is an independent financial adviser. You can contact him on 082 856 0348 or at Financialwellnesscoach.co.za Please send your questions to kenny@financialwellnesscoach.co.za