Saving versus credit: It’s all about balance

Making significant and consistent contributions to your savings over time is as important in securing your future.

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While making responsible use of credit can help you achieve your life goals earlier, making significant and consistent contributions to your savings over time is as important in securing your future.

 

Did you know that South Africa has an overall savings rate of only 3%, which is compounded by the changeable economic environment? Currently there are 25 million credit-active consumers, while household debt as a percentage of disposable income is at around 72%. This means that for every rand earned, nearly three quarters is spent on debt - a clear indication that as a nation we are prioritising spending over saving.

 

Saving is a mind-set that takes some discipline, but it is worth it in the long run. Savings is not only about putting money away, but ensuring you get the best growth through interest or returns on your savings. It’s never too late to start saving, here’s how to get started:

 

Be clear on your savings goals
Ask yourself: are you are happy with where your finances are right now? What do you want your future to look like? Depending on your life stage it could be anything from providing an education for your children, travelling the world, or retiring comfortably. Begin with the end in mind when plotting achievable financial goals and set a deadline so that you have a rigorous saving plan in place. Whatever your financial situation, it is important to look over your savings strategy every few months to ensure your plan is making the most of your money. You may also want to shop around for a registered financial advisor who can make recommendations based on your individual savings goals and life stage.

 

Save for better credit
When considering buying a big-ticket item like a house or car, it is likely you will need a loan. However, instead of financing the full amount on credit, it is preferable to save as large a deposit as possible. This will reduce your monthly payments and allow creditors to look upon you more favourably when granting a loan, hopefully at a better interest rate. Lastly, should your circumstances suddenly change, it will put you in a better financial position to quickly sell the asset.

 

An early start and patience pays off
The golden rule to saving is to start as soon as possible, even if your contributions are small. The reason for this is the combination of time and compound interest – i.e. earning interest on your interest. For example, if the goal is to save R1 million by age 65, a 20-year-old needs to save R362 a month (at a reasonable interest rate of 6%). If you only begin saving at 40, you will need to put away R1, 454 a month to reach the same goal.

 

Balance liquidity versus returns
When considering your options, the immediate availability (or not) of your saving investments will play an important role. This is known as liquidity and refers to how quickly you can convert an investment into cash. Having some liquidity in your savings strategy is important to cover unexpected expenses, such as a major vehicle repair.

 

As a rule of thumb, lower liquidity investments tend to give you higher returns. For example, the interest on a typical cheque account (highly liquid) is between 0% to 3%, versus notice deposit accounts (less liquid) which will typically yield between 3% and 7%.

 

Balance risks versus returns
In general, when considering savings options, higher risk investments will have higher potential returns, but also greater potential losses. Investing in the JSE All Share Index, for example, typically gives around 10% to 15% better returns than a bank-account based savings.

 

A factor to consider when making risk based savings is your age. Generally, as you get older and approach retirement your savings should carry a lower risk. When you are young, however, you are less likely to have major responsibilities, like paying for a child’s care and education, so a more-aggressive higher risk investment portfolio could be appropriate. The argument being that when you are young you have time to ride out the dips and turns of the stock exchange.

 

Get some help from the tax man
The government has a vested interest in its citizens saving for their retirement and offers significant tax incentives to encourage this. Saving in a provident fund, pension fund or retirement annuity yields a far higher rate of return than most post-tax savings mechanisms. For example, if your income is taxed at 26%, any money you commit to your retirement savings (before tax) will yield 26% return at the least. Any returns over and above this are gravy. There is, however, a limit to this tax benefit of 27.5% of your taxable annual income and not exceeding R350 000 a year.

 

Another, more flexible, tax incentive is a tax-free investment, which allows you to save up to R33 000 a year, up to a lifetime total of R500 000, without incurring any tax on that amount. But it’s important to note that contributions over R33 000 a year (or R500 000 in total) will incur tax of 40% on the amount over the allowance. A tax-free investment is a good supplement for retirement savings and has the advantage of allowing you to withdraw money should you need it.

 

Paying off debt versus investing in savings
While using credit should never be at the expense of a savings plan, an important decision is whether to use any excess cash to pay off your debt or contribute further to your savings. By downloading your credit report from TransUnion you get a clear, holistic view of your financial landscape (as the lenders see it). Your credit score is a good indication of the manageability of the various loans and credit facilities in your portfolio. If you find that you are heavily over-indebted it may be necessary to prioritise paying off that debt, but if your credit score is in the good to-excellent range, savings could become a priority.

 

Also consider the cost of credit versus the returns from your savings. The prime interest rate is currently 10%. Most credit attracts interest rates of prime plus, whereas liquid savings instruments usually offer lower than the prime interest rate. In general, a holistic budget should prioritise paying off high interest debt, while contributing to a retirement fund and putting some money aside for emergencies.

 

Save like a professional investor
There are so many factors to consider when determining what a good return on your long-term savings looks like. But if we look at it from a professional investor’s view, there are a couple of basic benchmarks to consider.

 

Firstly, investors use something called a “risk free rate of return”, which is usually benchmarked against 10-year government bonds. These bonds currently offer about 8% return on investment in South Africa. This means that if a long-term investment is getting returns of less than 8%, professional investors do not consider them a good investment.

 

The other benchmark is the average annual return you would make by investing in the JSE’s All Share Index over 10 years, which is currently at around 12%. Very few investors beat this rate over the long term, so if your returns are higher than this, you are in a great position but your investment is probably more risky.

 

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