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. 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. South Africa has an overall savings rate of only 3%. 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 mindset 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:
Understand 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 proper saving plan in place. Whatever your financial situation, it is important to look over your savings strategy every few months to ensure that your plan is making the most of your money.
Understand Credit
Many people fear the concept of credit, as it involves owing money to a bank or credit provider. But the truth is that there are both good and bad ways of utilizing credit. The two are generally contrasted as Good credit: When you borrow money for a good reason, such as to buy a house or to finance a car. It also includes getting a personal or business loan for a specific purpose — such as paying for renovations or buying stock for your business. In these cases, if you can afford the repayments and the debt will only be for a certain amount of time, these kinds of loans can improve your credit score. Bad credit: The money you borrow for no compelling or specific reason, such as a payday loan to simply help you get through the month. These kinds of loans often come with high-interest rates, which can make them very difficult to pay back. These loans are bad forms of credit, as they can lower your credit score. CAUTION!! Borrowing money for a good reason does not automatically qualify as good credit, the only befitting explanation is when credit is undertaken with a clearer understanding of interest rate, inflation, and the depreciating value of the asset to be purchased. When a purchase is made on credit and the interest rate increases with the decrease in value of the asset then that credit is bad credit. Is a credit card considered “good” credit?
When it’s used responsibly, a credit card can help you build a good credit history. Unfortunately, you need to have a credit rating first in order to get a credit card, which may be tricky if you’ve never applied for credit before. If it’s your first time applying for credit, ask for a lower limit or prefund your credit card so you can get used to managing your account. A credit card can also be an excellent way of consolidating your debt. Instead of having multiple store accounts, you can pay off all your accounts using your credit card, which means you consolidate your debt onto one card and in one account — with one monthly statement and one interest rate.
Consider your Credit Score
When buying a house or car, it is likely you will need a loan. However, instead of financing the full amount on credit, it is important to consider putting down as a large deposit as possible. This will reduce your monthly payments and allow creditors to look upon you more favourably when granting a loan and give you better interest rates. The healthier-looking your credit score the better for you and your pocket. Lastly, should your circumstances suddenly change, it will put you in a better financial position to quickly sell the asset.
The sooner you start the better
The golden rule in 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 VS 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. As a rule of thumb, less liquid 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 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. Tax versus savings The government offers significant tax incentives to encourage saving. Saving in a provident fund, pension fund or retirement annuity yields a far higher rate of return than most post-tax savings. For example, if your income is taxed at 26%, any money you commit to your retirement savings (before tax) will yield a 26% return at the least. 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, the tax incentive is a tax-free investment, which allows you to save up to R36 000 a year, up to a lifetime total of R500 000, without incurring any tax on that amount. Any contributions over R36 000 a year (or R500 000 in total) will incur a tax of 40% on the amount over the allowed investment, for example, if you contribute R40 000 in a year, you will not be taxed on the R36 000 but will receive a 40% tax on the R4 000. 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 while enjoying the tax-free privilege Paying off debt versus 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 knowing your credit score 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 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 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 longterm 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 riskier.
