When creating your investment and savings plan, you need to understand your goals and how to achieve them. You will have different strategies according to your goals. Independent financial educator Dave Crawford cites an example of a 36-year-old client, who by the age of 49 wants to have set up his investments so that he can live off the income they generate. This means that when he is 50 years old, he will be working because he wants to, not because he has to. He is, of course, ploughing money into investments and keeping his living expenses to a minimum. Everyone- will have different goals — we all want to retire in comfort, but along the way we have shorter-term needs such as educating our children, buying a new car or going on a dream trip for our 20-year wedding anniversary.
The basic starting point is to begin saving. It’s human nature, however, that no matter how much we earn, we will spend our full salary, if not more. So start with a budget. You should have some idea of how much you need to put away, over and above your pension, to meet your retirement needs. Then you need to have a five-year plan that lays out shorter term goals. The trick is to take off this money first. Before you go grocery shopping, for example, your bank account should be less your monthly savings. This will force you to compare prices when shopping and be more careful with your cash.
So far, so good. You are a dedicated person who wants to take control of your finances, but where on earth do you invest your savings? This is the part where people usually fall apart.
According to clinical and corporate psychologist Dr Merle Friedman, behavioural economics (made famous by economist Daniel Kahnenan) has shown that people are unable to make decisions when faced with too much choice.
Friedman cites an experiment conducted in a grocery store in New York in which shoppers were invited to taste and purchase a variety of jams. When the store put out six different jars of jam, 40% of the shoppers tasted the jam and 30% made a purchase. When they put out 24 varieties of jam, 60% tasted but only 3% bought. “This demonstrates that when faced with too many options, people can’t choose,” says Friedman.
So, when faced with too much investment choice, the brain says, “Oh to hell with it, just buy a big-screen TV.”
Crawford makes some simple suggestions that won’t tax your brain. His premise is that it doesn’t matter where you save, just start saving. The power of compounding shows that the longer you save, the greater the growth you receive. For example, forfeit one evening out at a restaurant a month and invest the R200 for 10 years. If your investment only performs at 3% above inflation (8%), you would have R37 000 saved — R13 000 of wealth has been created over and above your monthly savings. Over 20 years that figure jumps to R118 800 and a massive R70 000 of wealth has been created.
Debt
When it comes to saving, start with the “invisible” saving, which is basically cutting down on your interest payments. Pay off your high-interest debts such as credit cards and store cards. Debt consolidation can also help reduce your overall interest payments.
Cash
Once you have your debt under control, Crawford says, start with a simple savings account. This is interest- bearing and exposes you to no short-term risk. Your first goal is to reach a level where the amount saved is about three to four times your monthly salary. This means you have a stash in case of emergencies or if you lose your job. If you have a mortgage bond, you could keep this emergency fund in your bond as the interest rate you are getting by not paying it to the bank is better than anything the bank would ever give you, but it is also handy to have some readily accessible cash.
Bond
Now start adding a bit extra into your mortgage bond. This will shave years off your bond repayments, but Crawford warns against ploughing too much cash into your bond. With the low interest rate environment and the power of compounding, investments can outstrip your bond saving. But it is a very good idea to put enough in to create a buffer against climbing interest rates.
Investment
A year or two after buying your house, you should start a regular contribution to an investment, no matter how small. Don’t get too creative and try to be the next Warren Buffett; just start by contributing to a balanced investment made up of equities, bonds and cash. The younger you are, the more aggressive you can be with the equity exposure, but the key element to look for is costs. Higher costs will reduce your returns and studies have shown that over 20 years, most balanced funds perform in line with each other. No fund manager is right 100% of the time and, if you start early, a box standard investment will grow and reward you. So don’t complicate it, just start saving. Once you are at a stage where you are building up a really healthy nest egg, you can look at diversifying your portfolio.
Next month, M&G Money will look at asset allocation and how to align that with your risk profile, especially as you near retirement
What you need to know about your company pension fund
Dean Graham, general manager Old Mutual Corporate, which administers Old Mutual’s Evergreen Umbrella funds, answers some questions regularly asked by pension fund members.
What are the differences between a pension and provident fund, and how do these differences affect me?
The main difference is how you receive your benefit at retirement, as well as the tax implications. When you belong to a pension fund, you can take one-third of the final benefit in cash. Under a provident fund, the full amount of the benefit available at retirement may be taken as a lump sum cash payment. The tax concessions for members in respect of the two types of funds differ. In a pension fund, up to 7,5% of a member’s salary is tax deductible. In a provident fund, there is no tax-deductible benefit.
What are the tax implications when I leave the fund before retirement?
How tax affects you will depend on what you do with the money when leaving. When you change jobs, the best option is to preserve the contributions you have made to your retirement fund. Consider transferring it into a preservation fund, where it will not be taxed, and will grow and accumulate for when you retire. Alternatively, you can transfer it to your new employer’s fund, or leave it with your original employer (if the rules of the fund allow). If you take the money in cash, you will be fully taxed on it.
Does my fund offer death, disability and funeral cover?
Your employer or your fund may have group life assurance policies for all employees that would pay out in the event of your death or should you become disabled. In the event of your death, your retirement fund will pay your beneficiaries all the contributions you have made to your fund, plus interest and less expenses, as well as any group life assurance amount.
Does my fund offer me a choice in terms of the underlying investments?
You need to determine how your fund plans on investing all the contributions it receives. The trustees should have an Investment Policy Statement, which will prescribe how the fund’s assets are to be invested. You should also determine whether you have a choice in how that money is invested. This is called member investment choice. If your fund offers you member investment choice, you need to ensure that you are suitably skilled to make these important financial decisions.
What is life stage planning and how does it affect my decision on choosing an investment option?
Some funds offer what is referred to as life-staging investments. What this means is that there is an investment portfolio that caters for different life stages, with a different investment strategy for each stage. It is based on the principle that the younger you are, the more you are able to take risks to increase your potential investment return. As you grow older, however, you have to become more and more careful with your investments so that your retirement fund savings are not negatively affected by major market fluctuations just before you retire.
It also makes sense to view your retirement savings as part of your overall financial planning and it is therefore best to obtain the services of a qualified financial adviser to help you plan for your circumstances.