Despite the recent 25-basis-point cut in the repo rate to 6.75%, experts are warning that you spend wisely and ensure your money is working hard for you. A critical aspect in this regard is understanding the difference between saving and investing.
This is the view of the managing director of retail at 10X Investments, Emma Heap, who says that saving and investing are different activities, yet two sides of the same coin.
“ ‘Saving’ means putting money aside for future use. It is spending postponed. That future use may relate to your year-end holiday, or your child’s university education in five years’ time, or your retirement, still 30 years away,” Heap says.
“With few exceptions, we all need to save for retirement. Although the state does provide an old-age grant, this is currently a mere R1 600 a month, insufficient to maintain an acceptable standard of living. Nor should you expect anyone else, including your children, to provide for you.”
Heap says the onus is on you to secure your retirement: “Ideally, you should save 15% of your monthly wage or salary in a retirement fund over your entire working life. This should be enough to maintain your accustomed lifestyle in retirement, provided your money is invested appropriately.
“Investing is what you do with your savings in order to earn a return. If you hide your spare cash in the sugar jar, you are saving, but you are not investing, as that money won’t have added any return or interest the next time you check. Left alone, that money will not grow in amount or value,” she says.
Although there may be thousands of investment vehicles, Heap says that, in most instances, your money is usually invested in one of the following asset classes: company shares (local and international), government bonds, listed property and cash.
“The investment return is earned as interest, rent and dividends, or by way of a change in the price of the underlying asset.”
Heap says that, when you save your money as cash in the bank, the risk is generally very low and your potential to earn a return is essentially capped.
“But you can be almost 100% sure that, when you draw your money, you will receive all you put in initially, plus any accrued interest that is due to you.
“Share prices, in comparison with interest on bank savings, move on a daily basis,” Heap says. “You are thus never sure how much money you will receive for your shares until the day you sell them. However, to compensate for this uncertainty, investors have historically earned a real (after-inflation) return of 7% a year from a well-diversified share portfolio held for many years.”
Heap says the constant rise in the cost of living – known as inflation – steadily eats away at the purchasing power of your money.
“Assuming a 6% inflation rate, the money you spend on a loaf of bread today will buy only half a loaf in 12 years’ time. By the time you retire, it may buy you only one slice,” she says.
Depositing your money in the bank should at least preserve its purchasing power, but the money you accumulate this way will not be sufficient to pay for your retirement, unless you are willing to save much more than 15% of your income every month, Heap says.
“When saving at 15%, you are still dependent on the investment return to fund the bulk of your retirement. You therefore need to invest a big part of your portfolio in assets that deliver a high real return over time.”
Heap says a balanced investment portfolio with a high proportion allocated to shares has historically delivered a long-term real return of about 6% a year.
Heap says the key lesson is that you should start saving and investing as early as possible, to benefit from the strong compounding effect at the end of a long investment term.
She says it is important to remember that, even if you save diligently over your entire working life, investing in a low-risk asset class could curtail your standard of living in retirement by as much as 80%.
“That is a much bigger risk than exposing your money to the share market over the long term.”