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FULL STORY: PF 24.07 Savings spread
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PF 24.07 Savings spread
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Personal Finance
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Personal Finance
25 July 2010
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Staff Reporter
National Savings Month: get into the saving habit
It is National Savings Month. The reason for the emphasis on saving for the next 30 days is that
South Africans do not save enough to protect themselves from financial disaster and ensure
they can enjoy a better standard of living.
Not only do you improve your life by saving, but you contribute to a better life for all, because
the country will have more money to spend on things such as financing development and
creating jobs, which, in turn, enables more people to save � a virtuous upward spiral.
The flip side of the coin is that if you do not save or if you live beyond your means and have to
borrow to fund your household�s needs, your financial situation will not be secure. The more
you borrow, the less creditworthy you become, the harder it becomes to borrow and the higher
the interest rate you have to pay. Exactly the same happens at a national level.
In the long term, if each person increased his or her savings rate and, in turn, the South African
savings rate, it would help the country to recover faster from the financial downturn and
increase its capacity to grow in future.
If you are not saving or if your expenses are more than your income, you need to adjust your
spending patterns. Saving means nurturing your finances by following a budget, keeping clear
of unnecessary debt and then saving for specific goals.
And saving applies to all of us. Top professionals are almost as likely to get into debt and not
save as people on a low income.
HOW TO DRAW UP A BUDGET
Drawing up a budget will help you to keep track of your income and expenditure so that you
manage your money and not the other way around.
You must take the following steps to draw up a sound budget:
Step 1. Add up your household�s sources of monthly income, whether a pay cheque or interest
on a savings account. If you do not have a steady income � for example, you earn a variable
commission � be realistic and conservative when you put a figure to the amount you expect to
earn every month.
Step 2. List and prioritise all your expenses. Your list should include the following items:
• Reducing debt. This should be your top priority, because getting rid of debt means you will
not have to pay interest and you will be able to save.
• Savings. Pay yourself before anyone else. If you save a certain amount every month, you will
soon get used to living without that money.
• Saving for annual payments. You need to plan for annual payments such as motor vehicle
and television licences; school fees, books and uniforms; any additional tax; and possibly
insurance.
• Fixed expenses, such as your mortgage bond repayment or rent and your motor vehicle
repayment.
• Variable necessary expenses, such as electricity, water, groceries, transport and medical
expenses.
• Variable discretionary expenses, such as holidays and entertainment.
You can use old bills and credit card statements to work out a reasonable average for each of
these expenses.
When you draw up a budget, make sure that you distinguish between your needs and your
wants.
Prioritise your needs and make sure you have allocated money for your needs before you
allocate money for non-essential expenditure. When it comes to budgeting for expenses, rather
overestimate costs than underestimate them.
A budget is not static, so keep reassessing your expenses and income, because they change
over time.
Step 3. Your budget should have two columns: one for how much you planned to earn and
spend, and a second that records what actually happened. Very few people get budgeting right
the first time, but it does get easier with practice. You need to adjust your budget if you are
spending more than you are earning.
Don�t forget to take account of your cash spend each month, because the details of this
expenditure will not be recorded in your bank account or credit card statements. It may help to
carry a notebook with you to record all your expenditure. This will enable you to note the
�hidden� ways in which you spend your money � you will be surprised at how daily purchases,
such as lunch and magazines, add up to a significant amount each month.
Once you have drawn up a budget, you need to stick to it. This means being disciplined enough
to resist the temptation to spend, exercising restraint when you go shopping and resisting the
lure of store cards. After all, buying on credit simply means you are delaying the inevitable
payment. In addition, when you buy on credit, you are taking on further debt repayments,
which are likely to knock your budget off balance.
Sticking to a budget is not easy and you will find that you will need to try again. And again. And
again.
DEBT: HELP OR HARM
There are two types of debt: good debt and bad debt.
Good debt is debt that you take on to pay for an asset that appreciates in value, such as
property. Bad debt is a debt that you take on to pay for something that depreciates in value.
Sometimes that asset can be useful or a necessity, such as a car or a computer. But to take on
bad debt simply to buy clothes or a flat-screen TV is not sensible.
So borrowing is not in itself a bad thing, and it is difficult to be completely debt-free if you are
going to buy a house or a car. However, you can keep your debt levels manageable by not
taking on more debt than you can afford.
You can also save a great deal of interest by paying off your debt as soon as possible. For
example, if you have a home loan of R800 000 at an interest rate of 10.5 percent, your monthly
repayment will be R7 987. If you pay an additional R300 a month into your home loan, you can
reduce the term of your bond by more than two years � and save more than R140 000 in
interest.
WHY IT PAYS TO SAVE
Saving money can help you to achieve goals such as buying a car, going on holiday or retiring
financially secure. It is important that you set goals when you start saving so that you have
something concrete to work towards and on which to focus.
When you use debt to fund your goals, you will spend much more money because of the
interest charged. A huge advantage of saving is that your money works for you, because you
earn interest rather than having to pay it (see �Starting early � it all adds up�). The aim of
saving is to provide for future spending. This can be short-term spending, such as paying for
school uniforms or a holiday, or to cover you in the event of a crisis, such as unexpected motor
vehicle repairs.
One of the most important reasons for saving is to ensure you can retire financially secure. You
could even say the biggest advantage of saving is that you can have a dignified and comfortable
old age.
There are many benefits of reducing your debt and increasing your savings. They include:
• A positive credit profile, which works to your advantage if you want to borrow money to buy a
house or car. You will obtain a more favourable interest rate on the loan. In addition, potential
employers look at your credit profile, and a good profile will work in your favour.
• Financial security, because you have buffers to cushion you from the inevitable shocks that
life hands out, such as accidents, illness, retrenchment and theft.
• Reduced stress levels, because you are financially secure and living within your means.
STARTING EARLY � IT ALL ADDS UP
Compound interest, which is interest on interest that you have already earned, is a powerful
way to grow your money over the long term.
For example, a pair of twin brothers � Paul and Peter � both want to save for their retirement.
Paul starts saving R5 000 a year at the age of 25. He saves for 10 years and then stops
contributing to his savings at the age of 35. Paul earns returns on his savings at a rate of 10
percent a year. He makes a total contribution of R55 000 to his savings, which are worth R1.6
million when he turns 65, due to the effect of compound interest.
Peter, on the other hand, starts saving only at the age of 40 at a rate of R10 000 a year and
continues to save until the age of 65. He earns annualised returns of 12 percent a year on his
savings. Even though Peter contributed R260 000 to his savings (a much higher amount than
Paul) and earned a higher return, his investment is worth only R1.5 million at the age of 65.
NOW � MAKE A PLAN TO SAVE
Once you have a budget in place and you have started to reduce your debt, you can work out a
savings plan.
Saving is putting aside money from your income on a regular basis.
When you launch your savings plan, you should set different financial goals. Each goal has a
corresponding time frame and investment vehicles that best suit it.
An important aspect of saving is to make your money work for you. To preserve the value of
your savings against the ravages of inflation, you need to invest your money so that it earns
sound returns, but without taking unnecessary risks.
You can use four main asset classes in your savings/investment plan:
• Equities comprise mainly shares listed on a stock market. Shares historically provide the
best returns, but shares have a higher risk, because they can move up and down quite violently
in value. This has been the case over the past few years, due to the subprime mortgage crisis
and the global economic meltdown. For this reason, equities are considered longer-term
investments, because the volatility risk can be smoothed out over time.
• Bonds are a relatively defensive asset class and the risk of losing your money is lower than
when you invest in shares. Bonds are long-term I-O-Us issued by governments and companies
in which the issuer promises to pay back the lender (or investor) his or her capital at the end of
a specified term (when the bond matures). The investor is paid interest, usually twice a year.
Government bonds are considered less risky than corporate bonds, because a government�s
ability to repay your capital and interest is virtually guaranteed, partly because governments
can raise taxes, print money or both.
• Property can be bought in various ways, from direct ownership to indirect ownership through
a stock exchange. There are four types of listed property investments: property unit trusts,
property loan stock companies, listed property companies and exchange traded funds (of which
there is one in South Africa, Proptrax).
• Cash or cash equivalents are some of the safest investments but historically have provided
the lowest returns. Examples of cash or cash equivalents are treasury bills, money market funds
and savings deposit accounts.
SHORT-TERM SAVINGS: FOR LIFE�S EMERGENCIES
Goals for short-term savings are things such as school fees and an emergency fund, if you do
not already have one in place. An emergency fund is a fund that you set up to take care of your
living expenses when your normal source of income is disrupted, such as when an illness
outlasts your paid sick leave or you are retrenched.
You can also use your emergency fund for unexpected expenses, such as having to cover the
excess payable on your car insurance after an accident.
Experts recommend that you should have an emergency fund that is equivalent to at least three
months� salary. If you do not already have an emergency fund, do not despair: it is not as
daunting as it sounds if you break up accumulating the money into bite-sized chunks. Set
yourself an achievable goal � say, saving R3 000 for your emergency fund. Once you achieve
that target, congratulate yourself and aim for one month�s salary, then two and, finally, three
months� salary. Once you have set up your emergency fund, you can channel your monthly
savings towards another goal. In this way, you can build up a savings or investment portfolio.
Your short-term savings must be easy to access and not tied up for longer than a month. This is
because you do not want to be in a situation where you need to withdraw funds in an
emergency and have to either pay a penalty or incur a loss because you are disinvesting early.
For example, having to cash in an equity investment when the markets are down or trying to
sell a property in a hurry to realise cash. In addition, you need to consider the rate of return,
costs incurred and the rate of inflation. Ideally, you don�t want to lose money to inflation and
costs, although at different stages in the interest rate cycle the rate of return may be lower than
inflation.
The products that are suitable for short-term savings are:
Bank savings accounts Interest rates on these accounts seldom out-pace inflation, but you
have instant access to your money.
32-day notice deposits These accounts usually earn higher interest than a bank savings
account. However, bear in mind that you will have to give the bank 32 days� notice if you want
to access your money. In extreme circumstances, you can approach the bank to release your
money within one or two days, but the bank will charge you a penalty fee for this.
Money market investments A bank money market transaction account usually offers a higher
interest rate, but there are usually stipulations on the minimum initial deposit you must make to
open the account, and R10 000 is a ballpark figure.
You would earn an even higher return for short-term savings in a money market unit trust fund,
but in most cases you are required to make a minimum investment of R25 000. Money market
unit trusts do not charge you initial fees. Your money is normally available to you within 24
hours.
Mortgage access bonds If you have an access facility on your mortgage bond, you can pay
your short-term savings into your bond until you need the money. By doing this, you will reduce
the interest payments and, in effect, receive the best deal on a cash investment. If your
mortgage is at the prime lending interest rate of 10 percent, you will �earn� interest at 10
percent, which is a lot better than the about 5.5 percent offered by a money market transaction
account, for example.
But you must obtain a guarantee in writing from your bank that you will be able to access your
funds and that you will be able to do so at your discretion. During the credit crisis, some banks
prevented clients from making use of the access facility on their mortgages, even when they
were in �credit�.
MEDIUM-TERM SAVINGS: FOR EXPENSIVE BUYS
Medium-term goals can include saving for a new car or a deposit on a home. So you need a
savings vehicle that offers higher returns than those offered on bank deposits or money market
funds.
You need capital growth (an increase in the market price) rather than interest returns. The
improvement in the value of investment vehicles such as equities and property provide capital
growth. However, the promise of higher returns brings with it higher risk and usually means
your money will be tied up or inaccessible to you for longer periods.
One way to reduce risk is to spread your investments across the asset classes of equities,
bonds, property and cash, and into a range of options within each asset class.
However, most of us cannot afford to buy a portfolio of shares, nor do we have the time or
expertise to select the best-performing shares. The better option for most people is what are
called pooled investments, where your savings are combined with those of many other people to
provide access to the best investments in South Africa and abroad.
Pooled investments available for medium-term savings include:
Endowment policies These investment policies are taken out with life assurance companies,
usually for a minimum term of five years.
The important thing about endowment policies is they are what are called contractual savings.
This means you have to keep saving according to the contracted term or you may be penalised
by a maximum of 15 percent of your savings. The upside is that they are a disciplined way of
saving that keep you focused on your savings target.
Endowment policies invest in a range of underlying investments with varying levels of risk and
return. The underlying investments can range from what is called a balanced portfolio, where
the life assurance company decides on the investments to be made in all the asset classes, to
policies where you can select specific unit trust funds.
You are allowed to make one � and only one � withdrawal in the first five years of the policy,
subject to any penalties. Your withdrawal is capped at the initial amount you invested plus five
percent compound interest a year.
Tip: You can invest in endowments through a financial adviser or, increasingly, directly over the
internet.
Collective Investments Collective investment schemes (CISs), such as unit trust funds and
exchange traded funds (ETFs), are more flexible than endowment policies, because you can
access your savings at any time.
Most CISs are suitable for medium- to long-term saving, because they invest in shares listed on
a stock market that are subject to short-term volatility risk (the tendency for prices to rise and
fall often).
If you invest in a pure equity CIS, it is prudent to leave your money invested for five to seven
years to reduce volatility risk and recoup the investment costs.
ETFs and unit trust funds are similar, but ETFs are listed securities (shares) on a stock
exchange. Both invest in other shares and bonds, but ETFs can also invest in commodities, such
as gold.
ETFs track or mimic pre-selected indices, such as the FTSE/JSE All Share index. An index
reflects the overall performance of a stock exchange, geographic region, market sub-sector or
even a commodity.
A simple index takes account of what is called the market capitalisation (the total number of
shares issued multiplied by the share price) of all the companies listed in a chosen market. If
one company accounts for 10 percent of the total market capitalisation of the chosen market, it
makes up 10 percent of the index. An ETF simply invests in the same proportion as the index,
significantly reducing investment costs.
Unit trust funds are mainly actively managed, with asset managers deciding on the underlying
investments of the funds. CISs also offer lower-risk investments, such as asset allocation funds
and absolute return funds, where the different asset classes of cash, bonds and shares are
combined.
Unit trust funds and ETFs that invest in stock exchange-listed securities, either here or abroad,
are registered as CISs, providing you with greater security and tax benefits.
The required monthly contributions to a CIS are usually higher than those for endowment
policies.
Tip: You can invest in CISs through a financial adviser or directly over the internet.
Linked investment service providers (Lisps) Lisps enable you to invest in a broad range of
investments, from CISs offered by different companies to listed shares, through one service
provider.
An advantage of a Lisp is that you can switch between the CISs of different companies at a low
fee, saving on the disinvestment and reinvestment costs that you would have to pay if you
bought and sold CISs individually.
A disadvantage of a Lisp is that you pay an extra layer of fees when you invest. You have to pay
the individual CIS fees and a Lisp fee.
Tip: You can invest in a Lisp directly in some cases or through a financial adviser.
RSA Retail Bonds These are investments provided by the government that are an easily
accessible way to invest in bonds and can be used for your medium- to long-term savings. They
are available in a variety of different terms and you earn a higher rate of interest for longerterm investments.
There are two types of RSA Retail Bonds: fixed-rate and inflation-linked.
• Fixed-rate bonds. The maturity periods for fixed-rate bonds are two, three or five years,
and the interest rate is fixed for the investment period. The interest rates are based on the
yields on government bonds and are reviewed every month.
If the interest rates applied to retail bonds change, the new rates apply only to new investments
and not to existing ones. The interest can be paid into your bank account at the end of March
and September, or you can have the interest reinvested in the retail bond.
• Inflation-linked bonds. These bonds pay a floating rate of interest that is set above the
inflation rate. The floating rate is adjusted every six months in line with inflation as measured
by the consumer price index. Inflation-linked bonds have a three-, five- or 10-year maturity
period.
Early withdrawals are allowed after a year, but you incur a penalty in the form of lost interest.
Tip: You can invest in RSA Retail Bonds directly over the internet ( www.rsaretailbonds.gov.za),
or through the Post Office or Pick n Pay.
LONG-TERM SAVINGS: FOR YOUR RETIREMENT
After you finish your education, you have about 40 to 45 years of working life before you retire.
It is during those years that you will have to save all the money you will need during your
retirement. Nowadays, with longer lifespans, retirement can last 20 years or more, so it is
crucial that you have enough money to last the distance.
There are investment vehicles that offer significant tax advantages to make saving for
retirement more attractive.
The government has laws that encourage you to preserve your money for retirement. It has
also imposed strict controls on retirement funds to ensure they adopt sound, lower-risk
investment strategies.
The retirement savings vehicles are:
Occupational retirement funds Employers, industrial organisations and trade unions offer
these funds to employed people. The main occupational retirement funds are:
• Pension funds. Your contributions up to 7.5 percent of your pensionable income (your basic
pay without allowances) are tax-deductible, and all the investment returns are tax-free.
When you retire, you can withdraw up to one-third of your benefits as a lump sum (with scaled
tax exemptions). You must use the remainder to buy an annuity (pension). Your pension is then
taxed at your marginal rate of tax.
• Provident funds. Your contributions are made with after-tax money, so they are not taxdeductible, but the investment growth is tax-free.
When you retire, you receive all your savings from the fund, with your contributions added to
the tax-free portion of the lump sum tax rates. Only the contributions made by your employer
and the investment growth are taxed, but at favourable rates.
Retirement annuities (RAs) These funds are typically used by people whose companies do
not offer occupational retirement funds or by members of occupational retirement funds who
want to supplement their retirement savings.
RAs are available as both life assurance and unit trust-based products. Unit trust RAs are more
flexible, because you can reduce or even stop paying the contributions without a penalty being
levied on your savings, whereas life assurance RAs are contractual and any reduction in
payments could result in a penalty being applied.
Your contributions to an RA up to 15 percent of your annual non-retirement-funding income
may be claimed as a tax deduction.
You can draw a pension only after the age of 55. As with a pension fund, you may take up to
one-third of your benefits as cash, but you must buy an annuity with the balance.
Preservation funds You should always preserve your retirement savings whenever you leave a
job. If you do not, you will not have enough money on which to retire.
If you change jobs, you may have the choice of leaving your savings in the fund of the company
where you were employed and receiving your benefits at retirement, or transferring your
savings to the fund of your new employer. If neither of these options is available, you can
transfer your savings to an RA fund or a preservation fund.
You cannot make additional contributions to a preservation fund. If you want to continue saving
money for retirement, you will have to use another investment vehicle, such as an RA.
There are two types of preservation funds: pension preservation funds and provident
preservation funds.
To preserve the tax benefits, you must transfer from a pension fund to a pension preservation
fund or from a provident fund to a provident preservation fund.
You may retire from a preservation fund at age 55, when the same pension, lump sum
withdrawal and tax rules for pension and provident funds apply.
GOOD ADVICE
• The key to saving is to make it a habit. Put money aside at the beginning of the month
instead of saving what is left at the end, because the chances are that you will find there is
never anything left at the end of the month. An automatic deduction from your salary or bank
account is easy and takes the decision-making out of your hands. Very soon, you won�t even
notice it.
• For most people, it is best to seek advice on all your financial affairs, including saving, to
ensure that you have your priorities right, are saving enough and are using the right products.
Always ensure that the person who gives you advice is registered with the Financial Services
Board (FSB). You can do this by going to the FSB�s website, www.fsb.co.za. Click on the
�FAIS� link and then �Search for financial services providers�. Or you can telephone 0800
110 443 or 0800 202 087.