BECAUSE SPENDING AND SAVING are like the two sides of a see-saw, wise spending involves setting a wise limit of how much to spend and therefore how much to save. How much you should plan to save will depend on your goals. Your savings rate also depends on the stage in life you have reached and what you have achieved so far.
For example, a recommended primary goal for a young person would be to save 20 per cent of their net earnings. In the first instance, savings would be towards establishing a four-to six-month emergency fund. Such a fund is essential so that if the person is ever between jobs for an extended period, he is more likely to survive by drawing on such savings.
However, it does not make sense to save funds on a bank deposit with interest earning of under one per cent per annum whilst the person is holding high interest debt. Having just completed a broad discussion on debt, the very first step would be to get rid of any high interest debt like credit card balances or personal bank loans.
Where the interest you pay on such loans may range from nine per cent to over 20 per cent, paying off the balance on these loans translates into you earning that same nine per cent to 20 per cent level of interest on your cash. Alternatively, the same cash deposited to a bank account will likely earn interest income of less than one per cent. So, do not even think of saving and investing until you have pressed yourself to save to repay such high interest debts.
The emergency fund savings should then be invested in ways that allow the cash to be readily available if needed. Any investing needs to be built on a bedrock of continuing savings. For example, emergency funds savings can be invested in a credit union, a commercial bank or even in Government savings bonds.
These are options that allow your funds to grow in value yet remain available to you at short notice if necessary. However, treat these funds more like insurance against the contingencies of life rather than the basis of pursuing high investment returns.
Another important goal is saving for retirement. In such a case, a minimum savings rate of ten per cent of your net income is recommended. However, it is important to also invest these savings in order to maximise the growing value of the retirement funds over the long term.
When it comes to making good investments towards retirement, there is no one solution that is right for everybody; your choices are best made on what you like, your goals and your risk profile. However, you can take measured steps to get you from where you are to where you would ideally like to be as an investor: from just surviving day-to-day to becoming an experienced investor.
The investment of savings made for retirement will likely be for a longer term which provides access to higher interest earnings. An example of the investment vehicle for these funds is a balanced mutual fund. Yet, you continue to save, as the next major step is when you start to face diverse investment choices in trying to build longer term wealth.
Before you commit to any particular investment, you need to consider what your investing will fund in your life and when, what kinds of investment risks you can tolerate and what you would really like. Will you need to access these funds in five, ten, 15 years or more? Will you be ultimately investing in real estate – land or land and building; in a business; in a lifestyle change; in another planned acquisition or say, in funding a pleasure trip from the interest earnings on the base investment?
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. Email: LouiseFairsave@nationnews.com.