EFFORT IS REQUIRED FOR FINANCIAL SECURITY
A common theme that we have written about over the years is the topic of just how few people will actually achieve true financial security. A statistic often quoted in South Africa is that just 6% of us will be able to retire comfortably. In this month’s Financial View, we look at why the majority of people get it wrong.
The path to financial security is a long road. There are many turns and crossroads and there are many speedbumps and many potholes along the way. Life happens and many will not reach financial security as a result of events outside of their control, but unfortunately more will not reach financial security through bad decisions made along the journey. The minority of people that do reach financial security often make similar decisions when confronted with similar situations. It thus makes it easy to write a manual on reaching financial security. Whilst we each have unique circumstances, invariably there is only one route that most of us can take to achieve financial security.
Some of the things that would be included in such a manual would be as follows:
The acceptance of financial security being dependent on oneself
Most of us are not born with a silver spoon in our mouth. Similarly, most of us will not find a winning lottery ticket lying on the ground. It means that our financial fortunes are dependent only on the income that we ourselves earn and how much is saved. The correct allocation of this income will impact how much you have left over to “add” to your wealth. Each one of us will only earn a finite amount of income over our lives. Wealth is effectively what we haven’t spent on immediate needs or gratification.
The acceptance that one needs to save for retirement
People that reach financial stability often start saving for retirement at a young age. It is important to note that you can never catch up missed savings. Compound interest means that “time” is the biggest factor in investment growth. We may all wish to turn back the hands of time, but it is just impossible to do so. It is difficult to focus on retirement when it is such a long way away and generally when we are young, we prefer instant gratification. Those that have managed to start saving early often do so under influence of older people, whether their parents or mentors. Those that take in these life lessons, are usually well rewarded.
It is important to note that it is not sufficient to just be a member of a retirement savings plan. Many companies have low minimum contribution rates that will not allow for the individual to reach financial security. Conventional wisdom dictates that one needs to put away at least 10% (excluding risk costs and fund costs) of one’s earnings to reach comfortable retirement. Many companies have a far lower minimum contribution rate. Whilst the company fund will help, the shortfall is easily closed by just selecting a higher level of contribution. If you start late you should aim to contribute 15% to the fund.
The acceptance that early access to funds is wealth destructive
The most damaging decision one can ever make is to access long term capital for short term needs. We have briefly touched on the importance of time and the successful investor will have a good grasp of time. Many save for 10 years and then access the full value of their savings to meet a short-term need – such as a vehicle. What people neglect to remember is that it will take a further 10 years just to get back to the same point, however they now have 10 years less to benefit from compounding. Does that mean financial stability only reached 10 years later, perhaps forcing people to continue working (and earning income) for a lot longer, into later life.
The acceptance that inflation will erode value
Inflation is generally understood by most. A rise in input costs on goods will increase the selling price of those goods, increasing the cost for the consumer. The value of money erodes over time and we have all seen nostalgic images of how cheap food or petrol was 50 years ago. The reality is that food was no cheaper then, comparing historic prices against today’s value of currency just don’t take inflation into account. It is important to ensure that one’s money grows faster than inflation as this is the only way to ensure that you are wealthier today than you were yesterday. Those that reach financial security would have a high exposure to equities and the stock market over the long term to ensure that they are outperforming inflation more often than not.
The common traits
The typical person that reaches financial stability would have:
- Started saving early
- Saved money every month
- Saved at least 10%, but often more
- Never accessed their funds prior to the long-term objective
- Paid off debt as quickly as possible
- Taken advantage of all available tax breaks
- Always tried to maximise their investment return balanced against their risk profile, having a diversified portfolio with exposure to local and global equities.
Those are the people that get to enjoy their “Golden Years”. Not everyone will be as fortunate. Just do it consistently over a long term and you will be amazed at the results.
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