The best way to ensure you leave your dependants and heirs with a lasting financial legacy is by starting to build wealth through savings and investments from your very first pay cheque.
Oupa, a young graduate, who is about to enter the mining industry, will have about R7 000 to invest and wants to know how best to use this money to secure his financial health in the long term.
As a young man, Oupa understands the power that money has to build his legacy rather than simply spending it on a flashy lifestyle. “I am not ready to commit myself to less important things,” he says.
Oupa’s initial thought was to use the money to invest in property. He lives with his mother in a fully paid home and only pays rates and taxes on the property. To improve his earning potential, he is further advancing his studies through Unisa. He is paying cash for his studies and does not have any study loans to pay off.
His employer will cover 50% of his medical aid costs. He will also invest in a retirement fund through his employer. Oupa will belong to a union and his employer provides insurance for injuries and accidents.
Sinenhlanhla Nzama, a product marketing actuary at Old Mutual, notes that Oupa is in a fortunate financial position in that most people start work and already have debts such as study loans or don’t have much money left over after paying for their basic expenses.
Having a financial plan is important for him, as he will be able to think about his current and future financial positions. “The desire to invest in property and any other investments should be part of this plan. However, before he decides on a specific investment, he would have to ensure that it is suitable for him and can lead to his desired financial future,” Nzama says.
Plan of action:
- Month-to-month budgeting
Oupa’s strong financial position as an earner with no significant debt means that he can get into the habit of “paying yourself first”, by saving a portion of his take-home salary before he pays for other expenses. This could be the R7 000 he has identified as discretionary income or available funds.
He must come up with a monthly budget. The challenge is that Oupa’s monthly income is not fixed as it is based on a number of factors including overtime, production bonuses, a traveling allowance, a housing allowance and a night shift allowance. To counter this, he can work from his basic salary of R15 000 against his expected monthly expenses, while making sure that he is realistic about those expenses.
Nzama says in the first few months of earning a salary, Oupa can use the potential additional R13 000 that he can earn to build up his emergency fund as quickly as possible.
He must monitor his spending against his budgeted expenses and see where he might not be sticking to the plan and where he is too unrealistic. This will assist in managing his budget more effectively.
2. Short-term: emergency fund
Nzama says in the first few months of earning a salary, Oupa can use the potential additional income he can earn from overtime and production bonuses to build up his emergency fund as quickly as possible.
An emergency fund ensures that you do not touch your long term savings when times get tough. Emergencies can include anything from a death in the family to finding yourself out of work due to retrenchment. Most importantly, an emergency fund ensures that you have money available when you need it the most, at very short notice. This is why accessibility of these funds is very important.
Nzama says ideally your emergency fund should be equal to one to three months’ income. “That level can cover most unexpected emergencies. However, if you use these funds, then you must repay that money into your emergency fund as quickly as possible,” he warns.
Because of the high employment uncertainty in the mining industry, Oupa may need to make his emergency fund equal to at least six months’ salary. This can cover him for most of the unprotected mining strikes, temporary unemployment or an injury putting him out of work. It would also cover hime if his employer’ insurance is insufficient or only pays for medical bills.
- Medium-term needs
As he starts working he is likely to want to buy some big-price items, such as a car or furniture for his own home or his mother’s home.
The best thing to do would be to save for these expenses upfront rather than buying them on credit. The interest he would pay on credit could be up to 30%. But if he saves up for these expenses over one or two years (even three years if necessary), he would see much less of his money going towards interest payments.
Nzama says he can use part of his additional, potential earnings of R13 000 to save for these medium term financial needs. “If he uses 50% of any additional income, that is potentially R6 500 a month, which adds up to R234 000 after three years. With this amount of saving, he can achieve a lot more than if he bought things on credit.”
- Long-term needs
The main aim for Oupa’s financial plan is to ensure that he saves, and saves as much as possible for the long term.
A good budget ensures that he doesn’t misuse his emergency fund. The emergency fund and the medium term savings ensure that he doesn’t go into unnecessary debt when he needs money for unexpected events or to buy large items. “Most importantly, the financial plan outlined ensures that any long term savings are not interrupted as he progresses in life,” Nzama adds.
Oupa already has some form of retirement saving with his employer. He needs to check how much he is contributing to his employer’s retirement fund. With the assistance of a financial adviser, he can assess if this is sufficient for his retirement needs. If it is not, he can top up by increasing his contribution to his employer’s retirement fund, up to the allowed maximum contribution.
He can also buy a retirement annuity to supplement his retirement fund savings. However, choosing the appropriate retirement annuity product can be complex and he would need financial advice. Both his employer’s retirement fund and a retirement annuity would typically invest his savings in shares, bonds and property using skilled investment managers.
The risks of property investment
Nzama says some other ways of saving for the long term could be for Oupa to invest directly in these assets, as he indicated his interest in property investment. Whether investing in property fits his future financial position or not, he would need to be aware of the many risks of direct investment, especially in property. Some property investment risks include:
- It’s not an easy investment to sell if he needs money urgently.
- It’s difficult to know the right price to pay.
- A tenant is not always guaranteed and if there are months when there is no tenant, he will still have to meet the bond payments.
- High running costs such as maintenance, insurance and taxes. This can reduce the R7 000 he has available each month to R6 000 or less for the bond payment.
- High initial costs such as a deposit, transfer duties, estate agent’s fee.
- A home loan is a long term commitment of 20 years or more. If he becomes unemployed at any time, he may be forced to sell the property at a bad time for a poor price.
- If interest rates rise in the future (and they usually do), then the monthly bond repayment may increase beyond his affordability.
BOX: An example of a simple five-year financial plan for a discretionary monthly income of R7 000:
|Monthly Savings (building up his financial plan)|
|Financial Plan Component||Year 1||Year 2||Year 3||Year 4||Year 5|
|Emergency Fund||R 4 000||R 0||R 0||R 0||R 0|
|Medium Term Savings||R 2 000||R 4 000||R 4 000||R 0||R 0|
|Long Term Savings||R 1 000||R 3 000||R 3 000||R 7 000||R 7 000|
Assuming a 5% investment return on his medium term savings, 7% on his long term savings, he can accumulate the following savings over five years (assuming no return on emergency funds):
|Accumulated savings in first 5 years working|
|Financial Plan Component||Year 1||Year 2||Year 3||Year 4||Year 5|
|Emergency Fund||R 48 000||R 48 000||R 48 000||R 48 000||R 48 000|
|Medium Term Savings||R 24 600||R 74 400||R 125 400||R 128 500||R 131 700|
|Long Term Savings||R 12 400||R 50 100||R 89 000||R 179 000||R 272 000|
Emergency fund: “The R48 000 he maintains in the emergency fund from first year onwards is more than three times his base salary of R15 000 a month. It can be increased further to six times his monthly salary,” Nzama says.
Medium term savings: These savings can build up at a slower rate than his emergency fund, but Oupa could have more than R125 000 only after three years. This is a substantial amount to buy high-cost items for cash, or place more than a 10% deposit on a R1 million rand property. After five years, he could have the same 10% deposit and some R31 000 cash to cover the high fees involved in buying property (transfer duties, bond registration fees, estate agent’s commission etc).
Long term savings: The R270 000 in Oupa’s long term savings also builds up slower than the medium term savings, but will pick up momentum as time passes. He can use this for his retirement savings or to pay for his children’s education. He could already be planning a family as he approaches the age of 30.
- This article was first published in City Press on 15 September 2013.