Like many other things, there are varied reasons why we may set aside money for future use – for retirement, buying a home or a car may be some reasons, or the educational expenses of children may be another for some others. Whatever the reason is, there is always the need to dole out money in the future and perhaps, our present cash flow may not support it. Thus, the need to put something aside towards that time. When we have been able to pile up (save) enough for the need, we may then take the money and use as intended.
How do we usually set aside money for a future date? There are two main ways- savings and investments. Both involve suppressing the right to use our own money for a period. At the end of that period, we would usually take that money and spend it. However, saving and investing have stark differences. Saving is relatively risk free. The money is kept away (from spending) and it grows (from piling up with new additions). There is little or no protection from inflation. However, it is usually available to the saver at any time. So, there is safety and ease of access to funds.
Investing, on the other hand, is quite different. It usually involves taking risk. Even when the money is invested in so-called ‘riskless’ investment assets like treasuries, there’s some element of risk. The money is kept away from being spent by the owner. Others, however, spend it on a need in return for something and pay back later, to make it worth the while of the owner (compensation, interest, return, capital gain), the investor.
So, in terms of risk, the saver can sleep easy but the investor might be anxious during the investment period. Risk is a very important factor in investing, though saving may involve some degree of risk. A cousin of mine made it a habit to toss all coins he had on him (quarters, dimes, nickels and pennies), from time to time, into a plastic jar he had placed on his dresser. It was ‘safe’ in his house, on top of the dresser for a long time and it gradually became full. It must have contained about $300 then. One day, he had a break-in while he was away from home and the jar was, as you can image rightly – it taken away. So much for safety and accessibility.
When you invest, you are supposedly allowing your money to work for you. The money is given to someone who, in turn, uses it to pay for goods and services. This earns a profit or return and the investor shares in this. Therefore, the investor makes an earning for giving out money for the period. The risk is whether the money will be paid back and on time. For this reason, the one who is going to use the money would have to assure the owner of the money of payment on time and still coax the investor with ‘something’ as reward for the risk taken.
Saving is quite difficult because there are so many competing needs. Salaried workers usually find out, sadly, that their salaries ‘can’t do much’. How do I set aside something for a rainy day when I don’t have enough? This is a common worry for almost everyone, even if the money set aside can still be accessed.
Investing is even harder. How do you start? How do you give your money out for a while, with no access to the money during that time, with the assurance that you would be compensated for doing so, when you simply don’t have enough to go by? For how long can you wait? Is the assurance of timely repayment substantive and anything to go by? What else is competing for our monies?
There are reasons why we struggle with preparing financially for the future. The needs of the future are not lost on us but we are burdened with the insufficiencies we face today. Pension is coming, when we shall still have many needs – health included – but would we have the money we would require without falling on friends or relations?
Let us examine a typical worker. He is a husband and young father of one and lives with his family in a rented residence in Accra. He earns GHS 1,000 a month and his wife, GHS 700. How do they spend this GHS1,700?
Their major monthly (strict budget) expense items are:
- GHS 200 for rent for their single bedroom home
- GHS 600 for transport and lunch at work
- GHS 150 for creche fee for their child
- GHS 500 for feeding
- GHS 200 for utilities, including gas
- GHS 100 for toiletries
Clearly, these basics are more than their salaries can support. They make-do with cost savings here and there, and unexpected gifts (money, food, rides to work or back home, etc.) from friends and relations to go through the month.
The couple realize they have nothing saved for unexpected medical expenses and other emergencies and they are living dangerously. They both appreciate that it is not working because before they get paid, they are always indebted to someone. When they get paid, the money lasts till a little over two weeks, then they are down to bare minimum.
At this point, no amount of persuasion and explanation with examples would help them to begin to save and invest. Telling this couple to ‘pay themselves a little’ or save/invest a little’ will not make sense. So how does this couple go past ‘survival’ to ‘living’?
Clearly, two things can be done to save a little of their income. Firstly, they can critically assess their expenditure and cut down ‘non-essentials’. Can TV hours be reduced to cut down on utility expenses? Can lunch be prepared at home to take away the need to pay so much for a lunch meal? Any extra money obtained can then be set aside. With consistency, this money would build up and they can begin to save or invest once they go past their emergency fund requirement. It may appear, though, that a good number of people may have already done this assessment and cut off some cash drainers.
Secondly, they need to find a way to earn extra income without having to spend too much to do so. The man decides to offer to teach. There is a private primary school close by home and he can walk there and teach mathematics on a part-time basis, just to earn a little extra. His wife, an extremely good cook, decides to prepare snack packs on order for her colleagues and others for breakfast.
After they manage to begin these extra-income ventures, they realize their monthly income secures an additional GHS 450 on average. This is a good start for the family. The supplemental income gives them the opportunity to save for emergencies and invest for tomorrow. Without this, it would in all probability, be next to impossible to invest. As they continue to build up their ‘reserves’, they would now be in a good position to consider investing for tomorrow.
We thus realize that it is critical to earn enough to save or invest. It is good to urge everyone to set aside a little, no matter how small, each month, and patiently watch it grow. However, all these will fall on deaf ears if the prospective investor barely has enough for essentials. Anyone who would go ahead to invest in such a situation would most likely request to break the investment. A good investment is often curtailed because the investor tried to set aside money needed for usually necessary living expenses.
Also, there may be no emergency fund. As the need arises, the investment is broken to allow for withdrawals to be made for an emergency situation or to finance everyday living expenses. It is much better to urge the investor to look for ways to increase income and thus have more opportunity to do other things (like to invest).
Unplanned emergencies happen to all and we must prepare financially for them. There are a few that we can envisage may happen to us, like a child falling ill or getting injured, needing immediate medical attention. These cannot be put on hold when they happen. So, we set aside some money for happenings like these. A good estimate can be made as a target amount to set aside. This should be maintained as money that is easily accessible, either as cash or safer, on a debit card.
In many jurisdictions, a financial planner would advise that the next most important thing to ‘invest’ in is a life policy. The policy will keep the holder from emptying his or her emergency fund. It can offer protection for the loved ones of the insurer in the event of accident, sickness, disability or death. It is valuable at the start but after a number of years, it becomes less valuable. However, it may be worth starting an investment plan with it. A good policy would be one that would pay back all premiums paid if you outlive the policy period. The refund can be ploughed into an investment which yields a return without endangering the principal amount; for instance, a fixed income investment.
With care, a couple who would, hitherto, struggle to make ends meet, would now be able to feel a bit more comfortable about their finances. They can survive on their earnings till the next pay cheques are received. If a little emergency happens, they can have enough to cover it without having to borrow.
That way they would have embarked on the journey to financial independence.
About the Writer
Kwadwo is a Senior Investment Analyst at OctaneDC. Prior to joining OctaneDC, he worked as the Fund Manager at Dalex Capital as well as the Research and Portfolio Manager at SEM Capital Management Limited. Kwadwo has over a decade of experience in fund management and administration, portfolio management, management consulting, operations management and process improvement. You may contact him at [email protected] or +233244563530