Many people miss out on the benefit of investing their earnings early. What can 20-somethings learn from Actuarial Analyst Christopher Smith, whose money mindset and investment strategy are paying off?
"My financially savvy father-in-law gave me my biggest wake-up call," says 25-year-old Actuarial Analyst Christopher Smith. "He said that the selected percentage of a first salary that most individuals save and spend seldom changes, even when earnings increase. Debts rise and the cost of living goes up year on year, and you seldom catch up."
Smith has worked for Discovery Invest as an actuarial analyst for almost three years. Studying Actuarial Science gave him an understanding of various asset classes and their associated risk and return profiles, as well as the different investment vehicles available to investors.
"When I started doing projections for Discovery Invest clients and analysing retirement statistics, I realised how underfunded most individuals are," Smith explains. "That made me even more determined to invest my money wisely."
Investing is one of the key methods to keep up with inflation, which eats at your wealth every year, he says. "Yet many people - young and old - don't understand the financial sector and investment vehicles. When people don't understand something, they're open to being exploited."
Good cover is essential
For Smith, being financially savvy starts with good cover, including life cover.
Younger people may not have a mortgage or car to pay off so they think they don't need life cover. "They don't understand the value of the cover within life insurance products, such as life cover, cover for disability and severe illness, as well as protection against loss of income," Smith explains.
"The value of cover is in the peace of mind attached to it - the idea that if something happens to me, my wife will be taken care of. Or, if I become disabled at age 25 and can't work for the rest of my life, I will be okay."
From birthday money to bigger money
Smith didn't have a great investment culture growing up, neither did he grow up being taught to save. "My first savings account was for birthday money. I used it all as soon as I got to university."
Purely mathematically speaking, saving from as young an age as possible makes the biggest difference in the world to your money's growth.
Smith has friends who save R50 to R100 every month for their children, giving them 21 years of savings by the time they finish varsity. "A really good option for investing these savings is a tax-free savings account."
Investing with a Discovery Endowment Plan
"Equities are volatile in the short-term, so my investment outlook is long-term, a minimum of five years," says Smith, who was 22 years old when he invested in earnest for the first time.
"I didn't have a lump sum to invest, as I had just started working. My first investment was in a Discovery Endowment Plan, a type of product where the underlying funds are invested in unit trusts. I'd just started working and wanted to start some medium-term saving, so I looked at the Discovery Endowment Plan with a buy-and-hold type strategy."
Like most people, Smith was accustomed to accessing his funds whenever he needed or wanted anything. This investment helped impose discipline: you're allowed one withdrawal in the first five years, up to a maximum limit. Funds can then only be accessed again after the first five years. Smith made his one withdrawal to buy an engagement ring.
The more you contribute, the more you earn on your investment over time due to compound growth. He started by saving R1,000 a month, increased at 20% per year and is now contributing R1,440 a month. Over time, he has seen fair growth.
"My endowment is invested 60% in offshore equities and 40% in local equities and property," explains Smith.
The fact that Smith also owns a Discovery Life Plan results in fund-management fees of 2-3% per annum reducing to around 0.5% per annum. "That's usually what you pay for an investment without a fund manager involved," he explains.
Smith's 75% discount is also linked to his Discovery Vitality status (Diamond), rewarding him for choosing a healthy lifestyle. "Discovery's discounts make it the most cost-efficient in the market for the exposure that I get."
Unit trusts remain stable over time
Smith has also invested in a unit trust - a bonds-based fund.
"Bonds are like loans," he explains. "Bonds work along the lines of 'I give you R100 and in a year you give me R110 back' Companies loan money through issuing bonds on a large scale and they pay interest to the investor in return. Bonds give you a good return in line with inflation plus a little more. While possibly volatile over a day or two, they remain stable in the medium and long term."
Smith and his wife use this investment as a short-term savings account. "It's in line with the idea of 'dual income no kids'" he explains. "Together, we put in R2,000 a month, so R24,000 in a year. We rent a small place and keep our cost of living low so as to save more. This year we're going to Italy with the money we've saved through the unit trust. Your returns are better than you would earn on the money market and you can still access the money at will."
Smith has a further investment, also in a unit trust, but with 100% equities. "I pay 0.8% fees and contribute around R500 a month. This is more for long-term savings."
Keeping tabs on spending
He adds that a smartphone app stops the couple from impulse-buying. "We keep track of our budget so that we get a red flag on over-spending to warn us to slow down halfway through month if we have to."
Lastly, he adds that a culture of saving represents a massive mentality shift that most individuals his age aren't willing to make or don't understand. "Saving doesn't get easier. While my salary has almost doubled over time, my investments haven't increased commensurately. You have to start strong."
- Bonds: A bond is a debt security, similar to an IOU. Borrowers issue bonds to raise money from investors willing to lend them money for a certain amount of time. When you buy a bond, you're lending to the issuer, which may be a government, municipality, or corporation.
- Disability insurance: A plan that provides for a lump-sum payment when you're unable to work due to disability.
- Diversification: An investment fund that contains a wide array of asset classes to reduce the amount of risk in the portfolio. Actively maintaining diversification prevents events that affect one sector from affecting an entire portfolio, making large losses less likely.
- Endowment: A type of investment vehicle where tax is charged at an average tax rate of 30%, rather than the individual's marginal tax rate, but restricting the individual to hold the investment for at least five years.
- Equities: Equities are stocks - shares in a company. If you buy stocks, you're buying equities. You may also get "equity" when you join a new company as an employee. That means you're a partial owner, or can be, of shares in your company.
- Fund manager: An employee or department of a large institution (such as a bank, pension fund or insurance company) that manages the investment of money on its own behalf or on that of an outside client.
- Group risk: Part of an Employee Benefits Programme, it's group life insurance.
- Critical illness/dread disease cover: A policy in which an insurer pays a lump sum cash payment if a policyholder is diagnosed with one of the specific illnesses on a predetermined list.
- Income protector insurance: An insurance policy paying benefits to policy holders who are unable to work due to illness or accident.
- Life policy: A contract between insurance policyholder and insurer. In exchange for a monthly premium, the insurer pays out a sum of money to a designated beneficiary upon the death of the policyholder.
- Money market: An interest-bearing account that provides a higher interest rate than a savings account.
- Provident fund: A form of social safety net - employees contribute a portion of their salaries and employers contribute on behalf of their staff too. The money in the fund is then paid out to retirees, or in some cases to the disabled who cannot work.
- Pension fund/retirement annuity: An insurance product that pays out income, and can be used as part of a retirement strategy. Annuities are a popular choice for investors who want to receive a steady income stream in retirement. Retirement annuities help you to plan for retirement through tax-free growth. Tax is offset when you withdraw the money or when the retirement annuity is invested to give you an income at retirement. The sooner you start saving for one, the greater your capital will be in later years.
On the back of National Savings Month in South Africa, a recent report from the World Economic Forum (WEF) highlights the startling gaps between financial needs in retirement and what consumers are actually saving.
The thrill of earning your first salary is huge. But not everyone manages to get their money to cover their expenses and to provide for a rainy day. Two things are really important here ? becoming financially literate, and making and sticking to a budget.