I was always taught in relation to saving and investing that it is not the amount that counts, it’s where you put it – it’s allocation. Time is an investor’s best friend, and understanding the power of compounding interest, and other minor tricks can be the difference in turning a little into a lot. The median wage in NZ when annualized ends up being about $49,900, take away student loan payments and Kiwisaver, add rising rents, potential other debt (credit cards, HP’s, etc.), and this can be a heavy load to carry for an individual already, let alone trying to spare cash for savings and investments – which in many cases, the low risk ones such as bank savings rates aren’t even keeping up with inflation! What do you do?
Financial planning and your prudence around this topic will be the key in getting ahead, particularly if you are younger and have time on your side. Beginning with a suitable budget and planning the use for your net income is important. Looking at your gross-income is utterly useless in this scenario, as you can only invest what ends up in your hand. One method that seems to work well is treating your savings as your most important expense. This means that from your net income, you pay yourself first (usually a portion such as 10% of everything you earn), and then distribute the balance to your expenses. Wealthy individuals invest first, and then spend what’s left; it is the poor who spend first and then invest what’s left – a simple change in strategy can be the difference between poverty and wealth. Aside from this you should also have an emergency fund, which is where you dig into if unforeseen expenses arise – there is no use having a savings if you dip into it for everything unexpected. Lastly, after savings/emergency funds have been allocated for, expenses then incurred, you will have your new discretionary income figure. This is what you can use to spend on yourself. If this figure seems to small, it might be worth considering if you can cut down on your expenses (note: you don’t want to be cutting down on your savings).
Savings & Debt Management
Savings, and the management of debt can be in some instances, the same thing. You are in effect, saving yourself money if you are managing your debt efficiently.
If you have various forms of debt, you want to be allocating as much of your capital to the one with the highest interest rate, and having the minimum possible payments being made to those with lower interest rates. Once each high interest liability is repaid, attribute the same amount of income to the next highest, and so on, so you maintain the same repayment amount the entire time (or at least no less than) and end up creating a snowball effect. Once you have closed these ‘bad debts’ such as personal loans and credit cards, don’t get them again. Understand your own nature in this scenario, if you aren’t good with this, it’s unlikely you will change – accept this fact and find ways to delay your own gratification.
Many people spend more than what they earn, which gives them no hope of making any sort of advancements in their net worth. A quote I once heard goes as follows: “If your outgoings exceed your income, eventually your upkeep will become your downfall.”
If you still find yourself in a tight position after doing the above exercises, it may be worth considering earning a secondary source of income, particularly if you are overloaded with debt and need assistance in getting this out of the way. It may be short-term, but the additional income can definitely save you lots of money – because just like how interest works for you when investing, in most cases it works against you when borrowing.
One thing worth doing is seeing if you can re-negotiate the rates on your existing debts – all of them, from consumer finance to mortgages. Minor interest rate savings can mean significant savings in real dollars. If your lenders aren’t willing to work with you, consider the costs of refinancing to another.
Setting goals is the key to success, it’s as simple as that. If you don’t know where you’re going, you can surely never arrive. In terms of investing, it is likely your goal will be related to a net-worth figure. Due to this, it is important you create a balance sheet which totals all of your assets and liabilities, you then subject your liabilities from your assets and this is your net worth, or your equity position.
Your net worth is increased by reducing your liabilities, and increasing your assets – so don’t be discouraged if you aren’t immediately accumulating assets, provided you’re reducing your debts.
The key to achieving a high net worth is starting early. The power of compounding interest cannot be overstated – Einstein called it the 8th wonder of the world. For example, if you invested just $200 per month at 7% for 50 years, you would have $1,000,000!
The key in investing is understanding that patience is key, and that success isn’t reserved for those with high incomes. What you will often find is that many fortunes have been created by modest means, and patience and discipline are the real keys to success here.