Savings refer to any disposable income not spent on consumption and is aimed at securing future needs, both short and long-term. Rather than save what is left of your income after deducting expenses, it is more prudent to first deduct a set savings amount from your income and only spend what is left after saving i.e. “Pay yourself first.”People save for various reasons:
a) Emergencies: These could be any number of things: an emergency expense for the house, medical expenses, or sudden unemployment and loss of income
b) Education: With expensive education for children, it is important to save and plan ahead
c) Retirement: As you retire someday, savings will have to take the place of regular income
d) Social Security: Social Security was never intended to be the primary source of income and is only a supplement
Positive savings can help one achieve both current and future financial goals. At the very minimum, the basic rule of thumb is to save at least 6 months of living expenses to cater for any emergency.
Five Key things to note while saving and investing:
1. Make a budget: A budget is an estimate of the incomes and expenses for a set period. A budget gives you control over your money, saves the stress of suddenly having to adjust due to reduced income, and allows you to gauge how much you can save each week or month. Additionally, a budget aids in deciding which short-term expenditure to sacrifice in order to enjoy long-term benefits like a comfortable retirement.
2. Pay yourself first: Saving should not be viewed as what is left after current needs and wants have been satisfied. “Pay yourself first” is an effective savings strategy that entails first saving a portion of the money earned, e.g. 20% of net income, before spending on consumption. To successfully practice the “pay yourself first” strategy, one should set personal goals as you can focus on what you will be able to do once you’ve reached your goal rather than what you are saving;
3. Do not take unnecessary risk: Understand all the inherent risks in savings products. Ideally, savings should be invested in the highest returning assets, on a risk-adjusted basis;
4. Allow time to work for you: The concept of time value of money is important. The more time an individual has to save and invest, the more they end up with in the long run since money invested is compounded.Compounding occurs when the interest you earn is added to the balance in your account, creating a larger base upon which future contributions and interest can grow. So it can be a powerful force, especially over long periods of time. It’s probably why Albert Einstein once said, “compounding is the most powerful force in the universe”;
5. Diversify: Never put all your eggs in one basket. Spread your money between different kinds of savings products to help reduce the overall risk, as no investment product performs well all the time.
Where Can Money Be Saved?
In Kenya, there are a range of saving options and products, which can be broadly categorized into:
Deposit Accounts: These are accounts held by banks and earn interest on the amounts deposited. They can either be savings or fixed deposit accounts. The risk profile is low since the returns are guaranteed. However, a downside exists in that your money’s buying power is eroded over time if inflation is higher than the interest rates paid, which is the typical situation with most deposits.
Financial Markets Instruments: This refers to investments in shares of listed companies in fixed income securities such as Treasury bills and bonds. Stocks are suitable for long-term investors due to the volatile nature of the market and since the returns are not guaranteed, stocks have a higher risk profile. Fixed income securities are suitable for short to medium-term investors, and are not as volatile as stocks. Fixed income securities offer issuer-guaranteed returns hence have a lower risk profile.
Collective Investment Schemes (Pooled funds): These are schemes such as unit trusts and mutual funds, made up of a pool of funds collected from many investors for the purpose of investing in stocks, bonds, real estate and private equity, among others.
Structured / Private Solutions: These are usually saving solutions such as Structured Notes and Cash Management Solution (“CMS”) which are packaged by investment professionals, typically tailor made for the investor to enable investors access pockets of returns in the market that are not readily accessible through traditional investment avenues such as stocks, bonds and bank deposits. Structured products are relatively more complex, but they also offer higher returns relative to traditional products.
By Shiv Annop Arora
Investment Associate : Cytonn Investments