By Paul Nixon
In 2014, popstar Rihanna sued her accountant and financial adviser Peter Gounis, for “allowing” her to squander $9 million that nearly resulted in her bankruptcy. His quip in the media in response to the lawsuit was priceless, “Was it really necessary to tell her that if you spend money on things, you’ll end up with lots of things and no money?”
Conversely, lifelong petrol attendant, Ronald James Read, was such an ardent saver that he had accumulated a net worth of $8 million by the time he passed away at the age of 92. I often think about these two stories when I’m asked about the importance of saving one’s hard-earned money.
Saving is a fundamental part of building wealth. Even the most modest salary can build wealth for an individual who has cultivated the right saving habits, and even the highest-paying jobs can’t prevent you from going bankrupt if you don’t have a solid savings plan (looking at you, actor, Nicolas Cage).
Wealth comes from not spending on things or possessions. The premise here is that wealth is not a function of income it is a function of saving. It should also be said that there are few things as counter-productive as waiting to save until we earn more. The vast majority of people are often very surprised when they realise just how much they can save.
In light of this, the first step in creating wealth is creating “space” for saving. There is a deceptively simple rule of thumb that can help us to create this space. The 50/20/30 rule provides guidelines for our after-tax income.
No more than 50% of your income should be spent on contractual obligations (home loan, car repayments, cell phone etc.). Then, at least 20% of this income should be spent on savings. The remainder can then be spent on discretionary items like clothing, eating out or planning for holidays. Note, that “savings” is second on the list, so if you’re spending more than 50% on contractual spend, this should not be at the expense of your savings but rather your discretionary spend.
Next, it is important to consider what to do with the money that you save. Bank accounts are good for saving your money, but you should be thinking about how your money can be set aside in a way that will beat inflation. Equity-based investment vehicles can protect the buying power of your money over the long-term. Investing builds wealth and if done correctly, may supplement and eventfully replace your primary source of income.
Lastly, it helps to keep your eye on the bigger picture. Devise a goal for yourself that can keep you motivated. Whether it is for retirement or a dream home, a clear goal will help you to avoid spending and stay on track.
It is never too early to begin saving – the only real challenge is getting started. As soon as you embrace the savings mindset, you’ll be astounded at how easily you can start building real wealth.
Paul Nixon, Head of Momentum Investments Behavioural Finance
PERSONAL FINANCE