Saving is often very much at the back of any young, recently employed person’s mind, and we know unemployment among young people is high. In fact, that is an understatement – it is frighteningly high, with the official figure for young people at roughly just over 50%, which will probably be exacerbated by the economic climate we currently find ourselves in. Therefore, landing that first job is an achievement in itself! Rightfully it is a cause for celebration. But beware, do not throw caution to the wind. If a person wants to celebrate by showing off their new-found financial independence by indulging in elaborate purchases such as expensive clothes, phones, perfume or cologne and that very first car, they might want to think twice. Some short-term debt in the form of clothing accounts, credit cards or vehicle financing usually accompanies most of these purchases.
While some celebration is certainly warranted, now is the time they should start saving even more than at any other point in your life. This is very much because of the magic of compounding interest Let’s look at a hypothetical example of two people who recently started their very first job.
Jessica, 25, recently started her first job and cannot wait for her first pay cheque. However, she recently read about the many South Africans who cannot afford to retire. So, she decided to visit a financial advisor who advised her to start saving R1,000 per month in a tax-efficient investment such as a Retirement Annuity, or a Tax-Free Savings Account. While it represents quite a big chunk of her current salary, she is satisfied and feels empowered as she is taking control of her future financial independence. She continues saving R1,000 diligently for the next 10 years. But due to unforeseen circumstances, she must stop the monthly contribution. However, the investment continues to grow and generate returns.
John, who graduated with Jessica, was also lucky enough to land his first job, right after graduation. He, however, enjoys the smell of new cars and has had four different, fairly expensive cars over the last 10 years and likes wearing expensive clothes. At age 35, and married, he decides to engage the services of a financial advisor, who subsequently advises him to seriously start saving for his retirement as he has not yet made any arrangements for his retirement. Due to his very expensive lifestyle, he can afford to save only R1,000 monthly and decides, based on the advice of his financial advisor, to also take out a Retirement Annuity and a Tax-Free Savings Account. His decision to approach a financial adviser was a clever move and he continued saving his R1,000 over the next 25 years until he eventually retired at age 60.
The above example is clearly hypothetical and saving R1,000 per month is not enough, but will suffice for the purposes of illustration. Assuming that both Jessica and John’s investment grew on average at 10% per year. Who do you think had the largest sum of money at age 60? You might be surprised to learn that it is in fact Jessica, who contributed only R120 000 in total (R1,000 X 12 months X 10 years), who had the larger sum of money and not John, who contributed almost three times more: R300 000 (R1,000 X 12 months X 25 years).
How is this possible? The answer lies in compound interest as mentioned above. Albert Einstein apparently referred to this phenomenon as the eighth wonder of the world. Those who understand it, earn it, just as Jessica did, and those who do not understand it, pay it. The beauty of compound interest is that it works for you. For instance, if you invest R1,000 in year one and are able to realize a return of 10% in that year, after the first year your investment will be worth R1,100 (R1,000 plus the R100 return achieved). During year two, you will not only earn a return on the original R1,000, but also on the R100 that you made during year one.
The longer the period of time compound interest has to work its magic, the better, so the sooner you start saving, the better. Therefore, the mere fact that Jessica started saving so much earlier allowed her investment returns to start working for her and by year seven, the return she was receiving was already matching her contribution, i.e. R1,000. By the time she stopped contributing to her retirement annuity, her investment was delivering an estimated return of R1,698 per month, which exceeds the monthly contribution, and this is the reason why John could never catch up with her. Therefore, at the age of 60 Jessica had an amount of R2,478,228 saved, while John had only R1,338,890 saved.
Remember that you are always welcome to invite your children to partake in any meeting you may have with Resolute Wealth Management, whether it be a review or a client presentation, or our advisors are more than happy to meet with your children on a 1 to 1 basis in order to assist them with putting a financial plan in Place.