For all of us financial freedom seems an insurmountable challenge. How can I ever become free of the things that I need that I have to fund with large loans – such as a home, a car and an education. Add to this the high general cost of living and it seems that financial freedom will never be possible. A few practical steps will possibly assist with this journey.
It seems like a cliché but you must save.
The general recommendation is that a minimum of 10% of your take home pay must end up in a place where you cannot spend it. This is even if you owe other people money. A study has shown that people that save 30% of their income are more likely to become multi-millionaires. If we take the simple case of someone that earns R 7000 and 10% of their incomes gets saved at 5% annually. This leads to a nice R 47,000 after 5 years. What has been found however is that people that have this discipline tends to save more and in time get higher returns as they become more aware of expenditure and investment options.
Once you start putting money towards a goal then you start to build up capital. An important principle here is that capital should never be its own master – it must always have a purpose. If you are clear on the purpose that you need money for – it becomes a lot easier to justify the sacrifices that you are making towards that purpose.
As your money starts accumulating you will be able to start investing.
There is a model that says that you need to diversify your risk and start building a portfolio of investments.
Please always speak to a financial advisor as the below is not financial advice – but rather serves as a guideline for having a conversation with your financial advisor. A financial advisor may have the necessary training to analyse your needs – but information is provided to outline some directions for your thinking.
Cash
Cash is a good investment but the problem is inflation and tax. Make sure that if you invest in cash through e.g. money market accounts that you get good interest rates, low fees and that your investment is protected.
Positive
Usually the contribution that you make – i.e. the capital is guaranteed.
Cash is very easy to draw. If you lose your job and need some food or rent, your cash reserves can quickly be converted to satisfy whatever need is at hand. Savings can be converted to cash in hand fairly easy.
Bad
Cash becomes less valuable over time. So you interest rate needs to be higher than the inflation rate.
Historically, cash has earned the lowest returns of the major asset classes.
Risk/Reward trade-off
Risk = Low
Reward = Low
How to invest
Open a savings account
Overpay on your credit card (build a positive balance)
Open a money market account (usually requires a minimum balance)
Time horizon
Cash is useful over any time frame, but you are likely to get poor slowly if you hold excessive amounts over the long term. You need more interesting investment options to achieve most financial goals.
Bonds
Government retail bonds are tools that pay you a regular income according to a coupon rate. By investing your money with the government through bonds you create the opportunity to earn a stable income as the conventional wisdom is that governments do not default on their bonds.
Good
Government bonds are much less volatile than equities.
Historically, they’ve provided a better return than cash.
A lack of correlation with equities makes government bonds a useful way to protect yourself against stock market crashes.
Bad
Bond returns historically lag equities.
They are vulnerable to inflation (unless you choose index-linked varieties) and changes in interest rates.
Many investors struggle to understand bonds.
Risk/Reward trade-off
Risk = Lower than equities, higher than cash
Reward = Lower than equities, higher than cash
Time horizon You can match your bond holdings to any time horizon and know exactly what your return will be, if you hold the bonds until maturity. You may have to lock up your money for 1, 2 or 3 years to get good returns.
How to invest
In South Africa you can visit www.rsaretailbonds.gov.za or speak to a financial advisor on options to invest in bonds.
Most banks also have information on investing in bonds.
Shares
Shares (commonly known as equity or shares) are historically the riskiest and best rewarded of our main asset classes.
Because equities can go up and down, investors demand high potential rewards to play the game. Note that word: potential. There is no guarantee that equities will deliver; they do not provide a guarantee of income or capital. Instead, they offer part-ownership of a company and thus a claim on its future earnings.
Good
Equities have traditionally outperformed every other asset class when it comes to long-term returns. They are the most powerful asset class in your diversified portfolio.
Equities are capable of outstripping inflation.
The longer you hold equities, the better your chance of achieving your financial goals.
Bad
Severe losses can occur at any time and frequently do. You could easily lose 30% of your capital in a single year.
Losses can be very long-lasting.
The highs and lows of equity ownership can feed all kinds of irrational behaviour, from panic-selling in the face of loss to piling into a bubble market. Fear and greed rule.
Risk/Reward trade-off
Risk = Higher than bonds, property or cash
Reward = Higher than bonds, property or cash
Time horizon
The longer you can hold the better. Five years is the bare minimum, 20 years is a more comfortable stretch.
How to invest
Get a stock broker
Buy some stocks and sell them later – until you get an understanding of how this all works
Your own business
Even riskier than shares, but far more rewarding is starting your own business. Investing in yourself and your ability to take an idea and turn it into a mega empire is not for everyone – but those that do it will testify that there is no better way to make money.
Good
You are in control of your financial destiny
Your dreams and passion can be expressed
You create employment, financial freedom and growth
Bad
There is significant personal and emotional risk attached to starting a business
Risk/Reward trade-off
Risk = Higher than any other investment
Reward = Higher than any other investment
Time horizon
Most businesses that survive reach initial maturity after 10 years and start yielding exceptional returns only after 20 years.
How to do it
Get a product
Get a market
Sell !
Start employing others to do aspects of your business
Market !
Expand slowly according to what your customers want while sticking to your core business at all times.
Property
As an investment asset class, property (or real estate) refers to commercial property that delivers returns in the shape of rent and the appreciation of building values. It doesn’t refer to your house.
Exposure to commercial property is generally achieved through real-estate investment trusts (REITS) or ETFs. Sticking all your money in a ‘buy-to-let’ concentrates rather than diversifies your holdings.
Good
Historically, the risk and rewards of property have been a halfway house between equities and bonds.
It can be a useful diversifier, as global property returns have demonstrated a moderately low correlation to UK equity.
Property is also likely to keep pace with the rate of inflation.
Bad
Property bubbles can pop and inflict large losses on funds.
Property is illiquid, which can lead to funds imposing exit restrictions on investors during periods of market stress. In other words, they can’t sell their buildings quickly if everyone wants their money back at the double.
Investors tend to have a rose-tinted view of property due to the strength of the home market over the last 20 years. However the asset class has historically lagged equities.
Risk/Reward trade-off
Risk = Higher than bonds or cash, but lower than equities
Reward = Higher than bonds or cash, but lower than equities
Time horizon: 20 to 30 years.
For most of us these are some of the options. There is also a potential to invest in
- Commodities
- Exchange Traded Funds
- Derivatives
- Foreign exchange
- And a million other financial products.
- The cost of entering the investment
- The costs you incur while being part of the investment
- The cost of exiting the investment
- The return that is promised and the risk attached to that
- The return after costs
- The ability to exit an investment
Always negotiate the rates
Be careful not to borrow money at higher rates that you receive returns
There is no get rich quick scheme. You need to start by putting money to work to make you more money. Hard work, focus and purpose will still determine the winners and the people that will make the most of money in the long term. To make investments work you need to spend time to understand the different options that you have and take small steps to a bigger picture. If you start working towards your financial freedom you will achieve it.
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