Can you save too much?
It sounds like a silly question at first. How could it be possible to save too much money?
While it is a great feeling to be debt-free with money in the bank, there comes a point where hoarding money causes you to miss out on the opportunity to put your money to work.
After all, “having your money work for you instead of you having to work for your money” is the reason for investing.
So how much money should you save? Not surprisingly, the answer is different for everybody because everyone’s circumstances are different.
Most people I meet can’t survive for a month without income, particularly those in the home-building, children-raising phase of their life. Mortgage, credit cards, personal loans, work, school and household expenses must be met before the real living starts; regardless of income level.
So a good guide would be to reduce debt and save enough so that you can do without income for at least 6 months, and even more. This will provide you with a buffer of protection against some of life’s sucker punches.
Also don’t forget that, to the extent that you can reduce debt and remove loan and credit card repayments from your monthly expenses, the less you will need to save to achieve your safety buffer. Of course, the irony here is that the more debt you have the more buffer you need; whereas the less debt you have, the easier it is to save. (Mmmm … isn’t debt a drag?)
So once you have achieved your target savings buffer, the question is what to do next?
The next step is investment. Consider taking advantage of the power of compounding returns; the most fundamental element in the building wealth process. In simple terms, it means ‘money making more money’.
If you have a conservative approach to risk and you feel more comfortable saving your money in a bank account or term deposit, you effectively become a money lender. You lend your money to the bank, in return for interest income. At the moment, that return is quite low; and many times lower than the interest percentage that you would pay if you borrowed from the bank. However, unlike a true investment, there is no growth return available because your original capital remains fixed. In other words, you are always guaranteed to get your original savings back (no more, no less) at any time.
On the other hand, when you invest your money, you have the opportunity to earn two types of return; (a) an income return and (b) a growth return. A common example is a share investment where the dividend is the income return and an increase in share price is the growth return. So not only do you have the opportunity to earn income and have it reinvested in more share capital, you are also expecting your original invested amount to grow in value also. An increase in your invested capital generally means an increase in the income earned by your capital. As the value of your investment grows, so does the income it earns. Hence the concept of compounding returns.
Of course, it all seems rosy until you realise that growth return can also be negative. This occurs when (in this example) the share price drops. Less capital generally earns less income and this is precisely what happens in a market downturn. I am not trying to put you off investing. Quite the opposite. Everyone needs some level of income earning growth assets (e.g. shares, managed funds, property) in their lives. The question is how much?
Even if you think you don’t have growth assets in your life, take a look at your work superannuation. Most people have managed funds as the investments underlying their super. So it is a question of how much to invest and into what? It is vital that you put your investment portfolio together in a way that you feel very comfortable with the level of investment risk you are taking.
Two final points on portfolio and risk. Firstly, my use of the word portfolio suggests a range of investment rather than putting all your eggs in one basket. Secondly, in order to understand the risk you are taking, you must first understand exactly what you are investing in.
If you need some guidance, give me a call on 0408 756 531.
Happy saving and investing