The importance of good saving habits
As we emerge from the stringent lockdown restrictions of the past 100 plus days, many of us are now facing a world that looks quite different from what we were used to merely months ago. For many of us, things have changed drastically, especially financially. With July being “National Savings Month” in South Africa, it is perhaps time to pause and dwell a bit on the topic of savings.
Countless individuals have been faced with and/or might still face retrenchment, having to take unpaid leave, drastic salary cuts or the possibility of losing their business. This reality hits home hard. Due to the unforeseen and devastating aftermath of the Covid-19 pandemic, many individuals have been forced to tap into their savings. The current circumstances have made people acutely aware of how important it is to have an emergency fund and/or contingency plan.
With this in mind, let’s unpack the famous words of the well-known investor, Howard Marks: “you can’t predict but you can prepare”.
Prediction is a fool’s game
The first point to highlight is that trying to predict the market is fool’s game, however, it is human nature to try to find comfort in some sort of prediction of an outcome. This is because humans like to think they know what is going to happen next.
Using a very simple mathematical example, the below equation illustrates how the odds are against you when trying to predict an outcome. Firstly, you have to predict the event correctly, and secondly, you have to predict how the market will react as a result of the event. If you don’t get both right you won’t be able to capitalize on the opportunity. Let’s say you are exceptionally good at predicting and you get it right 70% of the time, the odds are still the same as flipping a coin.
Probability of predicting the event correctly x Probability of predicting the market’s reaction correctly
= 70% * 70%
= 49% (same odds as flipping a coin)
The table below details two examples of recent events that an investor could have predicted accurately, but most people got the second prediction – how the markets will react – wrong.
As we reflect on the events of the past couple of months, one thing is certain: it was impossible to predict the events that have unfolded this year and the resulted reaction of markets, governments and economies.
The only thing we can do is to do our best to prepare for times like these.
Preparing for the unknown
In a world filled with randomness and uncertainty a far better strategy than to prepare for the unknown is to focus on the known. What is known is that there are three primary drivers of results in life:
1) Your luck (randomness).
2) Your strategy (choices).
3) Your actions (habits).
Only two of these three drivers are within your control – your strategy and your actions. By focusing your efforts on your choices and habits, you take ownership of your finances, instead of leaving it up to chance.
The best way to prepare for these unknown and unprecedented times is to build up a nest egg. The most obvious way of doing this is by saving and taking advantage of the power of compounding.
In the words of Warren Buffett – “Do not save what is left after spending but spend what is left after saving”. Unfortunately, many investors tend to spend first and save what is left. Often these investors also make the mistake of not saving the little that is left, as they believe it won’t make a difference.
In January 2020, Victoria Reuvers, managing director of Morningstar Investment Management South Africa wrote an article in which she shows that anyone has the ability to become a millionaire. What it requires are two simple, but not easy, habits – firstly, start and stick to the habit of saving and secondly, be patient. Most investors’ path to becoming a millionaire is not by investing in the next big thing and making a quick buck overnight. For most of us, it is about building good habits and being disciplined when it comes to saving – even if it is just R200 a month.
We encourage investors to use July as an opportunity to re-think their budget, savings and spending habits and encourage their children to practice good habits from a young age. Think about a good savings habit like brushing your teeth. Twice a day for two minutes is all it takes, and although it may not feel like a big action at the time, the long-term positive effects are enormous. The problem when you don’t do it is that you only see the damage your poor habits have caused after a long period of time.
Some practical ideas to start saving
In South Africa, you can save R36,000 per annum in a tax-free savings account, and a maximum of R500,000 over a lifetime. This is probably the easiest vehicle to ensure you get the benefit of investment returns without the concern of a tax bill at the end of the financial year. Another effortless way to save is to set up a monthly debit order to an investment account. Not only do you then save first and spend after saving, but you also have the option to increase this amount annually and/or make lump sum contributions as well.
Other tips to start saving money every month:
- Assess what you are paying in bank charges and if you are using all the additional services. You can perhaps switch to a cheaper offering.
- Contact your insurance provider to re-negotiate your monthly premium.
- Cancel any memberships that you don’t use.
- To save electricity consider replacing all your lightbulbs in the house with energy-efficient ones and use gas appliances where possible.
- Reduce discretionary spend: Try to buy clothes, furniture, appliances and other discretionary items only when they go on sale and don’t buy these items on credit.
- Buying groceries in bulk can greatly reduce your grocery bill.
- When going on holiday, shop around for special deals on flights and accommodation and search for discount coupons in the area that you are visiting.
These are just a few examples and there are many more ways to save a couple of Rand every month. Don’t ever think that it is too little to have an impact. There is a lot of power in compounding value.
In unusual times like these, investors might feel vulnerable and powerless. But it is often during times like these that we should try to form new healthy habits and leave behind bad habits. Let’s try to kick the practice of trying to predict everything and kickstart the habit of saving, even if only in small increments.
Debra Slabber, CFA®
Business Development Manager
Morningstar Investment Management South Africa
This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.
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The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.