We often believe that transferring a portion of our income to a separate savings account is the most effective way to grow our wealth. However, there are pitfalls to doing this.
We consider the perils of stowing your savings away, and we look at alternatives that will enable you to arrange and apply your savings to best financial effect.
Tip: If your debt is becoming unmanageable, you should consider debt consolidation.
Money left in a savings account will decline
Imagine you’ve saved a large sum of money in your general savings account. You’ve diligently added to it, and it’s slowly grown. But should you leave it in your savings account?
According to Thomas Brennan, co-founder and CEO of Franc, the problem is that the money sitting in your bank account is doing absolutely nothing for you. In fact, he explains, it’s actually losing value due to inflation – the ever-increasing cost of living.
“Although it might look like a healthy balance now, in a year’s time it’s likely going to be worth about 5% less in real terms. In other words, the purchasing power of your bank account balance will be 5% less. This is a scary thought,” says Brennan.
He points out that, by doing this, you’re also missing out on earning any real interest on that money. Instead, you’re effectively giving it to your bank.
“To me, that’s an even scarier thought. The banks are already charging you fees to have an account, a fee when you withdraw money, and even a fee when you deposit money. The thought of giving them even more money should make you mad,” says Brennan.
Earn interest, don’t pay interest
Brennan says that in order to understand why leaving your savings in a normal bank account is problematic, it’s important to understand the basics of banking.
“Banks lend a portion of the money you deposit to other people, through home loans or personal loans for example. They then collect the interest the lenders pay on a monthly basis as revenue for the bank – and this is in addition to all the bank fees and charges,” he explains.
As an alternative, Brennan says, should you invest your money in a money market fund, you could earn this interest yourself, instead of effectively handing it over to the bank.
“By doing this, your investment will be lent out to banks and other large companies and institutions – ironic, isn’t it? Either you give the bank your interest, or the banks pay you interest,” says Brennan.
In addition to paying an interest rate that’s more than most banks’ savings accounts, money market funds are also safe and secure.
How to organise your savings
Brennan points out that, as a rule of thumb, you should keep approximately 50% of your monthly expenses - but no more than this - in your bank account. This is to ensure that you don’t go into overdraft.
You should also aim to set aside three to six months’ worth of income in a money market fund, which can act as your emergency account.
“Over and above that, you should invest for the future, for retirement or any other investment goal that’s important to you, such as a home loan deposit or a new car,” says Brennan.
He illustrates by saying that, if you spend R6,000 a month on living expenses, you don’t need more than R3,000 sitting in your bank account, and you should have an R18,000 emergency fund.
Now, he says, imagine that you're able to save an additional R10,000 during one month because you received a bonus at work.
“If you transfer this to an index-tracking equity fund that grows on average 10% annually, and you leave it alone for 10 years, you'll grow that R10,000 into R26,000,” says Brennan.
However, he explains that if you had left it in your bank account, you’d most likely be left with R10,000 in 10 years – which is R16,000 less than it could have been.
“This is why it’s so important to invest your money and not leave it lying in a bank account. You’re effectively losing money. If you’re investing for the long term, you should be choosing low-cost index-tracking equity funds that give you diversified exposure to the equity market," says Brennan.
“Don’t forget, when you invest in the stock market, diversification and a long-term horizon are key to ensuring you get the best long-term growth on offer,” he adds.
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