When people think of savings, what might come to mind is putting money under your mattress, in a shoebox, buying things at a discounted price “a bargain” or simply by leaving money in a bank account.
The true meaning of savings is putting money aside on a regular basis for a future need.
Saving is making provision for short-term needs or goals such as an emergency fund, paying off debt, purchasing livestock, holidays or any upcoming expenses within the near future.
Due to the fact the saving is meant to cater for short-term needs, one would normally not expect to invest in anything risky, which just means the risk of losing money at any given time should be low. Losing money could derail or prevent you from meeting your short-term needs, thus the risk taken with such money should be kept to a minimum. High risk normally means high reward, thus one should not expect to accumulate massive growth for a short term need. The savings goal for some is to ensure that the capital invested can at least be persevered, while still gaining slightly on top of that. So instead of expecting high investment returns or interest, focus more on slow and steady growth.
Nevertheless, when you really need your money to grow, the next level that is called investing. Investing is basically putting your money into an asset, with the hope and intentions of it growing or appreciating into a larger sum of money.
First you need to set money aside on a regular basis (as with savings), monthly, but with more medium to long term goals in mind. This can be anything from investing in future education, purchasing or paying off a house, and for retirement. The risk associated with investing should normally be higher than savings, to help increase the chances of meeting your future goals. This risk simply means that there is the possibility of losing some or all your money, however the investment specialists are meant to reduce the likelihood of losses as far as possible but also look for the highest possible growth or interest within reason and their proposed outcome. The risk taken is calculated, and the aim to construct an investment in such a way that investors could experience volatility, periods of ups and down in the investment value, however over time the growth trend would be upwards.
There are different levels of risk that have related returns and generally the higher the expected returns mean the higher the risk. The main aim of investing is to grow your money above inflation over the medium to long term and assist in achieving financial goals over the medium to long term.
Why is growth important and how does it work?
Above we spoke of the difference between saving and investing, meanwhile the two still have something in common, and that is to grow your money.
Investment growth can be growth on capital, interest earned or the appreciation in value of your investment over time, also known as investment returns.
Interest is earned and measured in different ways, based upon the investment option selected.
Simple interest is the interest earned on your capital amount, as per the example;
- if N$10 000 capital invested (once-off amount) earns simple interest of 8% per year for 5 years = N$14 000.
Compound interest is where interest is earned on both capital and the interest:
- if N$10 000 capital invested earned 8% per year compounded annually for 5 years, you will have = N$14 693.
From the above example, one can see that compound interest provides you with higher returns over time, and most investment options today offer you compound interest.
Now let’s look at investing N$100 per month, every month for 5 years that grows at 8% per year:
From the table above, if you invest only N$100 per month for 10 years in a balanced fund (moderate risk), the money could grow to N$18 128. This means that saving N$100 per month would amount to N$12 000 after 10 years (capital), and the N$6 128.32 would be the growth of the investment. In 10 years, your growth is just over half the value of the total capital invested at 8% growth, but over 20 years you see that your interest is much higher than the capital invested. Now look at the 30-year end value of N$141 761.32 on N$100 per month, now this truly shows the power of compound interest!
This next table shows the same principle, but with N$200 invested instead. IF you invested N$100 per month for 20 years at 8% equals N$57 226, you would have more money than someone who invested N$200 per month for 10 years at 8% growth equals N$36 256.64. The assumption is that if you invest double over half the time, you might end up with the same end value. The above tables illustrate again that this is not the case.
The principle learnt for this comparison is that time is the biggest factor when it comes to investing, as this allows interest compounded annually to work for you.
The above graph shows N$100, N$200 and N$500, invested per month for 30 years at 8% growth. The most common way people invest for this long is via pension or provident funds, retirement annuities, unit trust funds or endowments just to mention a few. Imagine, that N$500 invested per month equals N$180 000 in capital over 30 years, while the interest earned is over N$528 806. The total end value would be N$708,807. If you earned the same 8% per annum on N$1,000 invested monthly for 30 years, you would have over N$1.4 million dollars.
The 8% return is merely an example for illustrative purposes, this will differ in accordance to the investment option take. Note that investment returns in the past are not an indication of future returns.
The good news is you can also achieve similar to the above scenarios or better but simply just taking your time and allowing your investments to grow.
To conclude, one should always be clear on what your goals are for both the short term and the long term and find suitable options to match that outcome. To achieve higher returns, one must take on more risk and understand what that means.
Invest longer, and don’t be too concerned about volatility for longer dated investments, because it’s all about time! You can invest double or triple the money like the examples, but it’s very evident that it becomes very difficult to keep up with someone who invests longer.
As Albert Einstein stated, “compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn't, pays it".