The other day I was talking to a younger colleague of mine and it occurred to me that young professionals today have a specific problem.
No, it isn’t that they are in debt because of expensive but relatively useless education. As it happens, my colleague and his wife have paid all their debts, managed to get together the deposit for a house and are diligently paying off their mortgage.
My colleague’s conundrum boils down to the following: this young couple have money left over after they pay off all their bills. At the moment they keep their surplus in their savings account(s) and overpay the mortgage a bit.
‘But I want to be financially independent in ten years time.’ – my colleague said – ‘if I continue saving at the present rate this will take about forty years; by then I’ll be drawing out my state pension!’
He thought for a minute – he is a very clever guy – and then said:
‘And my savings will be melting away given the current rates of interest and inflation. Just can’t win, can I.’
You know what? Many of us think like that; I know I did for a very long time. This logic leads to one conclusion:
‘If we can’t win why even try.’
In terms of building a future of abundance this logic is a real killer: you just don’t make it in the game of wealth if you think like that.
This made me ask:
‘Is saving really a virtue?’
To answer this question, let us remind ourselves why we save.
Saving simply means that we keep some of the money that flows through our lives. Generally, we do it because of one or more of the following concerns:
- Desire to ensure that our lives will continue to be nourished. This is about being able to afford relatively large items that cannot be accommodated within normal, monthly budgets. In this case, we usually save for something; we save with a particular goal in mind.
- Desire to reach a situation where our lives will be nourished without the need to earn regular income. In this case, saving is usually geared towards achieving retirements – early or timely. There is a whole movement for early retirement where saving ‘enough’ is one of its three pre-conditions (reducing costs and understanding investments and tax is the other). A sub-class of that is a drive for not depending on a salary.
- Hedging against a future failure to earn. We all know that sh*t happens and losing your job is always a possibility. In today’s economy, this is not a distant possibility – many people lose their jobs. To make matters worse, the jobs that were lost are not coming back. Freelancing is on the rise and this brings with it different ways to manage money (there always has to be something put on the side).
- Hedging against different doodads. Our lives consist mainly of uncertainties but these are not always about occurrence; many of those are about timing. Simply put this means that you can be certain you’ll need to change your roof; you only don’t know when. And when you get three leaks in your bedroom, it is better to have ready cash for the roof than to go into debt to be able to do it.
This makes sense to me; the reasons for saving are sound. I have a bit of a problem not with ‘piling up cash’; I find problematic what we do with it.
You see, there are two types of mentalities around that:
- Saving every month, building up a nest-egg for the future, for a rainy day, retirement or just putting it in a ‘safe place’. Interest is earned so that the savings grow – slowly.
In other words you are working for your money.
- Building up some initial capital, investing it and nurturing it to grow. This requires taking some risk and seeing investing as one of your jobs; as jobs go this is a fairly light touch one but still investing needs knowledge and time.
In other words you make your money work for you.
These are not mutually exclusive and investing is often a continuation of saving. Which brings us to the difference between saving and savings: the former is a process of accumulation of wealth and the latter is about where you keep your wealth.
Saving or investing? Which is it?
If you don’t have any money left over after paying your bills you can’t have savings – it’s as simple as that.
But if you budget and ensure that your income exceeds your expenditure you should look for some good deals among the myriad offerings. It is a customer’s market: recently not only banks have been offering different savings accounts options but also some ‘diversified’ providers, like the AA with their AA savings account, have been getting involved.
At the moment, the best returns are on fixed rate deals where you leave your money for a given time – you can’t withdraw it within the period for which it is fixed.
- For a 1 year lock-in, there are various deals that pay up to 1.9-2% interest.
- For a 2 year lock-in, the rates are a little better at around 2.25% such as the AA Savings Fixed Rate Account. While this is a 2 year rate, it has a £1 minimum and allows you to withdraw money in an emergency, albeit with an interest penalty.
You get even better rates for longer terms – over 3% for a 5 year lock-in for example – but you could lose out as interest rates rise back to a more normal 4 or 5%.
There are two caveats to savings:
- In the UK, the first £85,000 is ‘guaranteed’ but this limit refers to all money deposited within a banking group – be very careful here because of cross-bank ownership. And it specifically does not cover shares in banks nor, and this is crucial, banking bonds.
- Tax will be withheld by the bank which reduces a 2.25% return to 1.8%.
You could invest in a Cash ISA – an Individual Savings Account – where there is no tax to pay but there is a limit (currently £5,760 per year). Your choice but note that the best of these pay only a little more than the 2 year fixed rate after tax.
Think about it: 2% of a year’s full Cash ISA allowance is a mere £9.60 a month. You need seriously more than £5k to yield any sensible money, even when interest rates go up a bit.
Come to think of it, at these rates, ISA or no ISA, you will need a million pounds to get even a half-decent passive income.
This would take about 500 years if you just save your Cash ISA allowance – there is a lot to be said about longevity.
The alternative of course is to start an investment portfolio but that’s requires a completely different mindset; one prepared to take risks.
Saving may be a ‘good idea’ but it is never going to make you seriously wealthy unless you can save a massive proportion of your income; and your income is massive as well.
On the other hand, investing can – and does – make people wealthy. But to start investing, you have to have some money.
So back to saving – doh! So saving can be a virtue but you have to move beyond keeping your money in savings and start investing to reap the full benefits.
Are you a saver or an investor?