Last week we discussed the ultimate savings goal - financial independence. While all of us want to be able to stop working at some point, getting there is much harder than saving towards a short-term goal.
The amount of money we need to be financially independent is so huge that saving it takes years for most people. Once you add time to money, the inflation monster starts to feed. Its favourite meal is your money. To fight this dreadful beast, you need to invest so your money can grow at a faster rate than inflation can eat it. Most investors concern themselves with finding the ultimate mix of asset classes and investment instruments to achieve this goal.
This all seems very complicated, but there are only four things that can stand in the way of your success. Luckily they can all be overcome if you understand them. Even better, they are all really easy to understand.
You don’t have enough time
As we discussed before, the main ingredient for compounding is time, not money. Even a small amount of money saved in the right way for long enough can turn into a big sum. The mistake most of us make is to put off savings until we “earn more money”. The longer we kick the can down the road, the harder we have to work to catch up. When it comes to long-term savings, don’t worry about how much money you have. Your biggest concern is time. The more time you have, the less money you need to save.
Your cost of living is too high
As we explained last week, the amount of money you need to be financially independent is based on how much you spend every month, not how much you earn. If you are just starting out, you are in a wonderful position to keep your spending where it is now and watch independence catch up with you.
If you don’t see any areas where you can cut spending, resolve to never again increase your monthly expenses unless you have to take care of more family members. Your goal is to widen the gap between what you earn and what you spend. Use the earnings and savings ratios to keep you on track. Remember, money you spend today is lost to you forever. Money you save is money that can keep working for you.
You don’t save enough
The less time you have, the more money you have to put towards achieving your magic number. It might be hard to believe, but you already have the money you need to save. You are probably spending it on things that seem essential but aren’t.
Rooms in your house you don’t use (the one that’s “for visitors” that never visit)
One or more cars that have more capacity than you have family members
A cell phone contract you renew every two years
A gym membership you don’t use
New clothes every month
Trips to the hairdresser (you’ll still have hair if you don’t go, unless you didn’t have hair to begin with or a family history of baldness)
If you are truly spending every cent on a roof over your head, food and education, you won’t find room in your budget. Your job is to get very, very comfortable with what you have. The more comfortable you are, the easier it’s going to be to resist the temptation to spend money on non-essential lifestyle expenses. Gifts, prizes and tax rebates are all for your future.
The money invested isn’t growing enough
This is what we might call a first-world problem. When you get here it means you have paid off your debt, found room in your budget, given your investments enough time and now the market is being mean to you.
When it comes to investing, certain types of investments deliver more bang for buck than others. Some investments are pure investing, while others act more like savings. When we have lots of time for our investments to grow, we choose a pure investing kind of investment. As we get closer to financial independence, it becomes more important to protect the money we already have.
If you are saving for financial independence using a retirement annuity, your product provider is required by law to have a certain amount of your money in products that act more like savings than investments. This is usually a combination of bonds and cash used to bring stability to your portfolio. The rest of your money is invested in shares that go up and down in price a lot in the short term, but tend to grow more than savings-like investments in the long run.
When it comes to retirement products, the only control you have is which provider you choose and which plan you choose. The more time you have before you need the money, the more aggressive your portfolio should be. That means you want as much of your money in shares as possible. If your product provider is any good, they will explain their different options to you in detail and keep you abreast of when they start moving you out of shares into savings-like products.
If you aren’t using a retirement product to save for financial independence because you want to be financially independent before you turn 55, you are responsible for deciding how much of your money you want to risk and grow and how much you want to protect.
In both cases, you will need a clear investment strategy that you will stick to even when the market doesn’t perform in the short-term. If your portfolio isn’t growing as much as you’d like, do the following:
Put off making a decision about your portfolio as long as you can. Buying and selling shares costs money and can have tax implications. It’s a very last resort.
Ask yourself how long you’ve been invested and how long you’re planning on being invested. If you have ten years or more to go, stick with your strategy while you research alternatives.
Get a few professional opinions on your asset allocation and what you hold. Sometimes another point of view can help you spot flaws in your strategy.
Ensure you have the right asset allocation for your investment time horizon.
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This article does not constitute financial advice as it does not take into account one’s personal financial circumstances. Please contact OUTvest before implementing any financial plan or advice to ensure that you make an informed decision.