30 Aug 2013
Financial freedom is possible for all of us, perhaps not in equal measures but, given the right tools, we can all be financially free and create wealth at the same time.
Women particularly are urged to think 'financial freedom' and not rely on a husband, a job or government – yes I know, it sounds all too common, think about it, if a husband dies, what then, when you are retrenched or the government has exhausted its social grants?
Perhaps to better understand financial freedom, one has to understand the role of money in our lives.
According to Ann Wilson, chief executive officer of The Wealth Chef, money it is not the end, rather, money is a powerful means to living a life filled with passion and purpose.
Be clear on why you need money.
For example, she points to the fact that 97 percent of people never achieve financial freedom, two out of three people will rely on their children to support them financially, less than 3 percent of the population will be able to stop working and lead the quality of life they had hoped for and most people worry their money will run out before they die.
If you are finding yourself in this situation, rethink your money purpose, and yes, for many people, there is just never enough money to go around.
However, it’s never too late to avoid staying in the money trap and credit mentality of buying now and paying later.
To get back on track to being financially free and creating wealth, Wilson says, firstly, it is important to spend less than you earn, that way, you have a chance of saving and investing your money.
Debt is a huge problem in our society, and when credit was freely available, people were not too shy to swipe their credit cards and retail store cards (some still do) hence they ended up being overindebted.
She says we live in a microwave society where everything is fast and once you see it, you’ve got to have it.
“Our expenses are more than income, before you go spending money that you don’t have, ask yourself, does it blow your skirt?”
Wilson says stay clear of debt and be sure to pay yourself first.
But before getting to the wealth creation part, she says there is a huge difference between saving and investing money.
She explains that saving is putting money aside to spend later for things we need. This is a safety net which can be for six to nine months (depending on what you're saving for) that can be put into a high interest rate account; your bank will be able to discuss various accounts to suit your needs.
In South Africa, the high cost of living limits the ability to save, according to FNB research.
This became more pronounced with the data from Statistics SA showing that the annual CPI inflation rate has increased to 6.3 percent.
Lezanne Human, chief executive officer of FNB Investment Products, explains that the change in the CPI between June 2013 and July 2013 is mainly due to a 9.4 percent increase in water tariffs, a 7.2 percent increase in electricity tariffs and an 84c/litre increase in the price of petrol.
“These are basic necessities which impact the pocket of almost every consumer and will certainly make their cost of living higher,” she points out.
Human notes that one of the main issues with inflation is that salaries do not always increase at the same rate, making the disposable income of the consumer lower.
“The harsh reality is that consumers may find themselves tempted to borrow for everyday expenses and this could spiral into debt and diminish their ability to save.
“Our research shows that 73 percent of South Africans who do not save indicate that the high cost of living is preventing them from saving,” says Human.
Furthermore, she says inflation causes the value of the consumer’s money to constantly decrease and makes planning and saving for retirement or children’s education a continuously stretched target.
While a savings account with a high interest rate offer is ideal, she warns that many savings products promise inflation beating returns, but with no capital guarantees and more importantly with associated fees that eat away at returns over time.
“Generally the interest-bearing cash investment products offered by banks don’t always allow a customer to keep up with inflation.”
She says the bank has seen a gap in the market and has introduced an Inflation Linked Deposit account which doesn’t attract fees but guarantees capital and saves a return of CPI plus 1 percent.
Wilson says investing is when money stays in your life, that is, you are able to convert that money into income producing assets.
Mike Brown, managing director of etfSA.co.za, says we can all build wealth through investing in Exchange Traded Products (ETPs).
These are securities traded on the Johannesburg Stock Exchange (JSE) and like any other listed shares, they give you access to a portfolio (fund) of shares and this fund typically tracks an index on the JSE.
But why would you want to invest in ETPs?
According to Brown, when you buy one ETP, you buy a whole portfolio (fund of shares), but you only pay for one share – brokerage and JSE settlement costs are only paid once and not for every share in the portfolio.
The important thing to note is that ETPs are low cost (as you pay the broker fees once), you can trade all day at the JSE, transparent (there is open share price on the JSE) and allow for diversification; for example, you may choose to buy shares in a listed property company such as Growthpoint Properties Limited and shares in BHP Billiton PLC, some of the companies listed on the FTSE/JSE Top 40 Index.
Diversification helps to spread the investment risk, reduces volatility and enhances performance potential.
“Buy one security and own a whole basket of shares on the JSE,” says Brown.
In the table below, Brown shows an how you can let your money work for you through investing in Exchange Traded Funds (ETFs), for example in Satrix INDI 25 ETF, in amounts of between R1 000 and R 5 000 per month.
|R1 000 per month (R)||R5 000 per month (R)|
|After 3 years||52 767||263 835|
|After 5 years||124 486||622 429|
|After 10 years||420 943||2 104 715|
|After 20 years*||4 630 940||24 249 105|
Source Profile Data/etfSA.co.za (12/8/2013) Total returns with dividends reinvested. *Exrapolated on past 10 years' performance (note, historic performance will not necessarily be repeated in future).
According to Wilson, financial freedom is possible for you too, what’s more, one can absolutely live life to the full while creating financial freedom.
“You are financially free when you have a big enough pot of assets that earn money for you and pay for your expenses without you having to work,” she says.
In order to start creating wealth, Wilson says it is important to understand four components and their impact.
The most important thing to note in the income statement is income (money coming in or earned) and expenses (money spent).
The income statement reflects both income and expenses
Wilson says it is essential to buy assets that increase in value over time, however, income is not the most important aspect, assets are.
“Investors therefore have to focus on the bottom line and their own net worth.”
What is spent from income earned, this could include paying your home loan, medical aid, groceries, for example.
An asset is something that makes money flow into your life.
The balance sheet reflects assets and liabilities.
Types of assets
1. Investment property
Wilson says investment property includes commercial and residential and she advises investors to buy property that is cash positive.
These are stocks and shares listed on the JSE as they are easier to get into and one can invest from as little as R300 a month.
3. Low input businesses
Wilson says, research opportunities for businesses that do not require a lot of effort but have the potential to earn steady and sustainable income. These could include operating a vending machine or car wash for example, in some cases, she says these may need lots of start-up capital.
Yes you heard right, you are an asset. Wilson says part of creating wealth and being financially free is improving your educational skills and using your abilities to create extra income.
A liability is something that makes money flow out of your life. For example, yes, we all want to drive fancy, luxury cars, but is a car an asset or liability?
When you purchase a liability (whatever you consider a liability), you lose money to buy it, lose to maintain it and lose money from the asset the money could have bought, explains Wilson.
Compound interest and investments
According to Wilson, the main goal in all of this is to increase money coming in and divert as much as possible of that into buying quality income producing assets.
To do this effectively, reduce your expenses as well as liabilities as they use money that could buy assets.
“Money seldom solves a person’s money problems, but financial literacy solves money problems.”
Wilson says in investing, it’s all about understanding the power of compound interest (this arises when interest is added to the principal of a deposit or loan, so that, from that moment on, the interest that has been added also earns interest).
In fact, she considers compounding as the 8th wonder of the world. How so? Consider this – if you buy a coffee each day, you could rather choose to make your child rich one day.
For example, she says if you buy a cup of coffee for say R30 a day, that is R210 a week, and in one month you spend R920, far more than the money you could spend to buy a bottle of good coffee for a month, for probably R100 or so.
She says if you take this money and invest in the simple stock market Index Tracker ETF and stop investing when the child is 18, that amount will have grown to the value of R610 000.
If the child is financially savvy and re-invests or takes over the investment and stops at 50, the investment will be worth R17 276 980, at 60, this would have more than doubled to R49 056 030 and at 70, it would be R139 292 420.
An example of compounding, she says if you were to invest R2 500 a month at 10 percent interest from 18 to 65 years, you earn R32.32 million for only R1.410 million invested.
Wilson adds that being financially free and wealth creation is never worrying about money again and being able to treat those you love without feeling guilty or worried about the money you’ve just spent. - Denise Mhlanga
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