In our modern economy, money is a means to survival. You need to provide for your basic needs – a roof over your head, food on your table, transport, clothing and so on. But one look at the society we find ourselves in tells you it does not end there. We buy more than we need and spend on things not because we need them, but because we like them, because they tell people about our social standing and because having them makes us feel a certain way. If buying clothing was purely about covering ourselves up and staying warm, the fashion industry as we know it would not exist today! In short, there are transactional aspects to money, but our spending decisions also reflect something about our emotional needs.
When spending is reasonable
If you work hard for your money, it is reasonable to want to spend some of that money in ways that make you happy (in addition to providing for the basics). But it’s important to acknowledge that many of our ‘needs’ are really disguised wants. You may need a car to get around, but do you really need a four-wheel drive, seven-seater SUV? You could probably commute just as happily in a less expensive car, and save on insurance and petrol to boot.
The reason that many people still fall into the trap of trying to keep up with the Joneses is because we derive emotional and social ‘benefits’ that ‘compensate’ us for the monetary expense. These benefits are largely intangible and based on our own perceptions though.
If this kind of spending is getting you into debt, you need to have a tough but honest conversation with yourself about whether your needs are really disguised wants.
Know when you intend to spend your savings
Thinking about when you intend to spend your savings has a big impact on what the ‘best’ investment is for you. You need to factor in your time horizon when setting a financial goal and deciding on your asset allocation. This is due to some fundamental truths about the economic environment:
• While we can largely ignore the impact of inflation in the short run, it quickly erodes buying power in the long term. Your main objective for long-term savings should be to outperform inflation so that your buying power is preserved.
• The investments that outperform inflation in the long-term can be very volatile and unpredictable in the short run.
• The value of cash-type and fixed interest investments are far more certain.
This means that:
• If you intend using your money in the short term (three years or less), your money should be allocated to cash-type and fixed interest investments. Your money is likely to grow at a stable, fairly predictable rate.
• If you are saving for a long-term goal, you need to be invested in investments that can grow faster than inflation. You need to be able to leave this money untouched for about seven years, as market performance tends to become more predictable in the long-run.
• If the answer is somewhere in the middle, you need a medium term investment that combines these types of investments so you can have the best of both worlds.
In addition to ensuring your asset allocation is aligned, also be sure to consider whether your product choice supports your goal.
Can saving ever be the wrong decision?
Saving by cutting down in the in the wrong areas is not advised. If your income depends on your ability to work (i.e. if you earn a salary), you want to ensure you (or your dependants) can continue earning an income even if you do not work. This means it’s simply too risky to save by cutting your spending on life cover, dread disease cover, medical aid or retirement savings. Similarly, trying to save on home or car insurance can be disastrous to your finances if the unexpected happens. A qualified financial adviser can help you weigh the options, and decide smartly about the trade-offs you can, and cannot, make.