An alternative view on saving

Bennie Crous, Senior Portfolio Manager at Equilibrium

The most basic definition of saving is the delayed consumption of financial means to meet some future financial obligation, says Bennie Crous, Senior Portfolio Manager at Equilibrium. However, what does that mean? And what if I have no future financial obligations? Or if I’m planning to meet financial needs as they arise using credit?

Firstly, it is important to recognise that every person has two sources of capital. The first is financial capital, or assets. These assets may be accrued through inheritance or some other windfall like winning the lottery, but for most people, assets are accrued through saving.

The second source of capital is human capital. Human capital is the ability to generate an income over your lifetime. Most people generally are born with a limited set of human capital. However, this may be improved by getting an education, learning a trade, or being entrepreneurial. 

As you start to work and convert your human capital into income, but that income is equal to your consumption, you do not accrue financial capital. Any income over and above your consumption is savings. Conversely, if you borrow money to meet financial needs, it can be seen as borrowing against your human capital: you sacrifice some of your future earnings for immediate consumption. Debt is not always a bad thing. For example, taking out a student loan to get a tertiary education can also be seen as borrowing from your human capital, but it also increases your human capital. The same could be said for borrowing money to start a business or buy assets. If the improvement in human capital or the value of the asset bought with borrowed money is greater than the value of the debt, then taking on debt is not always a bad strategy.

But, back to saving. We need to recognise that every person has a limited amount of human capital, and this diminishes with age to the extent that you have no more human capital when reaching a certain age. This age may differ for every person, but most people are required to retire between ages 60 and 65 and this event normally drastically reduces your human capital. No financial institution will lend money to retirees who no longer have any human capital or financial capital.

Now back to my example of someone consuming all human capital as it is converted to income, with the consequence that no financial capital will be accrued. This implies that one would have the ability to work up to the natural end of your life. Of course, there would be many reasons why this would not be practical, including reaching retirement age.

From the above it is clear that you would need to make some sort of provision for when your human capital is depleted before you pass away. This is the reason that people sacrifice some of their current income to make provision for this future event.

At Equilibrium we believe this could be achieved by partnering with a professional financial adviser to assist you through this process. The adviser will assist you with how much of your current income you need to sacrifice to meet future financial needs, also known as budgeting.

The adviser will firstly assist with identifying your various financial needs. Some financial needs may have a low likelihood of happening in the foreseeable future, however, if these events do realise, it may result in significant financial strain. These events include premature death, disability, significant medical expenses, or damage or loss to your property. Your adviser will typically assist you in identifying the appropriate insurance or medical cover for these events.

Some financial needs are predictable. These include saving for your children’s education, a deposit on a motor vehicle or a house, or saving for your retirement. There is no need for insurance to meet these needs since these events are certain and an amount can be determined with a high level of certainty. Your adviser will help you to assess the period over which you need to make provision for these needs. Some may be short term like saving for a deposit to buy a car, while others may be long term like saving and investing for your retirement. Your adviser will identify the most appropriate tax-efficient product and well diversified portfolio that speaks to your financial needs and when these will become due. From this your adviser will determine the optimal savings rate for each of your financial needs.

It is a fact that the earlier you start to save impacts the amount of risk you need to take in your investment strategy. Having the ability to take more risk means higher potential returns with the benefit of time and the compounding effect of returns. By starting early, you also need to sacrifice a smaller portion of your income to meet future needs.

Equilibrium builds investment solutions for advisers. By using Equilibrium your adviser has the time to focus on understanding your future needs and matching the best investment solution to these needs. Equilibrium makes it easy for advisers to help their clients achieve their goals and stay invested with more certainty and less anxiety.

Equilibrium Investment Management (Pty) Ltd (Equilibrium) (Reg. No. 2007/018275/07) is an authorised financial services provider (FSP32726) and part of Momentum Metropolitan Holdings Limited, rated B-BBEE level 1.

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