In this article from the "Are You Serious About your Money" series, we are going to talk about savings, which is the third level of Pedro Moreira's Money Framework version by Euroconsumers Invest. Let's quickly summarize the previous stages.
On the first level — "Where's the Money Coming From"— we addressed the origin of income recommending assessing the source of revenue in the family budget. We also commended to take concrete actions; in case you are not fully satisfied with the outcome of the assessment.
On the second level — Family Budget Management — we recall that the rule is always the opposite of what families usually do: spend the money after securing the amount to save, and never before.
After these steps, it's time to take good care of the saved money and experience the best of the investment world: liquidity, security and income.
Savings management involves several aspects. The answers are not always obvious; sometimes rethinking family budget options should be envisioned from an investment perspective and from the objectives that are intended to attain.
It can be a painful but necessary process, particularly one that often leads to changes in consumer habits (quit travelling or stop going to restaurants for a period, are good examples). In the long run, it will yield the desired results.
What seems today a minor problem (a small loan, for instance) can swiftly become something uncontrollable if you stop paying the instalments for long periods. Another example is unnecessary expenditures, even smaller ones, all added up quickly becomes a large amount of misused money at the end of some time. Benjamin Franklin summarized this warning in a sentence: "Beware of little expenses; a small leak will sink a great ship".
Start by getting rid of all debts
Usually, the rate of credit is higher than any savings products. Meaning, a debt loan probably won't be solved in a month or two. Hence, you will need to establish a specific savings plan to hasten the payment of all credits (except the house loan, which requires a different approach due to its nature). Remember, you are paying interest to the bank or the financial entity every month. At a time when applications do not profit much, it's in your interest to get rid of this burden. Therefore, in addition to paying less interest, you are stopping a regular payment obligation.
If you have several loans, the recommendation is to start writing off the lower debt and so on. If some have equal deadlines, focus on the one with the highest repayment. If there are several credits and, despite your payment plan, you will find that they will continue to weigh heavily on your short-term budget, renegotiate everything. Preferably, consolidating it all into a single longer loan, with lower instalments (for instance, if you own a house you can take out a second mortgage on it) and settle all others.
Automatic savings from your bank account
You can request your bank to put 10% of your wage on the side every time you receive your payroll check. A simple online banking instruction will immediately remove that amount from your current account to savings (or to a financial product with the same purpose). And, if your household receives a good monthly income, you can boost this percentage.
Personal fund for emergencies
One of the primary rules of personal finance is the creation of a Personal Emergency Fund. It is the so-called "pocket money" available for unexpected situations like a house or car repair, a case of unemployment or a severe health problem.
The Covid-19 pandemic has shown that everyone can fall victim to situations they do not dominate. And in this case, the Coronavirus crisis has created additional spending concerns. For many families, it represented not being able to exercise their activity and, as such, not being able to obtain revenue. This was the case of many independent or temporary workers (from the hotels and restaurants sectors, artists, lawyers, dentists, and so on).
Depending on your income level, reserve the amount corresponding to 6/12 months of your monthly expenses, it may require few years to attain the recommended sum but do it.
Don't leave your money sitting in the bank
"Be The Boss Of Your Money" reflects our suggestion towards bank deposits. The idea is that you should move your money freely and apply it to products that give you more revenue.
Leaving your money in bank deposits is secure, but this safety can be an illusion: it has guaranteed rates. In Europe, a Guarantee Fund secures bank deposit (in Brazil too, for example). The fund protects your money in case the bank goes bankrupt (in Europe, the maximum protected amount is 100,000 euros). Furthermore, you tend to know your account manager and this "close relationship" gives you some protection.
All this has its positive but also its negative side: first, the guaranteed rates. Rates are close to zero or even negative in some countries, which is historical in the bank industry. For this reason, it is hard to understand why Europeans keep a high cut of their financial assets in currency and bank deposits.
According to OECD data (2016), in Portugal, 45.1% of financial assets (total includes pension fund investments, corporate equity investments, shares and bonds, among others) are in currency and deposits. The same is true in Luxembourg (44.8%), Germany (39.3%) or Spain (39.2%). In France (27.6%) and Belgium (29.8%), they are under 30% of the total assets, therefore, with much more diverse and less investment in short-term products (you can also find out this data through your country's Central Bank).
As a benchmark, in the United States, the percentage of currency and deposits held by Americans are only 13.2%. And to add to that, we have this invisible element devouring savings and purchasing power: inflation.
Set these rules. First: no matter the annual interest rate on your current or savings account, whenever the yearly inflation rate is higher than what you receive, you are losing money. The argument is simple: with the same amount of deposit cash plus interest, you cannot purchase the same quantity of commodities in the same period of the previous year. Therefore, you must set yourself at the existing rate of your savings account. At the moment, data for August show annual inflation rates of 0.4% in the European Union and 0.2% in the Euro Zone.
Second: knowing current or savings accounts are partially covered by the guarantee fund in many countries, such as EU members or in Brazil, always check the jurisdiction to which the bank responds. Then, check very carefully the characteristics of the products you buy.
One of the lessons of the 2008 post-crisis bankruptcies is that some customers invested in products that they thought were bank deposits or equivalent but were more complex products not covered by the guarantee fund.
Third: Financial Literacy, the lack of knowledge of the financial market functioning (family budget management, credits and investments) is a global problem.
Even in the US, where there is a broad market culture, more than 40% of the population has literacy problems. And it leads families to choose more straightforward products and ask for counsel from the bank's account managers. Here we have the positive and the less positive sides to which you should pay attention:
On the one hand, it is very flattering to have someone "trustworthy" to guide you through all investment products and offer an explanation about its nature. On the other, remember that bank employees have targets to carry out, and the universe of products usually is limited to the offers set by the bank or affiliated financial institutions. They'll hardly recommend better savings account from the competing bank across the street.
Recommendation: search, compare and make the best selection for yourself. At the moment, many solutions include making long-term deposits (3 or 5 years) to have a higher rate, ensuring you can transfer the money. And never hesitate to walk into the bank to negotiate rates assuming the "no" as a granted answer. Likewise, take a proposal from another institution on hand. It helps you with the bargain.
Government financial commodities to investors or capital insurance can be an excellent alternative to bank deposits. Also, use comparative studies of credible entities in your country. If you are in Belgium see Test Achats Invest; in Spain: OCU Inversiones; in Italy: Altroconsumo Finanza and, in Portugal, Proteste Investe.
Create plans for each goal
With the emergency fund plan sorted out or having a first amount of reserve already defined, you can start another short and medium-term objective that you want to achieve. Want to buy a new car? A new notebook for your child? A plan for a great trip the following year? Program it, the bigger the anticipation, the better.Very important: don't use the emergency fund. Start one saving plan for each goal.
This approach is suggested for large purchases that come off the current spending list. Do the exercise of paying yourself: does a computer amount to a salary? Does it amount to two weeks of disposable income? Or three months of savings? Put "this payment" aside in a small instalment.
Regardless of the goals that will arise, the logic is always the same: How much will it cost? Make a budget, including expenditure projections and adjust it to the objective. There is a long-term goal that must be present: retirement. But we will talk about this in chapter 7.
So, "Be the Boss of Your Money" on all different steps, on the Income phase, on the Budget phase and the Savings management phase. If not, as Dave Ramsey (America's trusted voice on money, best-selling author and radio host) said: "You must gain control over your money or the lack of it will forever control you."
Don't hesitate to share your resource-raising strategy with your co-workers. Recommend Euroconsumers Invest in your company's HR Department. Ask them to contact us and learn more about our counselling services.
Read level 4 of the Money Framework by Euroconsumers Invest: 4. Investments: Let the Money Work for You.
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