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The cost of waiting to save

Jan 16, 2013

Girl Holding Plant

One of the more common questions that readers ask is “which fund should I invest in”. They often provide a list of funds and hope that some crystal gazing will allow them to select that fund which will outperform all others. However, your future wealth will be determined more by when you start investing than what you invest in.

About a year ago a 21-year old family friend had a long chat with me about where he should start saving. He is studying through college whilst working at a part-time job and he wanted to start saving R500 a month for his future. I suggested he select a low cost unit trust or exchange traded fund that had high exposure to equities (shares).

A few weeks ago he phoned me again and confessed that he hadn’t started the investment yet. The reason was that he could not decide whether to invest in the Satrix Rafi or the Satrix Divi. He gave me a long explanation as to the various pros and cons as well as past performance etc. He again wanted my opinion. My reply was simple “whilst you were agonising over two investments with virtually the same investment profile and similar returns the market is up by 20%. Your indecision has “cost” you R7200 in savings”.

I was reminded of this conversation when I received a press release from Allan Gray where they demonstrate the cost of delaying an investment decision. According to Shaun Duddy, a business analyst at Allan Gray, investments are returning 9% per year and you need to meet your objective in 10 years’ time, delaying saving for just 18 months will increase the amount you need to save per month by more than 25% in order to have the same lump sum in ten years’ time.

If your timeframe is five years, an 18-month delay results in more than a 50% increase in the amount you have to save each month. As Duddy explains, starting to save earlier allows you to extract maximum benefit from the power of compounding.

In the case of my friend, by delaying his savings by one year and not having saved R7600 by now, he will lose out on the compounding effect of that money. A lump sum of R7600 which grows at just 9% per annum over the next ten years would be worth R17 600. That is worth three years of R500 monthly contributions which is how much his indecision has cost him.

Spoilt for choice: The greed affect

One of the reasons people like my friend fail to invest is that there is simply too much choice combined with the fear of missing out. Investors often worry that there may be a better investment out there and they could have had an even better return. But let’s put that into perspective; even if the top investment fund provided a return 10% above the market it still equates to a zero return if you have not started saving.

It helps to keep in mind that even if you simply select an index tracking investment with low costs you should receive above inflation returns over the long term. It is more important to start saving today than to wait for the perfect investment.

But what if the market falls? The fear affect

One of the main reasons people hesitate to invest is that they are worried the markets are going to fall. During my investment days I saw many clients holding onto cash waiting for the “right” time to invest. They tended to sit in cash too long and then invest when the markets were at their peak. They allowed fear to overcome sound investment practise.

Duddy says while it’s true that you receive better value for money if you invest after the market has fallen, rather than at its peak, this doesn’t mean that you should put off saving if you’re unsure what the market will do next.

“In all but the most extreme situations, the cost of putting off saving exceeds the benefit of starting at the bottom. This is because even money that has decreased in value is a better contribution to a long-term objective than money that has been spent on short-term gratification. The right time to save is now. You can’t get time back once you’ve spent it,” says Duddy who adds that when choosing your investment it is important is to consider your risk profile and priorities and then to stay invested to reap the benefits. You may be tempted to time the market by investing into a money market fund for the first few months of saving and then switching into another fund, such as an equity fund, when you think the market looks more attractive.

Duddy says while you may be able to make some gains by starting in this way, if these first contributions are a small percentage of your total contributions, the overall effect at the end of the investment term is likely to be small. This small benefit comes at the cost of having to carefully research and monitor the market and a selection of funds and then making a call when you believe the time is right. However, with no crystal ball available, you run the risk of mis-timing the market and benefiting even less from your strategy.

If, like my friend, you are saving via debit order there is no need even worry about timing the market. Falling markets are good news as when the market falls you are able to buy shares or units at a lower price each month which means your long-term potential return is even higher.

So start that New Year’s resolution and sign those forms already!

First published in City Press.

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Maya Fisher-French author of Money Questions Answered

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