Young adults need to save early to make life easier later. And even as an ‘older adult’ it pays to remind yourself of the ‘financial planning for beginners’ ground rules. Ultimately everyone needs to come to terms with the need for financial self-reliance.
The rewards of financial planning
Some youngsters may hang on to their parents’ financial apron strings with what seems like a death grip! However, when they finally reach the stage where they need to break out on their own, the results can be highly rewarding for both first-time job-holder and parent alike.
There is obvious financial ‘reward’ for the parent – their cash flow should improve in a leap. Less obvious, but just as enjoyable, is the emotional reward of the parent feeling they have guided their child in to the reality of financial responsibility.
For the young adult there is the emotional freedom that comes with financial independence, even if they do not realise this immediately.
The essentials of financial planning for beginners
Once your children grow beyond their teens, there are three essential areas of financial planning that they need to fully understand:
- cultivating a habit of saving from the very beginning
- understanding the cost of debt; and
- the cost of educating a new generation.
1. The habit of saving and the importance of compound interest
With regard to savings, the most important aspect is time. If youngsters allow themselves as much time as possible to realise their financial goals, they also allow compound interest to work for them as long as possible.
Perhaps Einstein was in the business of financial planning for beginners – allegedly he called compound interest “the most powerful force known to man”! Whoever said it, there is no doubt about its ability to generate long-term wealth.
If you can convince your children about the merits of starting to save early, you will give them an enormous helping hand towards their future financial freedom. Unfortunately, many young adults consider retirement to be so far in the future as to be irrelevant. They would rather live for the now than save 10% of their salary.
The problem is that this mindset becomes entrenched, and it becomes difficult to apply financial discipline in later life.
2. The cost of debt on a mortgage bond
Few of us can afford to pay cash for our homes. The purchase of a first house is often seen as a financial coming of age as the reality of servicing a large debt takes hold.
Although first-time home-owners at the moment bewail the deposit requirement* to secure a loan from the major banks, in the long term this requirement will save them money in interest costs.
True, they will have to save a little longer before reaching the first rung of the property ladder, but this discipline will stand them in good stead for the years of monthly repayments ahead. And there are ways of reducing the time spent repaying the bond.
“Son, set your bond repayment higher.”
Make sure your youngsters read this!
Monthly bond repayments are split between capital and interest, with the payments weighted towards the interest portion for roughly the first half of the repayment term.
By paying an additional amount into the bond each month, over and above the monthly required payment, borrowers will significantly reduce the amount of interest paid and subsequently the repayment period. This is because the additional payment reduces the capital portion, and hence the interest charge is reduced as well.
Here’s a concrete example
To service a R1 million loan over 20 years at 11% interest, costs R10,322 a month. This equates to just under R2.5 million interest over the life of the loan.
If you opted to increase your installments by 10% to R11,354, you would repay your loan 5 years earlier and would save R428,000 in interest.
My advice is to utilise your maximum tax-efficient savings vehicles (such as pension and retirement annuity contributions), and then put anything else in the bond.
3. The cost of a good education
The leading private schools now cost in excess of R60,000 per child per annum for a basic education not including the extras of sports and cultural tours and the like. University may then seem relatively inexpensive at approximately R30,000 per year per student.
Undoubtedly, quality education comes at a price. If you want your children to follow this route, you need to urge them to consider these amounts early on, and start making the necessary provisions.
The bottom line on financial planning for beginners
Breaking in to the ‘adult’ world is scary when you are first confronted with the reality of providing for your own financial needs. Having an understanding of what can help to minimize costs, and provide for a comfortable retirement later on, can go a long way to smoothing this journey.
A CERTIFIED FINANCIAL PLANNER® can assist with planning the route to financial independence.
* deposit requirement: At present, with the average small home (80 sqm to 140 sqm) costing R653,000 (according to the Absa House Price Indices of 6 July 2009), a 20% deposit equates to R130,600 .
Debbie Netto-Jonker CFP® is the founder of Netto Financial Services and was Financial Planner of the Year in 2001.
