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Take a moment to breathe. As heady and exciting as your first pay cheque may be, the financial decisions you make in your twenties will have a material impact on your financial health for many years to come.
WHAT NOT TO DO
Some of the more common financial mistakes that youths today should avoid include:
Maxing out your credit to buy a car
For many people, the opportunity to buy the car of their dreams is too big to resist and car dealers are only too happy to help them max out their credit lines. It is only after a couple of months of driving the car that you realise it is unaffordable.
The monthly instalment is only half of the cost of keeping the car on the road and first-time car owners don’t always budget for insurance, petrol and general running costs.
At this stage, the new car owner also realises they cannot sell the car for what they owe the bank.
A car devalues the minute you drive it out of the dealership and if you finance it over six years, you will owe more money on the car than it is worth for the first four years.
Car finance is also the number one reason people are turned down for home loans, as they have no more credit capacity for a mortgage.
Avoid revolving credit
From your first pay cheque, credit providers will offer you around R3 000 credit for every R1 000 you earn.
It is a great temptation to tap into this credit but it could destroy you financially, especially if you opt for revolving credit, such as a credit card or overdraft.
Revolving credit is a credit line that is always available and never needs to be paid off in full. As soon as you make one payment, that credit becomes available again.
Many people end up in the situation where their pay cheque is simply going towards settling their overdraft – and they live off their credit lines each month. They are one pay cheque away from bankruptcy.
Procrastination
The youth often believes it has all the time in the world. Michelle Dubois, a legal marketing specialist at Liberty, says procrastination is the most common and destructive mistake. “Starting to save from your very first pay cheque creates a healthy habit of saving and allows compound interest to work for you,” she says.
Starting to save early means your money has time to grow and can ride out any fluctuations in the market. Delaying by even a few years could make a big difference to the amount you will need to save to reach your retirement goals. By delaying your retirement savings by five years or cashing out your pension fund when you change jobs at the age of 30 will reduce your income during retirement by a massive 30%.
WHAT TO DO
Delaying gratification increases your rewards. Here’s how to be super smart:
Plan
It is often said that failing to plan is actually planning to fail. Before you even receive your first pay cheque, you should find out from the human resources department what your net salary is.
The salary you agreed to at your job interview is not the amount you will receive in your bank account because you will have deductions for tax, retirement savings and possibly medical aid contributions. Once you know what your net salary is, draw up a budget that ensures you are able to meet all your monthly expenses.
Stick to the budget. If you want to buy a car, save up a deposit equal to at least 10% of the purchase price, budget for insurance and petrol and only finance the car over 48 months.
Risk cover
“When you are young, your most valuable asset is more than likely your future potential income, so this needs to be protected. Becoming disabled at a young age can have a disastrous effect on your lifestyle and ability to earn an income,” explains Dubois. That is why you need to take out disability and income-protection cover. An income-protection policy will pay out if you are unable to work due to an accident or illness.
If, for example, you start earning R20 000 per month at the age of 25 and never receive a pay increase above inflation, by the age of 55 you would have earned R7.2 million in today’s value. That is a pretty big asset and you need to have a plan should anything happen to you to prevent you from earning.
While the risk of death, disability or even severe illness may seem distant while you weigh up your whole life ahead of you, think about the fact that in 2014 almost 10% of Liberty’s claims were paid to policyholders younger than 35.
Of all claims submitted by men and women under the age of 35, the majority (43% and 53%, respectively) were for loss of income.
Motor vehicle accidents account for more than half of the claims for men. In fact, more than 60% of all claims (including life assurance and loss of income) by clients under 35 were as a result of unnatural causes – this figure is considerably higher than for other age groups.
Save for an emergency fund
The main reason people end up in debt is due to emergencies. These could include unexpected medical expenses, helping out a family member or having to pay excess on a car accident. An emergency fund helps you get through those emergencies without having to take out a loan or use your credit card.
You also need to build up a financial buffer should you lose your job. Last year, Liberty’s statistics indicated that the single biggest reason for loss of income claims by under 35s was retrenchment. Henk Meintjes, head of risk product development at Liberty, says retrenchment among men under the age of 35 accounted for 28% of claims for loss of income and women claimed even higher, with retrenchment being the cause of claims in 36% of cases.
Your emergency fund serves as a buffer and will prevent you from accessing your long-term savings or taking on debt to meet sudden expenses. Dubois says ideally you should have the equivalent of three to six months’ salary in an easily accessible bank account or liquid investment.
Work on an immediate emergency fund of R10 000 and build it up over time, using bonuses and other windfalls, to cover at least three months’ expenses.
Harness the power of compound interest
The younger you start saving, the harder your money works for you.
If you save R250 a month between the ages of 24 and 30 and stop your contributions but leave the money to grow, you will have accumulated more at age 65 than someone who saves the same monthly amount from age 35 to 65.
This is because an investment with a 10% return will double every seven years. So, the R18 000 you have invested by the age of 30 will grow to R815 000 by age 65.
The R90 000 you would have invested between the ages of 35 to 65 would not have the same opportunity to grow and would only be worth R570 000. Make sure you start saving with your company retirement fund or a retirement annuity from your first pay cheque.
Manage credit responsibly
If you take a credit card, always pay it off in full each month and avoid overdraft facilities. Learn to live within your means.
Dubois says it is always advisable to pay off expensive debt first, as the interest on this type of debt costs you quite a bit of money in the long term.
Look after your health
Last year Liberty statistics found that cancer accounted for the majority of critical-illness claims for clients under the age of 35 (39% of female claims and 18% for men).
For men specifically, cardiovascular disorders resulted in more critical-illness claims than cancer. Both of these diseases can be accelerated by stress and fast-paced lifestyles
