Are you a young professional in mid-level management, a chartered accountant (CA) in your second year of articles or a recent graduate about to plunge into the world of work? If so, there are certain things you need to know about money, but which your university, employer and possibly even your parents might never have shared.
Citadel Risk Advisor, Shane Murphy is also in his late-20s and frequently finds himself standing around a braai explaining the nuances of personal finance to his friends and acquaintances. Not giving advice mind you, just outlining the best financial behaviours to foster.
“A lot of my mates are now earning decently and have some excess income, but don’t really know what to do with their money,” explains Murphy, who believes the subject is extremely relevant but often information is pitched at experienced investors and doesn’t speak to young professionals.
For those in this position, where do you start? How do you narrow down complex financial planning methodologies and personal finance into core points which are both understandable and actionable?
For Murphy, there are 10 cardinal points which every 20-something needs to know:
- COMPOUND INTEREST ROCKS
Understanding how compound interest works and the power of it is crucial when it comes to investing and building an appreciation for remaining invested for as long as possible. “If you were to put a grain of rice on every square of a chess board, of which there are 64 squares, and you square the number of rice grains you put on each square, how many grains of rice would you have in the end?” asks Murphy. “The ultimate number is 18,446,744,073,709,551,615 – or 18 quintillion, 446 quadrillion, 744 trillion, 73 billion, 709 million, 551 thousand, 615.” This is a great way of illustrating what Albert Einstein once referred to as the eighth wonder of the world: compound interest. The Nobel Prize-winning physicist went on to say: “He who understands it, earns it; he who doesn’t, pays it.”
- LEARN TO BUDGET AND LIVE WITHIN YOUR MEANS
In 2010 a women called Grace Groner, a modest librarian, died in the United States at age 100. She left her old school a staggering US$7 million in her will. How did she amass this fortune? By living within her means and saving for 70 years. “Grace shows us that education and earning ability don’t always give you the edge; rather looking after your money with discipline is your best bet,” says Murphy. “In short, live below your means, put your money to work, protect what you’ve got and don’t interrupt compound interest when it’s busy performing miracles on your behalf.”
Curious as to how to do this?
Murphy explains: “As a rule of thumb, there are three numbers your salary should be split into: 15% should go into retirement funding, 5% to an emergency or holiday fund which comprises short-term savings that you should try keep to the equivalent of three months’ income and then 50% of your salary should be spent on living expenses and debit orders. That leaves 30% for entertainment and discretionary savings.”
Circling back to the issue of retirement funding, Murphy explains that the lowest contribution you can ordinarily choose on a group pension or provident fund is 5% of your salary per month, so most people just leave it at 5%. The norm is 7.5%, but even if you select 7.5% you would still have a retirement saving shortfall of 7.5% if 15% is the recommendation. That’s where opening a personal retirement annuity can come in handy, and it also gives you a tax break each year. An alternative to this is a tax-free investment, which is a good way to save and invest in a tax efficient way.
- PROTECT YOUR BIGGEST ASSET: YOUR INCOME
Telling someone who is young and fit, with their entire life ahead of them, to draw up a will, name beneficiaries and plan for the future may seem like a stretch, but it’s a good discipline to get into from an early age. “Protecting what you have is vitally important. For any of us, no matter our age, the ability to earn an income is our most important asset,” says Murphy. Unfortunately, many young professionals don’t stop to consider the impact on them and their families if they have an accident or contract a dread disease. “What if, at the age of 25 or 30, you are no longer able to earn an income?” asks Murphy. “There are medical advances which might still get you to age 60, but how are you going to pay for 30 years of healthcare and wellness?” But with lump-sum disability cover, income protection and lump-sum critical illness cover in your corner, you can bank on your financial parachute opening when you need it most.
- GET A JUMP ON LIFE COVER
“At this age life cover is less important than protecting your income, in part because at this age you are likely to have limited debt and few dependents,” explains Murphy, “but taking out life cover in your 20s is cheap, and it can be used as a legacy.” Another factor to consider is that life insurance, as a product, is changing and often gives the policyholder something back – this is an industry-wide trend which is specifically evolving to appeal to young and healthy individuals. “This means that premiums are affordable and you effectively get money back, so it is something that might appeal to some young professionals,” says Murphy.
- TAKE CARE OF THE PAPERWORK: HAVE A WILL
If you have a bank account, you need a will. It’s as simple as that. Over your life and career this document is likely to become more complex, but the key is to start early and get into the habit of keeping this vital document up to date. “Even if you have a one page will, each time something significant happens in your life you update it. This is something we update annually during our yearly review with clients, regardless of age,” explains Murphy.
Over and above considerations like beneficiaries – which should accord with the beneficiary form you complete on your work pension, for example – you can also clarify what happens with your social media accounts when you die. “What about your Instagram account? Do you want it closed or open in perpetuity?” asks Murphy, who recommends adding these instructions to you will.
- DON’T RELY ONLY ON YOUR COMPANY
Just because your employer offers a group medical aid, pension or provident fund, doesn’t mean you are secure. “Even if you have group benefits coverage courtesy of your company, you might still need gap cover in your personal capacity or an insurance product such as critical illness, lump sum disability and income protection,” says Murphy.”
- READ THE SMALL PRINT
Asking questions and scrutinising contracts is particularly important when it comes to insurances like medical and life where there are conditions and “once you stop paying premiums you lose it”, says Murphy. It’s also important to check if you can continue with an insurance policy if you change jobs. “It’s always worth asking questions,” he says. “There is no such thing as a stupid question. Whenever you are signing a contract or entering into a fund, then be sure to speak to someone who knows the nuances of financial planning.”
- PRESERVE YOUR SAVINGS
The most common example is when you leave a job and elect to take out your pension savings. “Don’t break into the vault,” warns Murphy. “You might want to take out that R300 000 but there are tax implications and you are effectively eating into your retirement savings.”
- AVOID THE DEBT TRAP
The first place to start when it comes to managing debt is understanding how a credit card works. “You may have left university with a degree in economics, but you have no idea how credit card repayments work or how to use limits and controls,” says Murphy, explaining that sometimes it takes a simple discussion to offer useful guidance. “With a credit card you ordinarily have 55 days interest free, so if you pay R5 000 for a new suit on your credit card you have almost two months to pay it off before you start paying interest on it. Now that’s the ideal way to use a credit card,” he says, explaining that credit cards can offer “good debt” if used intelligently. “Similarly taking out debt for higher education is ‘good debt’ as you are investing in yourself, as is buying a home. Although you might never have been taught this at school or varsity.”
- DON’T FORGET TO HAVE FUN
Yes, it may be ideal to have 15% of your monthly salary going towards your retirement, but sometimes that’s difficult when there are draws on your money, says Murphy, so you have to be practical about putting your money to work so you can enjoy the fruits of your labour. “Pay yourself first, under the budgeting principles,” says Murphy, “and that means putting away what you need to pay yourself into the future – even if it’s 25% – but once you’ve done this then enjoy your money.”
Finally, it’s important to remember that help is always just a call away. Guidance can come from a chat around a braai, an informative newspaper article or a radio talk show. But the best way to ensure you are ticking all the right boxes is always to talk to a professional.