There’s a lot of information around but how do you really know what is right for you? Your family? Your circumstances?
Get your notepad out, a pen handy and answer these three questions to get you on your way.
1. What is your purpose?
It might seem an obvious question but let’s look at it closely to help you define exactly what you want to achieve.
- Life doesn’t always go to plan and this year has demonstrated that in an extreme manner. Do you have a cash reserve to provide for your living expenses and lifestyle? A good rule of thumb is an amount equal to 6 months of your net household income. If you are yet to reach this, you should continue saving.
- Generally, the concept of saving implies that you have an intention to spend the money, likely in the short to medium term (between now to 3 years). So, is the money you’re putting aside, required for a purpose that you must fulfil (e.g. children’s education) or a purchase you do not want to forgo (e.g. a home)? If it is for a specific purpose in the short to medium term, you should continue saving.
- Investments can have varying characteristics, for example a stable balance, income generation, the opportunity for growth. Your purpose will determine what you need from your investments. It is important to have a sound understanding of both your savings and investments, as things are not always what they appear on the surface.
2. What is your timeframe?
Right, so we have a purpose but when are we going to do something about it?
- People generally refer to guaranteed cash money in the bank as savings. Investments on the other hand fluctuate in value. For this reason, even conservative investments like fixed interest, have a minimum suggested timeframe of 3 years. For high growth investments, maybe property or shares, the suggested timeframe increases to 5 – 7 years. These timeframes work on a reasonable probability that your investment will be higher after that time than when it commenced – however, even this is not likely during periods of significant market volatility.
- Outside of a fixed term deposit, your savings in the bank are generally immediately accessible to you whenever you require them. Other investments may take time to withdraw or sell (think here of physical property). Even investments that appear to provide immediate withdrawal can sometimes be restricted in certain market conditions. For example, during the global financial crisis several fixed interest investments ‘froze’ withdrawals, restricting access to monies for a period of time. If you can’t accept any variability when accessing your monies, you should continue saving.
- When is the right time to invest? Given investments do fluctuate in value and the period for investment is long, some people adopt an approach called “dollar cost averaging”. Rather than investing all of their money at once, they make numerous smaller periodic investments with the aim of getting an average purchase price over time. However, this option is not possible with all investments.
3. What is your appetite for risk?
And, we’ve saved the hardest for last. How do you ensure you sleep well at night with the decisions that you have made?
- Will you meet your goal without the need for investing? Any investment contains various types of risks which ultimately means there’s a real possibility it may decrease in value, even to zero. If you’ll reach your savings goal for its purpose without taking any risks beyond inflation, do you need to invest?
- Various factors impact the value of an investment, like interest rates, economic outlook, business performance, inflation – these are referred to as risks. Your willingness to accept these risks and the impact they have on the value of your investment is referred to as your risk tolerance. How much risk are you are willing to accept without being anxious and meet your purpose? How much of your investment could you afford to lose? Your response to these questions will influence your decision to either keep saving or invest.
- Following on from this, most people experience a greater negative emotion when they experience loss. Further, there are various personal biases that may influence our investment decisions and behaviour, including overestimating our risk tolerance. Tools are available to help you understand what you need from your investment and how you feel about risk and volatility.
Your purpose is the primary consideration in deciding whether to keep saving or to explore investing. Investments provide different outcomes and these must align to your purpose.
Remember too, that only with the minimum suggested timeframe and access requirements, will investing be appropriate for you and your tolerance toward risk and volatility will influence what investments may be suitable.
If you are not certain about any of the above, professional financial advice is the best way to navigate your purpose and the available options.
About Jeremy Quartermaine
As National Manager Wealth Management at Beyond Bank Australia, Jeremy’s approach is centred on the delivery of values-based financial advice for clients. Having 20 years of experience in the financial planning profession, Jeremy has been successful in leading the delivery of financial advice solutions across numerous customer-owned organisations.