The financial habits young people need

The right financial habits can help young people to make easier financial decisions and improve their overall financial well-being to become successful investors as someone who understands the basics of saving and investing.

The Oxford Dictionary defines the word “habit” as “a settled or regular tendency or practice, especially one that is hard to give up”.

“Good habits can have a lasting positive impact on the way we live our lives,” says Victoria Reuvers, managing director at Morningstar Investment Management SA.

“Habits essentially become part of our routines and can even become so ingrained in what we do, that we almost forget whether we did them or not, such as shutting the garage door when leaving for work. Imagine if good financial habits could be on autopilot in your daily life.”

Manage your money, don’t let your money manage you

From an early age, allowances teach children the value of money, Reuvers says.

“Giving children a budget to stick to can encourage smart decision-making. It forces them to make their own cost-benefit decisions and prioritise what matters. If they spend all their pocket money immediately and forfeit having enough money for something more expensive later, they will be forced to learn the valuable lesson of saving and not giving in to instant gratification.”

As we get older, the spending habits we learned with our pocket money can have a spill-over effect on how we budget later in life.

Whether you earn weekly wages or an annual salary, the first step is to realise the worth of your income and create a spending plan and budget with what you have.

Figuring out your budget at the outset and learning to stick with it will save you some pain down the road. If you are just starting out, do not wing it with your expenses. There are numerous budgeting templates available online to choose from.

At the end of the day, the habit of creating and sticking to a budget and spending and savings plan is important.

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Keep it simple with these basic rules of thumb

When it comes to building a habit, the more complex the desired behaviour is, the harder it can be, Reuvers says.

For your finances, using simple but effective rules of thumb can be a solution, such as not spending more than you earn, paying yourself first by saving and spending what is left after saving.

Here the secrets are to save up for big expenses instead of buying on credit, paying off debts as soon as possible and ensuring that you have an emergency fund.

Start saving as early as possible

Reuvers says people often assume that if they start very small, they do not have enough to invest. But the fact is, even if you have a very small sum, you can save and invest in the market, thanks to compounding interest.

“Over your longer time horizon, you may be able to accumulate even more than the person who starts with a larger sum, but waits for a longer period of time to get started. Even if you just start by saving your money in a bank account, you will be enforcing the habit of saving, which can become a very powerful habit over time.”

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The younger you are, the better

Reuvers says younger investors have the longest time to benefit from compounding interest and that benefit accrues even if they can only save small sums and the market gods serve up “meh” returns over their time horizons.

Starting from an early age, is more important than the amount you start with as demonstrated by this example:

• A 22-year-old who starts saving R200 a month and earns a 5% return per year will have more than R362 000 at 65.
• An investor who waits until 35 to start investing but saves R300 a month and earns a 6% return will have a little more than R300 000 at 65.

“Those first 10 years of missed compounding swamp both higher returns and higher contributions later on, underscoring the virtue of getting started on retirement saving as soon as you can, even if it means starting small.”

Reuvers says it really is worthwhile to save whatever you can afford to, even if it does not seem like much.

Money invested in your 20s and 30s is extremely valuable as these funds have several decades to compound and this money has incredible growth potential. R1 compounding at 6% per year will be worth R10.30 in 40 years’ time, while R1 compounding at 6% will only be worth a third of that, R3.20, after 20 years.

How to ‘double your money’

Getting children to understand the time value of money from a young age can help them plan their careers, understand why they need to continuously get raises and increase the value of their labour over time.

It can help them understand why investing a small amount of money in their 20s is so much more practical and valuable than a much larger amount in their 40s, Reuvers says.

She encourages people to use the rule of 72 where you divide 72 by the interest rate and the result tells you how many years it will take for your money to either double if it is invested or get cut in half if you talk about paying interest or inflation.

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Watch out for the infamous ‘lifestyle creep’

This is a bad habit to avoid, Reuvers says. Usually the more income you earn, the more money you spend.

“It is not strictly a bad thing. You work hard and when you get rewarded with a raise, you might be able to afford a bigger apartment closer to work or a house in an area with a good school district, for example.”

However, the more expensive your lifestyle becomes, the more you will need to save to fund its continuation but the more you spend, the less you will have available to save. Reuvers says a better idea will be to stay conservative about spending and not taking on too much debt.

“You will not only able to save more while you work, but you will also create a less expensive lifestyle that does not require as much money to fund when you retire.”