Save yourself!

I recently met with a young lady that had come to us for a Financial Plan. As it turns out, she is a terrific saver and saves about half of her after tax income each year. Quite impressive really! Now clearly, I could be no assistance in her becoming a better saver. She also has a very good handle on where she spends her money. A key ingredient in developing a good financial plan. Being a long way away from retirement and uncertain about how long she wants to work, she clearly was not here to plan her impending exit from her employer. What did she really need? She said, some help in determining how to invest her savings.

Invest her savings. What a great statement! Both, a common phrase and a common use of terms. That was when I pointed out to her, that it is a confusing use of terms. Why? Once savings become investments, they are no longer savings. Once you have investments, you no longer have savings. Was she asking to make more return on her savings or was she asking to convert her savings to investments?

I was reminded of a basic tenet of investing: always have savings before making investments. The fastest way to becoming a bad investor, is to not be a saver first. If you invest first, any financial difficulty that comes along will demand liquidity and accessibility. Why? Savings are best defined as having a known outcome for your principal and any earnings, and are both liquid and accessible. Investments, by contrast, have an indeterminable outcome for your principal plus any earnings and thus timing will influence liquidity and accessibility. There are often tax penalties that would again restrict liquidity or accessibility. In other word, savings allow you to always know what you have and when you can get it. Investments will have an unknown value at all future dates and accessibility may not be desirable given past results. Investments, by their nature, have practical limitations on their liquidity and accessibility.

As an investment professional, one of the biggest problems that I see is families with no cash reserves. Life has a way of getting in the way of even the best laid plans and emergencies do happen. Loss of a job, an illness, a home repair or a car accident are among the most common. You need savings to meet these surprises. You often need the cash now. Savings are for those NOW times. You also may have definitive plans to buy a house, buy a car, build a cottage or take a long trip. For these events you will need cash at the right time. You need savings for their liquidity and availability.

Being an Investor means that you are in it for the long term. If you have bought RSPs, you are an Investor. If you bought RESP for the kids, you are an Investor. If you own mutual funds, stocks or bonds, you are an Investor. If you need those funds NOW, you are a poorer Investor most of the time. Investments usually have very uncertain returns over a short time span, but are much more reliable over the long term. Lack of savings will cause you to often make withdrawals from your RSPs, stop the kids’ scholarship plans or sell those mutual funds on the worst possible day. Believe me, the lack of savings will make you a terribly unsuccessful Investor most of the time.

So, how did we help? We insisted on a definitive description of the future use for all of the accumulated savings. We wanted the young lady to be clear and committed to the time horizons associated with the funds. We helped determine what portion of the savings MUST remain as savings. We then helped determine what portion of the savings would remain untouched until retirement. This clearly is long enough to convert savings to investments, since liquidity and accessibility needs are a long way off. In between the two, we have a third area which is a bit grey, due to the stage of her life. Kids in her future, maybe, but a husband first would be good. Both, expensive items. A house, but when? Next year? Five years? Who knows? Our goal is to shrink the middle grey area to as small as possible, as soon as possible. Funds in this area are problematic. With savings, we must seek predictable outcomes, liquidity and accessibility, which we know will restrict possible returns. The long horizon funds may be safely invested to seek market returns from both the equity and bond markets. The grey area funds are where we are likely to make a wrong choice. Go long, and then move up the house purchase. Go for liquidity, and then not buy a house for five years, wrongly foregoing higher possible returns.

One common mistake, we are currently seeing with prospects, is the unbridled seeking of higher returns on savings. With interest rates so low, savers are becoming unintended investors overnight, as they forgo savings products and move into bonds or equities to enhance yields, forgetting that their savings were meant to provide liquidity and accessibility, not just yield.

Tell your broker, advisor, mutual fund or scholarship plan salesperson, “Help me become a saver and I will be a better investor AND client later!”

Merry Christmas, Season’s Greetings and a Happy New Year from all of us at Efficient Wealth Management. Join us for our next “Meet the Columnist” on January 16th from 2 to 4 pm. Space is limited so please contact Jean Dizon at 416-410-9809 or jdizon@efficientwealth.com to RSVP and obtain location information.