Gaining financial freedom

While policymakers have often grappled with theories of increasing domestic savings, little has been done to sensitise the public on the considerations in prudent savings.

While policymakers have often grappled with theories of increasing domestic savings, little has been done to sensitise the public on the considerations in prudent savings.

It is important to appreciate that a holistic approach in addressing challenges associated with lack of or minimal savings is required for a complete change in mindset as low income levels can never be a justification for lack of savings.

First, it is important to answer the simple question, why we should save in the first place. The underlying reason is financial and social security in the event of change in circumstances.

Both social and economic circumstances will always change during lifetime owing to one losing income as a result of poor health, or leaving employment due to retrenchment, dismissal or retirement.

The reality is that one still has income needs irrespective of change in circumstances and the reason for saving is to build a nest for that eventuality.

An important consideration is determining the adequacy of the savings. How do you know whether the savings are enough or not. The guiding principle is assessing your current income against future income needs should circumstances change.

The relationship between current income and the anticipated income should circumstances change is referred to as income replacement ratio.

For instance, if one is earning Frw1,000,000 per month from employment, if the same person was to leave employment for any reason, what proportion of that amount can the person get from savings and investments.

If such a person is able to get Frw400,000, then that is forty per cent (40%) replacement. The same percentage would apply to one who had Frw100,000 but is able to replace Frw40,000.

The higher the percentage, the better the replacement ratio which means that ones’ life does not change drastically in that event. This also means that irrespective of the income levels, the underlying factor is the replacement ratio and not absolute income.

As a guide, the first step is to build an emergency fund up to reasonable limits. This will caution you from unexpected expenditures which tend to weigh down on financial planning’ thereby resulting in long term debts.

Building such a fund like any savings requires discipline and the funds should be in cash or near cash instruments. Remember the earlier you start any savings the less pressure you have in building up reasonable savings.

The main objective of an emergency fund is short-term insurance against unforeseen expenditure needs.    

After building an emergency fund, the next step is to come up with long-term investment objectives. In doing this, several factors must be considered; namely age, type and available investment opportunities amongst others.

Age is important because it determines the investment horizon or the duration within which you have to invest any asset. This is significant as various investments have different degrees of risks and returns. For instance, the return on equities or shares will vary significantly from fixed income securities like government bonds or bills.

The investment horizon also determines the ideal investments. If you have a short term to invest then it is not prudent to invest in asset classes that are very volatile like shares and property as you may lose a substantial portion due to market volatility which is inevitable in any assets class.

Risk appetite is determined by age and the younger you are, the higher level of risk you should be able to take, noting that the higher the risk the higher the return. As one grows old, the risk appetite should diminish nearly to zero at retirement age.

This is because a young person has time to recoup any losses whereas an older person would not have such a time if he or she lost out on investments. Accordingly, investment options vary depending on age.

While it is true that diversification or putting your eggs in different baskets mitigates risk, it is notable that the proportion or exposure to certain asset classes should be recommended based on age of the investor.

The next step is to determine the asset classes and the proportion of allocation to each asset class. There are direct and indirect investments. Indirect investments are where you put your assets in instruments that promise you a return without involving yourself in management of the same investments.

Examples include buying of shares at Rwanda Stock Exchange, placing a fixed deposit with financial institutions or purchasing Government of Rwanda Treasury Bonds and Bills, buying units at National Investment Trust (NIT), amongst others.

On the other hand, direct investment refers to setting up own business like venturing into transport business, retail, wholesale, amongst others. Direct investments may not be visible for employed people due to time constraints.

The writer is a Pension and Investment Consultant.



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