How does a 4.0% Annual Percentage Yield APY sound to you? Do you feel super excited that your assets were out of your reach for a whole year just to accrue 4% returns or do you feel shortchanged?
Would you sit throughout the whole long year just to celebrate a 4% APY? Well, apparently, these are the kinds of returns that most savings accounts attract. “Small” returns.
Some debates seemingly never come to an end. It sometimes feels as if peace or serenity is just an interlude and it is just a matter of time before the arguments resume. These kinds of perpetual debates include the Ronaldo vs Messi argument, overtaxing the rich versus normal taxation, owning a house vs renting, saving vs investing etc. While the latter three are more concerning debates, a common theme amongst them all is the army of advocates on each side of the divide.
In this piece, I attempt to solve the dilemma of choosing between saving and investing in today’s Nigeria and of course paying no attention to the arguing crowd by the side.
Do I even need to save?
George Clason in his 1928 classic, the richest man in Babylon, advised people to save first before spending or investing. Fast forward to over 70 years later in 1999, popular author Robert Kiyosaki proclaimed that saving is ridiculous and investing in assets is the best option. The poor reader who lays their hand on these two contrasting ideas finds themselves in an emotional mangle.
Those who argue for or against saving or investing treat it as an all-or-none event. Who says you cannot save and invest at the same time? They are not mutually exclusive hence both can be done at the same time.
As per CNBC experts, it is advisable to use the 50/30/20 rule. This means you allocate 50% of your income to recurring needs and expenses, 30% to savings and 20% to investing.
Yes, you need to save. Some people erroneously see saving as a luxury and not a necessity. This is erroneous because bad things will and do happen and we need to have some buffer in the form of savings when this happens. As per research done by Ramsey Solutions, only 55% of Americans have more than $1,000 in emergency savings. In Nigeria, you would expect this to be far worse. Most Nigerians live paycheck to paycheck and barely have any dime in savings. In 2019, the Nigerian Deposit Insurance Commission NDIC disclosed that more than 99% of savings accounts in the country had less than N500,000. It is indeed worrisome and risky to live without any sort of financial safety net!
The money you save for these sorts of emergencies is called an emergency fund. They come in handy when unforeseen events like a health condition, a job loss, an asset loss etc. It is advisable to have at least six times your income saved up in an emergency fund.
Setting up an emergency fund
To commit to allocating part of your income to your emergency fund is difficult. You will need a lot of determination and grit to keep allocating even though no need for the money is forthcoming. Here is how to build an emergency fund with ease in 2024:
- Determine what percentage of your savings would go into your emergency fund each month.
- Stick to that percentage and resist the urge to bend your rules.
- Consider automating allocations into your savings account. You may consider digital solutions like Cowrywise and Piggvest for this.
Can I grow wealth by saving?
Forbes experts describe compounding interest as “magic”. This just goes to show the astronomical potential that can be unlocked when the balance in a savings account is reinvested and accrues returns over time. When you keep your money in a savings account, it is compounded over time.
Let’s look at a scenario where I have N10m saved in an account. If I save at an interest rate of 5%, by the end of 14 years, the money would have doubled because of compounding. So if I stashed N10m in 2000, by 2014, the money would be worth N20m. This doesn’t seem like a lot but imagine if this money was stashed in a kid’s savings account immediately after they were born. By the time they turn 18, the money would be worth around N25m, accruing an extra, N15m in returns.
As you can see, savings can double your wealth in as little as 14 years thereabout, but the problem is your principal. Imagine having just N10,000 as your principal. By the end of the 14th year, you will have just N20,000. Apparently, savings do not do a great job in building wealth but fare well in wealth preservation and consolidation.
Sorry but there’s inflation
Ermm, our above calculations were a bit flawed. The reason is because we did not factor in inflation. Inflation is basically the reduction of the purchasing power of a currency over time. In our above scenario, it is unimaginable that the cost of items stayed the same between 2000 and 2014.
The problem with saving in Nigeria is that interest rates on savings are far outperformed by our high hyperinflation. For context, as per NBS, inflation in Nigeria stands at around 28.92%.
Investing vs Nigeria’s inflation
Unfortunately, if your saving returns do not outperform inflation then your efforts may not necessarily be of positive impact at the end of the day. This is because as we explained earlier, inflation erodes the meagre returns from savings.
That is why investing is sometimes encouraged than simply stashing monies for a meagre 4% APY. More than the mouthwatering returns investing promises, they help to preserve your assets from depreciation.
An investment in Meta stocks in 2023 would have 187.27%. This outperforms Nigeria’s hyperinflation by a multiple of more than 7! That’s a pretty smart way to ensure that your assets aren’t stuck in depreciating economic circumstances.
I love investing but isn’t it too risky?
Your first look at a stockbrokerage’s blog or your favorite stockpicker feed and one of the first things that catches your attention is the disclaimer, “If you choose to invest in any fund described or referred to in this Website, your capital will be at risk and you may therefore lose some or all of any amount that you choose to invest”. Did they just say all of my money? So I can lose all or my money investing. Well, not only do people lose all their money, in margin trading you may even incur debt that must be paid by law.
Contrary to what your favorite broker advertises showing a working mom who just goes about her normal daily routine and manages to squeeze a wink to scan the markets, invest and make a fortune, investing is difficult and very risky!
Risk appetite
Before taking the flurry into investing you must understand your risk appetite. One way to quickly have a self-assessment of your risk appetite is knowing how much you are willing to lose. This is because most investments like equities and commodities rarely just kick off and begin to print returns. Instead, they dip first and then start to appreciate thereby paying the investor for their confidence in the form of returns. These dips are called portfolio drawdowns.
How much of a drawdown are you willing to take? Say you have n N100,000 portfolio, what will be your reaction if you refresh your assets terminal and see a -20% (N80,000 remaining)?. Do you panic or are you calm and see it as a part of the investing business? Conservative investors cannot wrap their minds around large drawdowns and mostly stick to assets that pose lower risk. These assets are classified as low risk assets.
Aggressive investors on the other hand are more inclined on their returns and don’t mind a -30% decline in their portfolio. They have rules on how to exit should it become clear that an investment isn’t going to pay off but they don’t get too emotionally attached to their losses. You see this kind of investor heavily invested in equities, commodities, and more recently, digital currencies.
So there are low risk investments? Tell me about it.
Treasury bills, government-issued bonds, and low risk mutual funds are all great low risk investment vehicles. These sorts of investments have very downside potentials and to no surprise, their upside potential is also limited.
For example, as of September 2023:
- Stanbic IBTC bond fund (3.65% YTD) a fund that invests in bonds returned 3.65%. This means that a N1,000,000 investment would produce N36,500 in returns.
- Stanbic IBTC conservative fund (YTD 19.84%) a fund that invests primarily in low risk assets and quality equities returned 19.84% to investors. A N1,000,000 investment would produce N198,400 in returns.
Obviously, these low risk investments do not promise the best of returns but conversely, the risk of losses is way lesser than investing in digital currencies for example. In 2023, a digital currency called Solana appreciated more than 900%. A N1,000,000 investment would have yielded N9,000,000 in returns. This will take you about 45 years to make this sort of return if your mutual fund investment yields 5% returns. Apparently, with great risk comes great reward.
Setting up an investment portfolio
To balance things out, you may consider setting up a balanced investment portfolio. With this approach, you have exposure to both high-risk and low-risk assets albeit in varying proportions. Literally, it is akin to getting the best of both worlds.
Say your net income for the month is N1,000,000. Using our 50/30/20 rule, you set aside N200,000 for investing. This means you have N200,000 to play with.
You may decide to expose just 20% of your portfolio to high-risk assets. This would mean you may purchase equities like Nvidia(239% ROI in 2023), Tesla(105.5% ROI in 2023) and Bitcoin(157.08% ROI in 2023). This 20% may be across three assets for diversity. Using returns from 2023, the N40,000 investment in risky assets would produce N66,718 in returns.
With the remainder of your portfolio, you may invest in four low risk assets sinking 20% in each. Say you invest in ARM ethical fund (YTD 7.2%), ARM money market fund (YTD 13.01%), Stanbic IBTC bond fund (YTD 3.65%) and Stanbic IBTC conservative fund (YTD 19.84%). These would produce N17,480 in returns from investing N160,000. This is roughly 10% in returns.
In total, the N200,000 would have been able to yield 42.09% ROI which amounts to N84,198 in returns.
Setting up a balanced savings portfolio
Say your net income for the month is N1,000,000. Using our 50/30/20 rule, you set aside N300,000 for investing. This means you have N300,000 to save in your emergency fund, save up for that new house and car and save for your kids or retirement. Sometimes it gets overwhelming. How do you go about this?
The solution is implementing the 50/30/20 rule again on the total amount set aside for savings.
You may consider setting aside 50% for saving up for big projects like a new house or car, house rent, a wedding ceremony etc. This would amount to N150,000 being set aside for this purpose.
30% is set aside for emergency purposes. This would amount to about N90,000 being stashed aside every month. At the end of the year, you would have put aside N1,080,000. In six years, you would have set aside six times your monthly income( this is without even considering compounding interest) allowing you to switch careers without much hassle if necessary.
The remaining 20% can be split in half with 10% going into retirement savings and the other 10% being saved up for your kids. This would amount to N360,000 for each purpose each year.
If your career spans 30 years what would you have saved? When your kids turn 18 what would you have saved?