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### Managing Personal Finances in South Africa

# Garth Coppin

Copyright 2015 Garth Coppin

ISBN 978-0-620-65887-4

Smashwords Edition

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Table of Contents

Chapter 1 – What this book is all about

Chapter 2 – Using graphs and data

Chapter 3 – Compound interest

Chapter 4 – Attitude towards finances

Chapter 5 – Consumer Price Index

Chapter 6 – Budgets

Chapter 7 – What money is spent on

Chapter 8 – The use of credit

Chapter 9 – Housing, vehicles and appliances

Chapter 10 – Children

Chapter 11 – Savings for goals and retirement

Chapter 12 – Insurance

Chapter 13 – Taxes

Chapter 14 – Retirement funding

Chapter 15 – Giving

Chapter 16 – Other issues

Chapter 17 – Reflections

About the author

### Chapter 1 **– What this book is all about**

To drive a motor vehicle legally I need to prove that I have mastered the necessary skills to drive a vehicle and am able to drive on roads without being a danger to others. How do I prove I am allowed to drive a car legally? I can produce a driving licence which needs to be renewed periodically to show my eye sight is still good enough for driving.

What proof do I need to show that I have the necessary skills to manage finances before being allowed to manage my own finances? Nothing, absolutely nothing, even though the potential damage can, like driving mistakes, be devastating. A lack of financial skills is not a barrier to being able to carry out financial transactions, such as being able to buy, sell, borrow or invest. Financial mistakes have the potential to ruin a person for the rest of their life and can affect family members as well.

It is worth considering how well South Africans are managing their finances. Recent comments in the press indicate the following:

  * The amount of debt of South Africans when compared to their annual income is, on average, much higher than it was in previous years
  * A large number of South Africans have impaired credit records
  * A relatively small number of people are able to retire comfortably financially
  * A large portion of the public wants to learn how to save more.

Accordingly this book is aimed at those who want to improve their financial skills and aims to be of assistance to those who want to live healthily from a financial perspective. Life will judge whether people have 'passed' the test of living financial healthy lives. As a person gets older it is likely to become more difficult to improve their financial health, but not always impossible. Accordingly, if a person has the right approach to finances early in their working lives, it improves the chances of them having healthy finances when they reach the end of their working life.

In a book I was reading recently ( _What are the Chances of That_ , by William Hartston), it said that 88% of people in the United Kingdom see financial problems as a trigger for depression. This book is written from a South Africa perspective and so if the views of South Africans are similar to the British, then there seems to be a need for help on financial issues. This book is about what I have learnt about the various aspects of personal finances over many years and my views on financial issues; which I believe others should be considering. In some areas there are not right or wrong ways of doing things, but different ways of doing them, and so this book is about the various areas to the considered from a financial perspective, the choices available and in some cases the way I chose. Even if a person was to follow the ideas noted in this book, it wouldn't guarantee financial success, but it should help that person on the way towards living in a financially responsible manner.

I started thinking about how to live healthily from a financial perspective about the time I started working, which is now over 40 years ago. I heard a quote then to the effect that few people are able to retire with financial comfort in South Africa. If I recall correctly the number was about 6%, which still seems to the current number. At that time I didn't have much financial knowledge on how to achieve that goal, or even know whether I would be able to accomplish it, but I started out trying to ensure that on a daily basis I was able live without too much financial stress. This book is about what I have learnt along the way. As I have reached retirement with sufficient funds I believe I have achieved that goal, even though I have had to cope with various challenges along this way. This book reflects on my learnings and what I think others should be thinking about in relation to their personal finances.

For the purposes of this book I define financial health as living with limited financial stress during one's working life with the ultimate goal of being able to retire without financial strain.

People should be able to manage some of their finances on a 'do-it-yourself' basis, with some requiring more help in certain areas then other. This book is aimed at those wanting more information on the 'do-it-yourself' aspects of personal finances. This can help them gain more confidence in dealing with the various areas of personal finances themselves as well as assist them dealing with professional advisors. That said, there are always some areas where it would be wise to use professional advisors, particularly in complex areas, issues subject to change and areas not commonly dealt with. While a person might want to save on the advisors fees, in some cases this might be a case of _'penny wise, pound foolish.'_

While authors generally know the contents of their books before they write them, I have another objective in writing this book; namely to learn. This is because one should continue to be open to learn even as one ages. One lesson I learnt about a dozen years ago, which I wish I had learnt while I was at school, was that we have different learning styles. Winston Churchill did poorly at school probably because it didn't cater for his way of learning, namely learning by writing.

Accordingly this book will contain information that I will learn from writing, because that is also how I learn. While I don't by any stretch of imagination claim to have the same literature skills as Churchill, who won a Nobel Prize for literature, hopefully this book will help some to improve their financial health. There are some areas where I want to obtain more information, but I suspect that in other areas I will gain additional insights from reflecting on issues being written about.

What the rest of the book is about

Before the various aspects of personal finances are considered in detail in later chapters of this book, there is merit in having a quick overview of some of the major issues to be covered in this book.

In order to make sense of financial issues, there are some useful starting points; these are dealt with in chapters 2 and 3. Often when looking at financial issues graphs can be used to help give a picture and as they say _'a picture is worth a thousand words.'_ Accordingly **chapter 2** will give some tips on the use of graphs and data.

Albert Einstein is widely rumoured to have once said that _"compound interest is the most powerful force in the universe."_ Whether this is correct or not compound interest plays an important role in the creation and destruction of wealth. **Chapter 3** is devoted to dealing with this topic.

A person's attitude towards finances is, in my view, the most important determinant for influencing whether people live healthily from a financial perspective. **Chapter 4** deals with attitudes, as well as identifying those who are less likely to be able to achieve financial health.

For those who earn a salary, whether salary increases match the consumer price index (CPI) can be important to that person. **Chapter 5** explains how the CPI is determined, whether increases in CPI can be expected to match the increases in the expenses of individuals and how to use the CPI to manage expenses.

The ability to manage expenses is the most likely cause of financial problems. A budget is the best way to manage expenses, but unfortunately this is avoided by some. **Chapter 6** gives guidance on how to set budgets and to track actual expenses.

**Chapter 7** deals with some major categories of expenses and other payments. Using financial records I have kept it shows that expenditure by category can change over time and also how some expenses compare to the CPI over time. This chapter also notes that by monitoring cash flows that this can help to focus on whether the amounts spent on the various categories is appropriate or not.

In this day and age it can be easy to obtain credit. **Chapter 8** comments on the use of credit, when credit is appropriate and what 'bad' credit is.

Following on from the use of credit, **Chapter 9** deals with the financial aspects of housing, vehicles and appliances as these are important aspects of being able to live comfortably in South Africa and as credit can be used to acquire them.

Most families have children and as much as they can be a joy, they can be a cost for many years. **Chapter 10** comments on the financial aspect of having children and eventually weaning them off their parents financially.

While having expenses being equal to or being less than income is an important starting point in looking at financial health, saving is also important. This can be savings for unexpected expenses, a dream holiday, an expensive new 'toy' or for retirement. Accordingly **chapter 11** deals with optional and obligatory savings.

One area of grudge purchases is insurance. **Chapter 12** covers short-term and long-term insurance, including medical aid cover and why insurance is necessary.

Benjamin Franklin said, _"The only things certain in life are death and taxes"_ to which one unknown person responded _: "Death and taxes may be certain, but we don't have to die every year."_ Income tax can be one of the largest expenses we incur, even though we might hate paying it. Some people go to the effort of avoiding paying tax and might end up regretting this at a later point, whilst living with a guilty conscience in the meantime. Taxes are covered in **chapter 13**. This covers all forms of tax we pay such as income tax, Value Added Tax (VAT), Capital Gains Tax (CGT), estate duty, transfer duties and rates. While the ability to reduce taxes legally is limited, this chapter mentions the more common ways the payment of taxes can be reduced or postponed.

**Chapter 14** deals with retirement funding. It covers the common ways people can accumulate funds for retirement; whether pension or provident funds are sufficient for retirement; the different types of annuities that can be used to obtain monthly pensions; what expenses should be changing upon retirement; when to retire and the use of lump sums. It also covers how to prepare for retirement, as well as the extent of funds needed for retirement.

Whatever our financial situation there will always be those that are less fortunate than ourselves. **Chapter 15** provides comments and thoughts for consideration concerning giving of time, effort and money to worthy causes and my views on lotteries.

Some remaining issues are dealt with in **chapter 16**. This includes holidays (including timeshares), the use of loyalty schemes, providing sureties and an area that has the potential for major problems, namely managing finances as a couple.

Finally, **chapter 17** summarises some of the main points of this book and sets the scene for those who want financial health and who have the will to take the necessary action. It also notes what I learnt while writing this book.

What the book doesn't cover

For the sake of completeness it is also important to know what this book doesn't cover. The book focuses on what a person might do with their income, namely their expenditure and investments, but not on how to achieve income. The book is suitable for those who earn a salary, but doesn't deal with issues such as how to maximize a salary, whether and when to change jobs, including whether to move to another town or city, or how to choose an appropriate job or career.

For those who work for themselves, including entrepreneurs, this book can also be used to assist with living in a financially mature way, as long as a reasonable amount is allocated towards living expenses. For those who only receive large amounts irregularly the book can still be used profitably, but some adaptions might be necessary. For example, the fact that it could be a few months or longer before the next amount of income is expected to be received should be taken into account when determining one's standard of living. This includes having discipline in spending amounts received over a period, instead of all at once.

While the book covers investments, it explains the various types of investments, but is not intended to be used as investment advice, as what is an appropriate investment can change over time, This is because an appropriate investment needs to take into account the current and expected future economic circumstances, a person's risk appetite, the related tax consequences, the ability to dispose of assets if needed, but can also change as retirement approaches. A financial services advisor is a person registered to provide such advice on which investments people should be investing in and should be consulted on specific investments when people need assistance when deciding on investments. Those who are not a financial services advisor are however allowed to provide factual information on the various types of investments available. Accordingly this book provides factual information on investments; in addition I am not in the business of advising others on their investments but a person who has managed my own finances successfully with some help from advisors.

Some people may need to make use of professional advisors to help them manage their financial affairs. This can relate to insurance, investments and tax affairs and can include the use of trusts and off shore investments. Those that need such advice should be able to afford to pay the necessary fees for such advice, but this book should assist them in assessing whether they are being given appropriate specialized advice.

The state of some people's finances could be such that it is too late to just follow the suggestions in this book. They might need to take drastic steps, including going into debt review or insolvency, which involves courts to stop creditors taking action against them and agreeing upon a repayment plan. Those in this unfortunate situation should consult with those with the appropriate skills and experience, as this book is intended for those who have the ability to manage their finances without the need to involve courts.

### Chapter 2 **– Using graphs and data**

When dealing with financial information it is often useful to make use of graphs. It can be useful when viewing continuous information, such as the share price of a company over a period of time. It is also useful when comparing information, such as whether a share price has increased more than the inflation rate, or to make sense of a lot of data, for example, when comparing the relative share price of a number of companies over a period.

It is for this reason that graphs can be useful in quickly obtaining an understanding of data. However, readers need to be aware that they may get a misleading picture from just a quick look at the information presented. Accordingly they need to understand what the graph is trying to represent, including what data has been captured. Some graphs can give a distorted trend, which I suspect in some cases might be deliberate, therefore graphs should be used with caution.

Let's look at some examples.

Periods covered in graphs

Table 2.1 - Comparing share prices of two companies

Table 2.2 - Comparing share prices of two companies

In both tables the share prices of two companies are compared over a period of time on a relative basis. This means the actual share prices are adjusted so that they are both assumed to be 100 at the beginning of the period. For example, if at the beginning the share price of Company A is R20, it is multiplied by 5 to get 100. The actual share price throughout the period is also multiplied by 5, so while it shows 130 at the end of the period in Table 2.1, the actual price is R26 (130/5). The same applies to company B; if its price at the beginning is say R5, this price is multiplied by 20 to get 100 and while Table 2.1 shows 110 at the end, the actual price is R5.50 (110/20).

Now assume you had the opportunity to spend R1,000 on buying shares in either Company A or Company B. If you looked at Table 2.1 you would say that over time Company A's share price has performed better than Company B's, because over the period Company's A share price has increased by 30%, while Company B's share price has only increased by 10%. Based on this you might decide to invest in Company A purely on the graph.

If we look at Table 2.2 and had the same choice you might decide based on the graph to invest in Company B, as its share price has increased by 28%, while Company A's share price has only increased by 20%.

If I told you that Company A and Company B were the same in both tables then your investment decision might be more difficult. What you weren't told was that Table 2.1 covered a 6 year period, whereas Table 2.2 covered the last three years of this six year period, so Table 2.2 is in essence the second half of Table 2.1 with the share prices adjusted, so that their starting points are the same.

When using graphs such as the above be sure to understand what period is being covered by the graph and what starting point has been used and why. I suspect that sometimes the starting point that is used is deliberately selected to bolster a point the presenter wants to make. Normally when comparing prices over a period it is better to use a longer period, say 5 or 10 years, unless that is not appropriate (e.g. the company was only listed, say, 3 years ago). Be careful if the period seems arbitrary (e.g. 2 years 4 months) without explanation, as this could indicate that a biased picture is being painted. While the period might be justified, for example, to show the increase in prices from when a share price index bottomed out, this should be clear from comments accompanying the graph.

Compression of information

Table 2.3 - Share price over 6 years

Tables 2.4 and 2.5 - Share price over 6 years

Table 2.3 and 2.4 both graph a share price over a 6 year period, but in table 2.4 the price increase seems to be steeper than in Table 2.3. In fact the same share prices are used in both graphs; but in table 2.4 the graph is more condensed horizontally which has the effect of accentuating the changes.

Normal vs logarithmic scale

When Table 2.4 and 2.5 are compared, they are the same size, so that the effect of condensing information horizontally is removed. In this case, the price increase in Table 2.4 seems steeper than in Table 2.5. Again, the same share prices are used in both graphs; it is just that the vertical scale has changed to a logarithmic scale in table 2.5, which reduces the impact of increases. Accordingly caution needs to be taken in understanding the scales used in graphs.

It might seem that the use of logarithmic scale is misleading, but this is not always the case. When data is presented over a long period, e.g. 30 years, particularly where information (e.g. average house prices) has been impacted by inflation, if a normal scale is used the increases might be exaggerated. A normal scale shows prices increasing steeply in later years, but if a logarithmic scale is used it typically gives a better view of the trend of prices, namely whether they are fairly even over a period, as can be seen in tables 2.6 and 2.7 below.

Tables 2.6 and 2.7 - Amounts increasing annually by 6%

Starting point on graphs

The graphs used so far use lines to indicate changes, but other types of graphs can also provide pictures that can be misleading, unless the reader is alert to this. Consider tables 2.8 and 2 9 below.

Tables 2.8 and 2.9 - Dividends over the past 3 years

These graphs show the dividends that a company paid over the past three years. Table 2.8 suggests there have been large increases over that period, whereas in Table 2.9 it seems the increases have been more modest. In this case the dividends are exactly the same, namely 100 cents in year one, 105 cents in year 2 and 115 cents in year 3. What is different is where the graphs start; Table 2.8 starts at 90 cents which has the effect of accentuating increases, while in Table 2.9 it starts at zero and gives a true picture of the increases.

Accordingly where a graph starts can affect how information is understood.

Using percentages vs amounts

The next example is one I realised recently I was party to in giving information that was probably misleading, as I was the treasurer of the organisation involved. The graphs in Table 2.10 were used in the raising of money for two projects. The graph shows progress made, with giving towards project 1 being 90% of the budgeted income, with giving for project 2 being 103% of what was budgeted. What the graph didn't show is that the budget for project 2 was only 4% of that of project 1. So while the graphs suggest that the projects were of similar size and that on an overall basis the giving was close to the budgeted amount, this was definitely not the case, with the surplus on project 2 having hardly any effect on the deficit on project 1.

Table 2.10 - Comparison of actuals with budget using percentages and not amounts

Condensed data

This chapter so far has dealt with information given in the form of graphs, but information can be given in other forms as well. The information in the table below is typical of information given in the press on unit trusts.

Table 2.11 – Value of investments over one and three years

This table indicates that holding unit trust Y would have been a better option than unit trust X both over one and three years. Now let's look at other information on the same unit trusts, with unit trust X being the local units and unit trust Y being the foreign units.

Table 2.12 – Price of units over 15 years

The following comments arise when considering this graph:

  * While table 2.11 shows that over a one and three year period unit trust Y (foreign) had a better performance than unit trust X (local), but over the fifteen year term in the above graph this is not the case, with the local unit trust performing better than the foreign unit trust. In this table A is the end of the three years and B the beginning.

  * The data in table 2.11 just shows information at two points of time, but doesn't give information in between those dates. If similar data was obtained about 5 years earlier it would show that the end point (C) was about 33% higher than the beginning point (D) for the local units and about 16% for the foreign units.
  * If the data for points C and D only had been provided it wouldn't have shown the following:

  * At point C prices were dropping

  * In between points C and D prices had risen before falling

  * Point C was substantially below its highest point in the past 3 years

  * If point B was the end point and point C the start the price of the local units dropped about 6% over 2 years and about 8% for the foreign units. In that period prices had dropped, but were increasing.

This shows, that while the data in table 2.11 provides useful information, it doesn't tell you whether prices were increasing or decreasing at the selected points, nor what happened in between. In addition, if different periods were used (e.g. five or ten years) then a different picture might emerge.

This type of data is often used to show data covering all available unit trusts, where providing graphs for each unit trust would not be practical. Accordingly, the limitations of using such data need to be appreciated.

I am sure there are other examples of graphs and data possibly giving a misleading or incomplete picture. Hopefully the examples above illustrate the need to be careful when reading graphs and data. In the remainder of this book, when graphs or data are used, the reader should assess as to whether they are misleading or not.

### Chapter 3 **– Compound interest**

Wikipedia states that _"Compound interest arises when interest is added to the principal of a deposit or loan, so that, from that moment on, the interest that has been added also earns interest. This addition of interest to the principal is called compounding."_

Compound interest is a powerful force that can significantly increase the value of assets as well as significantly reduce wealth through increasing liabilities. The longer it is allowed to affect the amount of assets or liabilities the more effect it has. Albert Einstein is rumoured to have said that compound interest is the most powerful force in the universe.

Impact of compounding over different periods and frequency of compounding

When looking at compound interest, it needs to be determined how often compounding occurs. Sometimes it might only compound annually, but it can also compound monthly. For example, a person might have a fixed deposit of R10,000 for five years, with an interest rate of 5% compounded annually. This means that for the first year the person will receive interest of R500 (5% of R10,000), while in the second year they will receive interest of R525 (5% of R10,000 plus R500) as the interest for the first year is reinvested. On the other hand, if a person has a mortgage bond, the interest would normally be compounded monthly.

The difference between no compounding of interest and interest being compounded annually and monthly is illustrated in the table below. This is similar to the graphs in tables 2.6 and 2.7 above, where an interest rate of 6% was charged, which was compounded annually.

Table 3.1 – Amount of R1,000 invested at 6% interest rate

This table shows the difference between compounding and no compounding over a short period is not much, with it only having a 0.2% impact over one year and 4% over five years. However, for longer periods it has a major difference with it resulting in the investment growing 180% over 30 years with no compounding, but a massive 502% if interest is compounded monthly. At that date, with interest being compounded monthly, the amount of the investment is 115% more than it would be if the interest wasn't compounded. This percentage increase is 222% if the funds are invested for 40 years. The percentage difference nearly doubles between 20 and 30 years and nearly doubles again between 30 and 40 years.

The one fact that surprised me in compiling this table is that the difference between interest being compounded monthly and it being compounded annually is less than I expected.

Impact of compounding on retirement funding

Where does compounding have relevance? One example is the impact it can have if a person delays saving for retirement. The above table starts with a lump sum, but when saving for retirement a monthly amount is frequently contributed instead. Let's say a person starts saving R1,000 per month at the age of 25 and intends to retire at 65. This means that the person will have saved R480,000 over 40 years. If the return on the investment is 6% per annum, the person will have an investment worth R1,991,491 at age 65.

The table below shows the impact of delaying saving for retirement; by showing the amount that needs to be saved per month, if the same end investment value is wanted at age 65, using an unchanged return on investments.

Table 3.2- Achieving an investment worth R1,991,491 at age 65 assuming a return of 6% per annum

This table shows the impact of delaying saving for retirement. If the start date is increased 10 years to 35 years of age, the monthly contribution required to achieve the same amount at age 65 has nearly doubled, increasing from R1,000 per month to R1,983 per month. If the start date is delayed a further 10 years to 45 years of age, the monthly amount is no longer R1,000 per month, but R4,310 per month. While it might be tempting to say that the increased amount could possibly be afforded at a later date, if a person doesn't have a habit of saving at a young age, it will be more difficult to start at a later age, particularly if this requires expenses in other areas to be reduced.

Impact of compounding on mortgage bonds

Another area where compounding has a major impact is on home mortgage bonds. The amount of interest that is paid on a bond might not be appreciated. The table below shows the amount of total payments and the amount of interest that is paid on a bond of R1,000,000, based on an interest rate of 8.5% per annum using different repayment periods.

Table 3.3 – Bond of R1,000,000 repayable using interest rate of 9% per annum

This table shows using a 20 year bond, which is the normal period for repayments, that a home owner pays more by way of interest (namely R1,159,342) than capital of R1 million. It also shows that by increasing the repayment period to 25 years the monthly repayment is reduced by 6.7%, but that the interest amount increases by over 30%. It also shows that by reducing the repayment period from 20 to 15 years the monthly repayment increases by 12.7%, but the total interest paid reduces by close to 29%. It is for this reason that financial advisers recommend that bonuses received are deposited into bonds and that part of salary increases are also used in this way. In addition, it is beneficial to keep repayments the same when interest rates decrease.

The table below shows the impact on the repayment period and the amount saved by paying more than the minimum amount into a bond of R1 million, using an interest rate of 9% from the start of a 20 year mortgage bond.

Table 3.4 – Increasing bond repayments assuming a bond of R1,000,000 repayable at an interest rate of 9% per annum, with a starting repayment period of 20 years

Accordingly if the bond repayment is increased by R90 per month (1%), it has the effect of reducing the repayment period by 6 months. This means the total payments are R2,126,358 which is R32,984 less than if the monthly repayments had not been increased; this is a reduction of 1.5% in total payments. Likewise if it is increased by 5% (R450 per month), it reduces the bond period by over 2 years, with total repayments decreasing 7.3%.

Impact of compounding at various interest rates

Finally, it needs to be appreciated that the impacts illustrated above are even more pronounced as interest rates increase. For example, in table 3.3 the interest payable on a 20 year mortgage bond is 116% of the capital assuming an interest rate of 9% per annum. The table below shows this percentage using other bond rates.

Table 3.5 – Impact of interest rates on a 20 year mortgage bond

This illustrates that using an interest rate of 15%, which historically has been paid at some stages in South Africa on mortgage bonds that the total interest paid was more than double the capital being paid.

Likewise, using information included in table 3.1 above showing the growth of investments, if the investment earned 10% per annum, instead of 6% used in that table, that over 30 years the investment would be worth R19,837 if compounded monthly (against R6,023 at a 6% interest rate), which is 395% more than R4,000 which the investment would have been worth if interest was not compounded. This compares to 115% at a 6% interest rate. This also shows that the investment amount of R19,837, which was achieved using an interest rate of 10% is more than 3 times the amount it would have been if the interest rate was 6%. The multiplier impact is so much more at higher interest rates, which I hadn't appreciated until doing this calculation.

This explains why higher interest rates can be so attractive, but it also shows how prices can increase with inflation. With a 6% inflation rate the price of an item increases from R1,000 to R6.023 over 30 years, but to R19,837 over the same period if the inflation rate is 10%. This can be scary to a pensioner whose pension does not increase in line with inflation.

Compound interest can be a friend or foe depending on how it is used.

### Chapter 4 **– Attitude towards finances**

For those who want to live in a healthy way financially, I am firmly of the view that this can only be achieved by having the right attitude towards finances. What do I mean by this?

This chapter deals with how finances are viewed and dealt with. This has to do with the philosophy of finances. Is money something we spend as soon as we receive it, or are we hoarders and do we keep any financial records?

I believe that in order to have financial success discipline is necessary. As I will mention later even discipline might not be enough, but without discipline it will be very difficult to have financial health. By discipline I mean having some idea of what amounts you receive, what you will spend it on and knowing whether you will have funds for purchases that will be paid for later.

Charles Dickens in his nineteenth century book David Copperfield, has the character Micawber say _"Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six pence, result happiness. Annual income twenty pounds, annual expenditure twenty pounds and six pence, result misery."_ While this might have been written in a period when debtors were regularly imprisoned if unable to pay debts, it nevertheless illustrates the type of attitude that is needed for financial health.

Stanford University Marshmallow Test

The Stanford marshmallow experiment refers to a series of studies on delayed gratification in the late 1960s and early 1970s led by psychologist Walter Mischel then a professor at Stanford University. In these studies, a child was offered a choice between one small reward (sometimes a marshmallow, but often a cookie or a pretzel, etc.) provided immediately or two small rewards if he or she waited until the experimenter returned (after an absence of approximately 15 minutes). In follow-up studies, the researchers found that children who were able to wait longer for the preferred rewards tended to have better life outcomes, as measured by SAT scores [a standardized test for most college admissions in the United States], educational attainment, body mass index (BMI) and other life measures.

[Source: Wikipedia]

One of the conclusions of the above test is that some might find it difficult, not only early in life, but also later in life to have much self-control, which might also extend to their financial life. This means that some might find it difficult to have the required self-discipline to have a healthy financial life, because a large part of that discipline is resisting buying items on impulse and ensuring there are sufficient funds for purchases. Thus for discipline there might be a need to delay purchases, because it may be more expensive in the long term to make purchases without having the necessary funds immediately available to pay for the items as the previous chapter on compound interest illustrates. Some might never succeed in having financial health, while others might need help in this regard, either from a spouse, family member or financial adviser. I suspect that attitudes towards financial issues might be a major cause of conflict in many marriages where the spouses might have different views as to where money is spent, whether to save or not and what is a reasonable amount to spend on categories such as clothes, entertainment and luxuries.

I was fortunate in learning one of the most important financial lessons shortly before marrying. Strangely I learnt this lesson in a book found in the humour section of a library. While I learnt a number of lessons from this book it was a difficult book to categorise because it starts with the question as to whether the book is a joke, which it doesn't answer. It says readers of the book think it is a bizarre new management theory or an elaborate joke aimed at the business community.

This book, The Company Savage by Martin Page deals in one of its chapters with the Law of Executive Insolvency which argues that it is futile for an executive to live within their means; however hard they try their expenses will always exceed their income. I think many today, and not just executives, seem to live according to this rule. Whether I wanted to refute this law or to show it was a joke I am not sure, but this law definitely had a major influence on my attitude towards finances.

The way I internalised the rule was as follows – people live not according to their current income, but according to the income they expect to receive with their next salary increase. This has been illustrated to me in a number of ways. When I moved to Johannesburg in the late 1980s we bought a house, but between buying the house and taking ownership the bond rate went up three times. When we bought the house it was at a price close to the limit we could afford and as a result of the increases in bond rates we decided to delay some changes we wanted to make to the house. We found however that for some others we knew they didn't adjust their lifestyle at all, but seemed just to increase their liabilities instead.

In an article I read in a financial magazine a while ago (Finweek, 11 July 2013 – Why entrepreneurs should drive old cars) the columnist recalled attending a course on goal setting. Apparently for 80% of the attendees, their biggest goal was to get out of debt within five years. According to this columnist, the worst part of this goal was that it didn't include some of the most obvious ways to achieve this, namely changing to a more modest vehicle or cutting back on their lifestyles; instead it depended on earning more to clear debt. Thus to achieve financial health, I argue there should be an assessment of the current lifestyle.

The attitude of living based on future income might also be evident in trade unions making wage demands. There has been a call for a living wage, which presumably means unions are arguing that income is not sufficient to meet expenses. If expenses are based on what future wages are expected to be, then of course expenses will exceed current wages. While not denying that trade unions may have legitimate demands, this should also be balanced by an assessment as to whether it is possible to live on the current wages. If wages are expected to maintain a certain standard of living that is one thing, but it seems that sometimes trade unions want their members to enjoy an increased standard of living, which might be a legitimate aspiration, but arguably not without improved productivity on behalf of the employee.

The impression I have from reading articles over many years is that there are those who have an internal monster which needs to be fed; it says Buy! Buy! which they regularly do in order to feed the monster, which is never satisfied. The joy of making a purchase is short lived before they have an urge to visit shops again, possibly to buy clothes, shoes or other items which might rarely be worn. They can also want to be seen wearing the latest branded items, not realising that being viewed favourably by others is not something that creates real friendship and that the only real satisfiers are not items of desire but living at peace with oneself.

It is no use living beyond one's means during one's working life as so called friends are likely to evaporate as soon as help is needed to fund retirement. It is better to live frugally with real friends and then have a comfortable retirement. It is also no use acting like an ostrich and sticking one's head in the sand and acting as if financial problems don't exist or will disappear, because problems are likely to grow if not dealt with. It is better to deal with big problems now than problems that could become insurmountable if not dealt with timeously.

Life is like a race, it doesn't matter who is winning in the early stages, but how one finishes is what counts. Accordingly in the living one must pace themselves for the end.

I suspect that many don't ask themselves whether their purchases are needs or desires. While purchases to meet needs are normal, purchases of items to meet desires can be questionable. If I have the funds to acquire these items it might be acceptable, but if I don't then that can be an indication of an unhealthy attitude towards finances. In this day and age when many want instant gratification, an approach of waiting until I have sufficient funds to acquire an item is likely to be derided, but no one has said that the road to financial health is easy. It is for this reason that discipline, which means possibly swimming against the stream, is required.

Even if a person has funds for a desired item, it should still be questioned whether the item should be acquired. Am I spending money because I am jealous of my friends'/co-workers'/neighbours' house, car, clothes, sound system, smartphone, jewellery or other items that they show off? It is likely that some will not answer this question truthfully, even to themselves, but find some other reason to justify the purchase. Nevertheless this question is probably a good test of whether a person has a responsible attitude towards finances.

Is this question much different from the last of the Ten Commandments, which says _"You shall not covet your neighbour's house. You shall not covet your neighbour's wife, or his manservant or maidservant, his ox or donkey, or anything that belongs to your neighbour"_ other than the question having been updated for 21st century items?

Other's views on finances

The Bible also warns that the love of money is the root of all evil. Those that go overboard with the love of money could have problems obeying the first of the Ten Commandments, where God says _"You shall have no other gods before me."_ A minority might go to the other extreme and think money (and not the love of money) is the root of all evil. Thus a balanced approach is needed towards finances.

The Bible gives some advice about money. For example, the book of Proverbs says:

  * Place people's needs ahead of profit (chapter 11:26)
  * Be careful about borrowing (22:7)
  * Store up for the future (21:20)
  * Be generous in giving (11:24,25 and 22:9)
  * Help the poor (19:17 and 21:13)
  * Be cautious of being a surety for another (17:18 and 22:26,27)

King Solomon who wrote many of these proverbs also wrote the book of Ecclesiastes in the Bible. In chapter 10 of this book he says that _"He who loves money will not be satisfied with money, nor he who loves wealth with his income; this also is foolishness."_

Over the years there are many who have expressed their views on money. Here is a selection of some of them:

  * For I don't care too much for money, for money can't buy me love – John Lennon
  * Money can't buy friends, but you can get a better class of enemy – Spike Milligan
  * Money, it turned out, was exactly like sex, you thought of nothing else if you didn't have it and thought of other things if you did – James Baldwin
  * Money differs from an automobile, a mistress or cancer in being equally important to those who have it and those who do not – Kenneth Galbraith
  * Remember time is money – Benjamin Franklin, showing he understood the concept of compound interest
  * To be clever enough to get that money, one must be stupid enough to want it – GK Chesterton
  * We haven't the money, so we've got to think – Ernest Rutherford
  * You can be young without money but you can't be old without it – Tennessee Williams
  * Money flows to those who demonstrate that they can manage it, and flees from those who don't – John Demartini

And then there is the one that was on paperweight that I was given many years ago which said _"If you are so clever, why ain't you rich?"_

Can all have financial health?

It is important to consider the question as to whether it is possible for everyone to live healthily financially. This book starts with the comment that possibly only about 6% of people live in comfort when they retire. I don't believe that will ever be 100%, but if people had discipline and the right attitude that number could increase, but for this to occur people need to help themselves, assisted by structures that help achieve this target, such as compulsory retirement savings.

As the Stanford University marshmallow test illustrates there will be those who will battle with the required discipline. Sadly there will also be those who don't want to take responsibility for their own finances and blame others when their financial situation is dire. I personally know of couples who have been given financial advice but haven't followed that advice. This includes having a full time maid and eating out frequently, when the wife doesn't work and should be able to do these functions, and paying a child's monthly bills even though the child has a reasonably paid job.

There will also be those who will battle financially because of circumstances. This includes:

  * Having a disabled child, spouse or parent, which could have been from birth or an accident
  * Being unemployed for a lengthy period of time
  * Losing assets, whether from investments going into liquidation, a surety ship being called up, theft or from fraud
  * Divorce
  * Supporting children or parent or, in some instances, both children and parents financially.

In some cases people can do nothing about their circumstances, such as a birth defect or retrenchment, but in other cases they might not be willing to acknowledge their responsibility for their own circumstances. If an accident is due to driving with a high blood alcohol level, it is unfortunate if the injured driver was sober, but for the injured drunk driver they should accept responsibility for their own actions instead of blaming it on an accident, implying it was out of their control.

If the reason for long term unemployment is due to resigning without a replacement job, then it needs to be asked whether this was a wise decision. While valid reasons may be given justifying the resignation, such as having a monster of a boss or no annual increase in salary, these can be excuses and not reasons; for example the person might not be pulling their weight in their job.

People can also be affected by other's financial health. If a parent didn't provide adequately for their retirement, the burden can fall onto their children. In addition, children might not have been set a good example by their parents, or their parents might not have provided them with guidance (assuming this wasn't their responsibility?) and end up supporting those children for an extended period after they have finished school.

Even when people are making good efforts to live in a financially healthy manner, events late in life, such as accidents and divorce, can destroy that health. The problem is at that stage it might be too late to recover.

Divorce, which seems so common in South Africa, in my view, could have been avoided in many cases with the right attitude. Some people don't want to face and deal with financial difficulties; the same can apply in marriage where undealt with issues can become insurmountable. In some cases the issues might be financial themselves, where, for example, one spouse is spendthrift, while the other is miserly. This isn't helped in many cases by spouses thinking they are entirely blameless and that the other spouse is entirely to blame. While not being qualified to be an expert on this topic I suspect that there is some blame on both sides in more cases than spouses will admit.

The issue of divorce has probably been made worse in South Africa by the Bill of Rights in our Constitution. This seems to have led to many focusing on their own rights and probably in many becoming selfish in many areas of their life. Accordingly I suspect that selfishness plays a large part in divorce where one party wants a divorce on the basis that the other spouse hasn't met their needs. I believe a successful marriage requires both spouses to consider their obligations as well, namely am I meeting my spouse's needs, instead of focusing on my own needs. While this is not a guarantee of success, I believe it will improve the chances of success.

Likewise a right attitude towards finances will not ensure financial health, but it is likely to improve the prospects of financial health.

Maslow's Hierarchy of Needs

Attitudes towards finances can also be affected by what motivates people. Abraham Maslow developed a theory commonly known as Maslow's Hierarchy of Needs in the mid-1900s. His theory states that there are five levels of need and that the needs at one level need to be met before an individual will look to satisfy needs at a higher level. His theory states that the lowest level of need is physiological needs, which are physical requirements for human survival. This would include air, water, food, clothing and shelter.

When these physical needs are met, then safety needs play an important part is an individual's behaviour. These needs include personal and financial security and a general well-being and so the individual is concerned with issues such as job security, savings accounts and insurance policies.

The third level of human needs, according to Maslow, is interpersonal and involves feelings of 'belonging.' He believed that individuals had a need to feel a sense of belonging and acceptance among social groups, which could be of different sizes. If these needs are not met individuals could become lonely and be subject to social anxiety. The need for belonging could even overcome the physiological and security needs, depending on the strength of the peer pressure.

The logic of his theory is that while money can be a need, when that need is met an individual looks for other needs to be met. Accordingly when the financial needs are met, it does not become a satisfier, but leads to further needs. This contradicts the belief held by some that sufficient financial resources results in happiness. Accordingly while finances can be important it shouldn't become the most important issues in our lives.

This theory also indicates that even when the financial needs are met, that this need can be undone if an individual succumbs to peer pressure in trying to show that they belong in their group. It is for this reason that I suspect that those who are starting their working career can have difficulties financially; peer pressure can result in them making decisions they wouldn't otherwise take. If this is realised, then they have a better chance of making the correct decisions; even better, they could even try to influence their group to make decisions that will make life easier in the long term. A focus on the short term might not be the best in the long term.

[Note – most of the quotes in this chapter, other than those acknowledged above, come from the Bible or the Bloomsbury Dictionary of Quotations]

### Chapter 5 **– Consumer Price Index**

The consumer price index (CPI) is an index compiled monthly by a government department, Statistics South Africa, measuring the change in consumer prices over time. The change in the CPI is colloquially termed the inflation rate. While a CPI index is published monthly, it is normally compared with the index for the same month in the previous year and then expressed as a percentage to reflect the extent to which prices have changed. The South African Reserve Bank tries to keep the annual inflation rate between 3% and 6% by monitoring and changing interest rates when it believes this is necessary to influence expected future inflation rates.

While it is intended to reflect how much prices have changed, it is often used as a benchmark for salary and wage increases. Salaried employees would often be satisfied to receive a salary increase that equals or exceeds the inflation rate.

Construction of CPI

The CPI attempts to reflect actual changes in prices by obtaining prices on a regular basis. Most prices are obtained monthly, such as the fuel price, while others might be obtained quarterly or annually, particularly where prices might not change regularly. For example, medical aid contributions and school fees are obtained each February and March respectively. In compiling the CPI Statistics SA uses a basket of goods and services selected to be representative of households' expenditure during a period. For this purpose it measures the cost of purchasing a fixed basket of consumer goods and services of constant quality and similar characteristics. For example, petrol initially has a 5.38% weighting in the index, which translates into a certain number of litres. Accordingly when the price of petrol is obtained each month, this relative weighting could change depending on whether the price for this number of litres has changed more or less than the average change in prices.

In addition, on a periodic basis, presently every five years, Statistics SA obtain data as to what money is being spent on, in order to determine whether the relative weighting of items in the index should be changed; alternatively, items might be included or excluded from the index. When the weighting of items in the CPI is revised, the revised CPI is then reset to 100, while previous CPI indices are revised.

When the CPI was revised in December 2012, at that point the previous CPI for December 2010 of 113.0 (which was based on 2008 being equal to 100) was revised to 89.2. In addition, one of the biggest changes in weighting was transport, whose weighting in the index decreased from 17.8% to 16.1%. Some of the items which were added to or deleted from the index at that time were a bit surprising, as illustrated below. In some cases however, it seems the items are less specific than previously (e.g. casserole dish, cup and saucers and coffee mug is replaced by crockery).

Table 5.1 – Examples of items added to and removed from CPI in 2012

Different version of CPI

While there is an 'all items' CPI, also termed CPI headline, a large number of other CPIs are also published. This includes ones for different expenditure groups (five quintiles and pensioners) as well as for different areas (primary urban, secondary urban, rural areas as well as one for each of the nine provinces). In addition there is a CPI for different types of expenditure (e.g. goods, services and administrated prices, with goods also split between durable, semi-durable and non-durable goods) as well as a number of CPI excluding one or more category (e.g. CPI excluding petrol, CPI excluding housing etc.).

Quintiles are five equal sized groups based on the number of households in the country, constructed on the total household annual expenditure in 2010/11, updated to December 2012, as given below. As can be seen in the table below, the 20% of households with the lowest expenditure across the country spend only 3.52% of total expenditure, while the top 20% of households across the country spend 59.47%. These percentages are 2.27% and 66.47% respectively for those living in urban areas, indicating that proportionately there are more quintile 1 households in rural than urban areas, while the converse applies to quintile 5 households.

Table 5.2 - Quintiles

The weightings can also differ in the different versions of CPI. For example, in the all items CPI food has a 18.19% weighting, while in the 'all urban areas' weighting it has 15.41% weighting. This shows that households in rural areas spend proportionately more on food than households in urban areas.

For June 2013 the inflation rate was 5.5%, but for quintile 1 households it was 6.5%, 6.3% for services and nil for durable goods, illustrating that the CPI can affect different groups of people and different categories of expenditure more than others.

Does the CPI reflect my actual expenses?

As the CPI attempts to reflect items actually being purchased it should reflect actual changes in expenses. Often the comment is made by individuals that the CPI doesn't reflect their actual change in expenses. While there may be merit in this, I suspect that more often than not that this is based on gut feeling rather than detailed calculations. When, for example, electricity prices increase by, say, 12% when the CPI increase is only 5.5%, these type of comments might be made, ignoring the fact that petrol prices might have decreased by say 4%, on the basis that increases can result in emotional responses, but decreases less so.

It should be appreciated that the CPI does not intend to reflect the actual change in expenses of each individual, but a large group of people. People have different expense profiles so for some their increases might exceed the CPI increase, while for others it could be less than the CPI increase.

As the CPI reflects society, it includes various assumptions that probably don't reflect any individual, but reflect a collection of individuals. For example, it includes smokers and non-smokers, so it assumes how many cigarettes an average smoker has each day (say 20) and then what portion of the population smokes (say 20%) to arrive at the index assuming 4 cigarettes a day are smoked. While the detailed assumptions included in the CPI are not published, these are the type of assumptions that are likely to be included. It might, for example, assume an average family has 2.3 children, lives 25 kilometres from work, supports 0.3 parents, buys 1.2 litres of milk a day etc.

What I hadn't realised until reflecting on it, is that one of the reasons why young families might battle financially is that for a number of years their expenses might increase by more than the increase in CPI. For example, expenses might increase due to the addition of children, moving to a bigger and more expensive house that is further from work, possibly also acquiring a bigger vehicle, which with being further from work can result in an increased fuel bill. More expensive items such as clothes, smartphones, television and sound systems might also be acquired and if salaries are only keeping in line with inflation then financial difficulties might arise. The CPI assumes the size of the family and its standard of living remains the same, so when standards are raised, particularly where promotions are obtained, the actual increases in expenditure will exceed the increase in CPI.

The opposite can occur at the end of one's working life. Children might leave home and earn their own income, so the level of expenses spent on food, water, electricity and fuel might decrease; in addition the parents might down scale to a smaller house, so reduced running costs could be incurred.

The CPI probably assumes that families increasing in size balance out with those reducing in size, as it does not distinguish on age, other than those already retired.

What is excluded from CPI?

It is important to understand what is included and excluded from the CPI. For some income tax is a major portion of their expenses, but income tax is not included in CPI. While employees might receive a salary increase equal to the increase in CPI, when tax is taken into account the increase in their take home pay is likely to be less than CPI due to tax being applied on a progressive scale.

The CPI also does not include any provision for retirement funding, which again can be a large amount each month; nor interest or any savings.

Regarding housing, it assumes that some own their own homes while others rent their homes. Accordingly the index includes both categories. For those who rent their homes the index tracks actual rentals. However, for those who own their own homes it uses an owners' equivalent rent basis. As owners might have owned houses for various periods of time, with different possibilities on financing, such as mortgage bonds which have been paid up, new mortgage bonds where little repayment has occurred or where re-advances might have been used to finance other items, it is difficult to compare the cost of a house acquired a number of years ago with a paid up bond with a newly acquired fully bonded house. Accordingly the owners' equivalent rent basis is the opportunity cost incurred by the owner deciding to live in their own home, rather than renting it out. In essence it measures a virtual rent owners pay to themselves. At one stage the cost was measured by interest rates on mortgage bonds, but this was changed as it reflects the cost of debt rather than the cost of housing.

CPI weightings

Given below are the weightings for the major categories of expenditure in the current CPI for the various income groups, on an all items basis together with the weightings in the previous CPI on an all items basis.

Table 5.3 – Current CPI weightings

From looking at the above table I noted the following comments:

  * For those in quintile 1 their biggest expenditure is food (41.12%). In quintile 5 the amount spent on food is about a quarter of this (9.96%). Thus as consumers move to higher quintiles they spend proportionately less on food, but more in monetary terms. In quintile 1 a household spending R21,000 will spend about R8,600 on food, but for a quintile 5 household spending R150,000, they will spend about R14,900 on food. Thus while total expenditure is about seven times higher for this quintile 5 household, their expenditure on food is approximately 75% higher than for a quintile 1 household. The same applies to alcoholic beverages and tobacco; this accounts for 12.05% of expenditure in quintile 1, but only 3.70% in quintile 5. A similar trend applies to clothing, where proportionately expenditure halves, but the actual amount could triple (6.32% of R21,000 equals R1,327 versus R4,815 [3.21% of R150,000]).   
As consumers earn more, while they are likely to spend proportionately less on food, alcohol and tobacco and clothing, they are likely to spend proportionately more on categories such as housing, transport, recreation, education and miscellaneous goods and services. Housing reflects the likelihood that they will own their own home; transport also reflects the higher costs of ownership of vehicles in comparison to using public transport. Education indicates the need to pay school fees in more affluent areas; while for miscellaneous services this is mostly due to the costs of belonging to medical aid schemes. Recreation includes amounts spent on outdoor recreation items, sporting services and pet products. Taking the annual expenditure amounts of R21,000 and R150,000 again quintile 1 households spend about R3,400 annually on housing and R1,570 on transport, while quintile 5 households spend about R38,400 and R27,900 respectively on housing and transport. For this purpose housing includes electricity and water.  
Amounts spent on health (which excludes medical aid premiums) and communication remains fairly constant as a proportion of total expenditure across the various quintiles. Health is 1.28% for quintile 1 and 1.53% for quintile 5, while communication, largely telephones is 2.56% for quintile 1 and 2.60% for quintile 5.
  * For pensioners, as would be expected, their clothing and education costs are on the low side, while their biggest expenditure is housing (28.15%). Pensioners are less likely to need new clothes too often, but the fact they still have education costs might reflect the need to pay fees for grandchildren. The amount allocated to medical aid premiums (7.23%) and health (1.90%) for pensioners is substantially more than the same expenditure for quintile 4 households (4.08% and 1.21% respectively) reflecting higher medical costs as one ages.

Generally the major categories of the CPI are broken down into sub categories. Given below is the breakdown of the food and non-alcoholic category for all households. The index also breaks these sub categories down further as illustrated below, but without giving their weightings.

Table 5.4 – Analysis of food component of CPI

Trend of CPI

It is also interesting to see how the CPI has changed over time. The table below shows the increase in the CPI over a thirty year period.

Table 5.5 - % increase in CPI from 1984 to 2014

Although this graph starts in 1984, for every year from 1974 to 1992, the CPI increased by more than 10% each year, peaking at 18.5% in 1986. Since 1992 the only time the increase exceeded 10% was in 2008, when it reached 11.4%, with a low of 1.5% in 2004.

At the end of 1973 the CPI index was 2.5 (based on December 2012 equalling 100; yes - prices did increase 40 times between December 1973 and December 2012), increasing to 28.4 in 1992, an increase of 1,036% in 19 years. In the next 20 years it increased to 100.0, an increase of 252%. This again illustrates the effect of compounding; in the 10 years from the end of 1982 the index increased by 284 % (from 7.4 to 28.4), showing the cumulative increase in prices in that 10 year period was more than the cumulative increase in the next 20 years.

The rule of 72

The table below shows how long prices take to double at various inflation rates. This shows, for example, that at an inflation rate of 5% per annum that prices double every 14 years and 3 months and that at an inflation of double that, namely 10% per annum, prices double in 7 years 3 months.

Table 5.6 – How long it takes for prices to double with inflation

There is a useful rule of thumb, called the rule of 72, which can be used to calculate how long it takes prices to double. This rule states that 72 divided by the inflation rate gives the number of years it takes prices to double. For example, 72 divided by 8 equals 9 years, while 72 divided by 15 gives 4.8 years, which is not far off the actual amount of 5 years. This rule also applies to investments, namely how long it takes values to double. For example, assuming a return of 9% p.a. the value of an investment will double in 8 years (72/9).

Using the CPI to manage expenses

Despite the above comments, the CPI can be used to determine in which categories people are spending more or less than expected and then they can assess whether this is appropriate or not. It might show, for example, that the amount spent on clothing is excessive, which could indicate shopping for branded items at boutique stores, when the income earned suggests this is not appropriate. If electricity usage is high, it might be due, for example, to geyser temperatures being too high or lights left blazing during the night.

In the table below I have taken my actual expenses for a recent year and compared it to the 'all items' index for a quintile 5 household. For this purpose I have excluded actual rental and owners' equivalent rent from 'housing,' as this represents a hypothetical amount and I don't know what the home I own would rent for.

Table 5.7 – Comparing CPI weightings to actual expenditure

While I have fairly good records of my expenditure, I am not fanatical and accordingly I have some unallocated expenses where I didn't keep records of cash spent. The unallocated expenses above also include amounts where I am not sure where they are recorded in the CPI or whether they are included in the CPI. This includes expenditure on presents and pocket money for children.

The actual expenditure was also influenced by an irregular amount, namely after many years of my wife wanting to take our whole family to the Victoria Falls on a package holiday, it eventually occurred in this year. In the previous few years there wouldn't have been any amounts for this.

The table above also shows my expenses differs from the norm, as I don't smoke or drink, I paid for one of my children's accommodation, as she was completing her studies in another town, which also meant I paid for her car insurance in addition to my wife's and my own. The CPI probably also reflects that many do not comprehensively insure their vehicles as I did. If I had prepared a similar table a few years earlier it would also have included amounts for the purchase of vehicles, but those have now been paid off. The table also shows the extra costs, largely security, as a result of living in a housing cluster.

As my wife and I are more mature we probably have reached the stage, similar to pensioners that we are spending less on clothing; also my employer paid the costs of my cell phone resulting in communication being less than the CPI weighting.

The table above shows the following:

  * If my profile doesn't match the typical household, then my expenditure will not match the CPI weightings, hence the explanation for the variances above.
  * If I spend less in certain categories (e.g. alcoholic beverages and tobacco, clothing, communication and education), then by definition I must spend more than the CPI weighting in other areas, as the expenditure is based on a proportionate basis and not an absolute amount in Rand terms.
  * Very importantly this exercise does not show whether I am overspending; all it does is show the 'shape' of my expenses and I can then, as illustrated above, determine whether there are valid reasons for my expenses departing from the CPI weighting. If all my expenses were to increase 10% it might mean I am now spending more than I earn, but the table above would be unchanged as the relative amounts spent would be unchanged. In addition, the table doesn't show whether if I don't spend amounts on alcohol and tobacco whether I save this amount or whether I use this saving to spend more in other categories.

The CPI is based on five quintiles; if it instead had a different number of groups, say 10, then while the overall CPI weightings would be unchanged, the weightings for the group applicable to me is likely to differ from that above. This again illustrates the need to assess whether departures from the 'norm' are reasonable or not.

While not directly observable from the table, the amounts excluded from the CPI weighting can be substantial, particularly as tax can be a large deduction from a salary. However, if expenses paid are tracked from a take home pay and not the gross salary then this becomes less evident, because on this basis tax is not shown as an expense (unless tax is paid because of other income [e.g. interest, rent or own trading activities]). This is because for a person earning a salary or wage their take home pay is after tax has been deducted.

What I also discovered practically from doing the above exercise is that in a number of cases how I categorise expenses differ from the CPI weightings. Fortunately from having fairly detailed financial records I was able to reallocate amounts so that a comparison with the CPI was possible. For example, I have a category called 'holiday' which included use of the Gautrain, car hire and airfares which are included in 'transport', a package holiday and various activities while on holiday, which are included in 'recreation and culture' and hotel costs which are included in 'restaurants and hotels'. Holidays also included kennel and visa fees, where it is not clear where they are included in the CPI weightings.

Thus knowledge of actual expenses and the relevant CPI weightings can be useful in determining whether the relative amount spent on various categories of expenditure makes sense. Whether on an overall basis the level of total expenses is appropriate is dealt with in the next chapter.

[Note – information in tables 5.1 to 5.5 were obtained from the Stats SA website] 

### Chapter 6 **– Budgets**

What is a budget?

In its most simplistic form a budget for our purposes is a projection of future income and expenses.

Why prepare a budget?

For those who are battling to make ends meet, a budget is useful to determine where expenses in particular can be modified, reduced or in some cases postponed, in order to assist in ensuring expenses don't exceed income.

Even for those in the fortunate state of having their income exceeding expenses, a budget can be helpful in ensuring one is saving for the future and spending money wisely.

How often should a budget be prepared?

Initially I think a person should be preparing a budget on a monthly basis (or even weekly, if paid weekly); particularly if that person is having difficulty in ensuring their budgeted expenses doesn't exceed their income. This is because they might not have any idea as to what they are spending their money on and so efforts to balance their budget might need refining or help from others. In addition, initially the financial problems might be immediate ones and so they should start with the next month first.

The budget doesn't have to cover a calendar month. At the beginning my budgets went from one pay day (25th of the month) to the day before the next pay day (i.e. 24th of the month), in order to see whether my money would last that long.

Now that I am more financially secure, I prepare an annual budget, made up of budgets for each month of a particular year. If I wanted to, I could revise the budget during the year, but I haven't done so yet.

Initially I prepared my budget close to each pay day, but now I do it early in a calendar year, once I have recorded all my expenses for the previous year, as this data is used in preparing a budget for the current year.

How does one prepare a budget?

A person needs to have a fairly good idea of what amounts are likely to be received and paid. Initially I suggest the focus should be on what amounts are received and paid in cash and via a bank account.

A budget should be based on the best estimate of the amount that is likely to be spent. For this purpose one shouldn't be too optimistic; it is no good consistently thinking you will spend less than will actually be spent. This can result in thinking income and expenditure will balance, but finding out at the end of the month that this rarely occurs. On the other extreme, a budget shouldn't be based on the maximum possible amounts that could be paid, as it could result in a person imposing hardship on themselves, when at the end of the month this proved unnecessary.

It is expected that some actual amounts will vary from the budget, but generally a budget should be prepared on the basis that the 'overs' and 'unders' should balance out; if not monthly then over a few months. It is for this reason that a budget should be based on realistic estimates.

Some of the amounts to be included in a budget will be known, such as fixed monthly amounts (e.g. salary, rent, loan repayments, insurance etc.), with some amounts being fixed for longer periods than others (e.g. salary and rent might only change once a year, while others might change more or less frequently, for example loan repayments which change whenever interest rates change).

Other amounts might vary but might be within a range, such as amounts spent on food, electricity, water etc. Then there are amounts that vary significantly or occur on an annual basis. For example, amounts spent on repairs and medical expenditure can be difficult to anticipate, while holidays and TV licences might be an annual amount.

When the time comes for budgets to become more sophisticated they can also capture amounts spent in one period but likely to be paid in a later month, instead of just cash payments. For example, if a person has a credit card they might use it to spend amounts on food this month, which might only get paid at the end of the following month.

What categories should be included in a budget?

Because people have different items they spend money on, there is no one budget that will meet all needs. While the CPI, as explained in chapter 5, can be used to prepare a budget, there are other examples as well. Given below is an example based on one of my recent budgets, as well as one used many years ago, before we had children. These can be used a starting point to prepare one's own budget.

Table 6.1 – Examples of budgets

In comparing these different budgets the following comments are relevant:

  * In some cases I might have a category (e.g. food) while for others I might have subcategories for different types of expenditure under these headings (e.g. children and communication). In the early years' budget there were no subcategories.
  * For some of the subcategories I could even have more categories than given above; for example instead of having one amount for petrol, I could have a separate amount for my wife, daughter and myself. If I own more than one property I might have a different category for each property and then have similar subcategories in each (e.g. electricity, water, rates, repairs etc.).
  * The same applies to investments; instead of having one amount I might have a different budget amount for each investment
  * The budget also has an 'Other expenses' category as I don't budget for every cent I spend; I have an allowance for amounts that I forgot what they are spend on or are fairly small. The problem is that this can become a black hole, so one should decide what amount one would be comfortable with; for some this might be R100 per month, while for others this might be R1,000 or more per month. Some amounts might have been in 'other' in the early year's budget, which were recorded separately in the later budget. This includes amounts for outings, sporting activities and hair.
  * Two categories you will not see above are 'cash withdrawals' and 'credit card' as these can often be large amounts. If these amounts were only spent on one category that might be acceptable, but for budget purposes one should generally estimate the split of what the major amounts of cash and credit card payments are spent on.
  * .One also needs to make some decisions as to what categories are to be included or not in the budget. For example, salary could be my take home pay only, or the different components of the take home pay might be captured separately. In the early year's budget the amount shown as salary is the take home pay which comprises salary and travel allowance less tax, unemployment insurance, pension contribution, medical aid contribution and motor vehicle costs as these were paid by my employer then. In the later budget these categories were recorded separately. Another example is loan repayments; they can either be shown as one amount or split between various components, such as interest, administration costs, insurance and repayment of capital.
  * It is not clear from the above, but if one is likely to incur large amounts on an irregular basis, it might be prudent to set an amount aside for this on a monthly basis. For example, if you go on leave once a year you may not have enough money in that month for a holiday, but this can possibly be afforded if an amount is saved each month for this. For example, the budget might show R500 for holidays each month for 11 months, so with R5,500 saved during the first 11 months plus R500 in the twelfth month there should be R6,000 for a holiday. For this purpose, it is suggested the amount be deposited in a separate savings account monthly, so it will also earn interest and by being in a separate account hopefully there will be less of a temptation to use it for other purposes during the year.
  * As noted above not all expenses can be accurately predicted, so again, it is suggested that a 'rainy 'day' fund be kept for these unexpected amounts. While I have seen a number of commentators suggest this fund should be equal to about three months income, I wouldn't feel guilty if this amount wasn't achieved and would start with a more modest target. If you have sufficient insurance to cover most unexpected events, such as loss of a car, medical expenses or burglaries then a smaller amount might be appropriate.
  * One amount I deliberately didn't include in my budget was a bonus. There were a number of reasons for this. Firstly, it gave me a buffer if expenses exceeded my budget. Secondly, it also allowed me to reward myself, which I think can be important, because if one is always careful with one's money, it has the possibility of becoming a grind, so having something to look forward to can be helpful. Thirdly, it allowed me to possibly buy something that arose during the year which I hadn't thought about or included in my budget.

Initially it can be a challenge to prepare a budget if one does not have a good idea of what money is being spent on. Therefore a budget might be something done in stages; one might start with known amounts, such as amounts paid out of the bank account and then if one pays amounts in cash to either use a debit card or credit card to keep track of expenditure or makes notes (on withdrawal slip or smartphone or even keeping till slips) of what amounts were spent on. My wife, for example, keeps a notebook to record her cash payments. In a month or two one should then have a better idea of what money is being spend on. One can then budget more intelligently.

As noted above the first objective is to ensure income is at least equal to expenditure. If expenses exceed income, then the expenses should be looked at to see how they can be adjusted. This might mean cutting of expenses, buying less expensive items or deferring acquiring items. This can be one of the most difficult aspects as one needs to be honest with oneself. This can require an assessment of whether items are needs or wants, where it can be easy to justify a want as a need.

Given below are some issues to consider in helping to balance a budget:

  * Clothing. A book I was reading recently (What are the Chances of That, by William Hartston) said the average American man buys 35 articles of clothing a year, while the average American woman buys 54 articles a year, thus this might be more of an issue for women than men. How often do you go shopping for clothing? How many different sets of clothing do you have to wear to work (e.g. if it is more than ten, consider reducing this)? Which stores do you shop at - are these appropriate for your quintile? How much of your shopping is done at sales (or do you despise them)? Even shopping at second hand stores can be a possibility – one family member bought a fair portion of clothes at these stores when living overseas.
  * Housing. Is the amount you paid for a house, its size and the area in which you live appropriate, or is it done mostly to impress others? How often do you move (i.e. is this affecting your finances as you move to more prestigious housing)?
  * Vehicle. How often do you change your car and does it need to be the standard it is? Should you be looking to acquire a new car when your finances suggest a second hand vehicle is more appropriate? While a reliable vehicle is appropriate some seem to acquire vehicles more frequently than needed and of a higher standard than required. Again to what extent is the vehicle acquired appropriate or does the cost of impressing others come with a price that can be ill afforded?
  * Food. How often do you eat out and at what type of restaurants? How much of a coffee or wine connoisseur are you? Does this match your finances? Based on your expenses should a more modest approach be taken? If you go shopping for food when you are hungry you are likely to buy more than if you are well fed.
  * Use lists. If you go shopping without a list you might see items that you suddenly decide you 'need.' Preparing a list beforehand of what you need and keeping to that list helps to reduce the chance of unnecessary items being purchased. If you go shopping just to see what is available or because you feel a need to spend, you might end up spending amounts on items you shouldn't be buying if you are battling to control your expenses.
  * Do it yourself. It can be cheaper to pay yourself to do things instead of others. This includes cooking, cleaning, washing and even sewing (although this might be a dying art). However one needs to be careful not to go overboard on this as while intending to save costs, one could end up paying more; such as trying to repair items one has no experience in that area. Have you considered making cards and presents to give to others instead of buying them; they might even appreciate the time, thought and effort you expended instead of thinking you cheap? Remember time is money, so if you don't have time to do things yourself you can pay others to carry out chores, but if you don't have money you need to make time to carry out some chores yourself.
  * Spending intelligently. In some cases this means spending less, such as buying no brand items as opposed to branded items, buying a cheaper brand or buying less (e.g. fewer drinks and snacks). In other cases paying more now might produce savings over a longer period. This includes buying in bulk and buying energy saving light bulbs. Another possibility is buying items with a friend or family member and then sharing the items; this might result in a lower unit cost than if one buys an item by itself. Also be on the lookout for specials and coupons you can use.
  * Use cash. This has the potential to be a benefit although some might feel the urge to spend money just because they have it in their pocket or purse. It can be easy to buy items on credit, but if cash is actually used the price of items might be appreciated more and could thus lead to fewer or less expensive purchases. In addition, amounts will only be purchased when the person has the cash to buy items. I read a comment recently which indicated studies show that people spend about 25% less if they use cash as opposed to cards. However this suggestion should be treated cautiously, as it might open a person to be targeted because they have cash on them and in addition it might be difficult later on to remember what was purchased if records of expenses are kept.
  * Spending later. As noted above it is possible that some items we classify as needs might be wants. Have we been seduced by advertising or have we succumbed to peer pressure? It can be useful to ask how long we can survive without a particular item.
  * Consider the long term. Pets can be cute when initially acquired, but over time can become expensive when vet fees and the costs of kennels when going on holiday are taken into account. Accordingly, these costs should be taken into account when deciding whether a pet should be acquired. The same can apply to hobbies; some of which can be rather expensive, particularly when the most up to date equipment 'must' be had. I have a good quality camera but do I need to constantly upgrade it or get a new lens? If a person has a tendency to want to replace equipment frequently then considering whether their spouse is in agreement could help relationships at home. A few years ago my bicycle was destroyed while being transported and when I replaced it I had to ask myself if I bought a bicycle that was a lot more expensive than the bicycle that was destroyed, how much faster would I go? If I bought a top of the range bicycle was I buying it to impress others; if not was a more modestly priced bicycle not just as likely to be reliable and adequate for my needs?
  * When preparing an annual budget take into account that certain expenses are likely to increase during the course of the year. For example, amounts spent on electricity, water, insurance and municipal rates normally increase each year. Accordingly even if on an annual basis expenses equals income, in the first few months of a year income should exceed expenses, with this excess being used to fund higher expenses later in the year.

Should actual expenses be tracked?

If a person is having difficulty in controlling their overall expenses, then having a budget is the first step in gaining control over one's finances. However, if a person does not know what they are currently spending their money on then this becomes difficult.

Accordingly keeping track of one's expenses is beneficial. It can help in refining a budget. As noted earlier knowing where money is spent can assist in identifying areas where expenses are possibly higher than they should be. In addition, part of the discipline needed to have financial health is having regular checkups; am I able to keep to a budget; could/should I be saving more; do I have enough funds for special occasions (e.g. a special birthday or attending a friend's wedding in another town or country); if I wanted to buy a house or car what amount can I afford to spend on a monthly basis?

How should a track of expenses be kept?

There are a number of ways to keep track of expenses. These include the following:

  * My parents used the envelope system. This required them to have a separate envelope for all amounts that were going to be paid in cash and then putting in that envelope the amount of money for that category. When money was spent it was paid out of the relevant envelope and from this they knew how much they had left for the rest of the month for each category.
  * My first system was to keep a record in an old diary. I wrote down each category with a column for the budget and another for actual amounts. I used one page for expenses, with the opposite page showing income and the opening and closing bank balance.
  * In the early days of computers I wrote my own program to keep control of my finances, which worked well for over ten years. Like the diary method I prepared a budget for each month and it only required me to update it once a month.
  * I then changed to using a spreadsheet. This had the benefit of being more flexible as my finances changed, as my computer program would have needed to change, which would have been time consuming. The other benefit was that I was spending money on more categories and so a spreadsheet enabled items to be captured more regularly and to be finalised at a month end. Again like the other systems mentioned it had a focus on bank balances.
  * Finally I moved to using software specific for personal finances, which helped me to take even better control of my finances. I used one program for many years which I rated highly, but in recent years it was no longer available in countries outside the United States and I was concerned about moving data to another program. I now use a program called Moneydance and I was able to transfer my data to this program without many issues.

There are a number of personal finance software programs available, that range from fairly simple ones to others that are fairly comprehensive; in addition, some can be downloaded for free, while others need to be paid for. Moneydance is on the comprehensive side of the spectrum and the amount I paid for it was reasonable.

There can be a number of benefits of a personal finance program, including the following, although not all programs might provide all these benefits:

  * Having the ability to prepare a budget, for each month or a year; also the amounts can vary from month to month. Budgets can also be revised; for example if a new vehicle is bought later in the year, the budget can be updated for new amounts, such as payments for a lease, insurance, vehicle tracking and petrol.
  * It is easy to compare actual expenses, once it is captured, to the budget. The program includes reports to help understand progress against a budget, which could be for a particular month or year-to-date.
  * It is easy to add, change, delete or merge categories and subcategories.
  * It provides a reminder of amounts to be paid or received, which helps to ensure they are paid on time. For example, some amounts might be paid annually, such as a TV licence, and it can be easy to forget to pay these amounts when they fall due. In addition, some amounts might be paid by stop order, such as insurance, and having a reminder helps to ensure there are sufficient funds in the bank account to pay these amounts when they fall due.
  * The program can be used to reconcile accounts; to ensure all amounts charged to bank accounts are valid payments, the amounts are correct and that all expected payments have been paid.
  * When entering amounts it remembers the last amount paid to a particular party, so instead of entering all the data again, only the information that is different needs to be edited. This saves on capturing time.
  * Individual payments that cover a number of categories can be accommodated. For example, I record one payment for my credit card each month, but when I do so the payment is split between the various relevant categories, which can change from month to month.
  * It can also be possible to download data direct from a bank into a program to reduce the amount of time and effort needed to capture data.
  * Keeping records can make preparation of a tax return easier. For example, reports can be produced for specific accounts (e.g. motor vehicle expenses, medical expenses and retirement annuity contributions) for the tax year. While for some categories, such as retirement annuity contributions and interest received, it is normal to receive a tax certificate from a financial institution, with the benefit that is possible to check that all retirement annuity contributions have been included on the certificate and that all interest according to the certificate has actually been received.
  * Programs can keep track of your investments, so that in addition to the cost of an investment you can track the number of shares or units acquired, interest and dividend receipts, the current market value and profit and losses on disposal, which can have capital gains tax implications. It can also show the performance of investments over time and thus help in making decisions as to whether to keep or sell a particular investment.
  * The program can give you a quick overview of the state of your finances by showing your various assets and liabilities at any time.
  * You can also use the program to keep track of your liabilities and seeing to what extent payments are just covering interest and what extend they are reducing the amount owing.
  * The information in the program can also be used to project whether you are on course to have sufficient funds upon retirement.
  * The program can also be helpful for insurance purposes. If you are unfortunate enough to suffer a burglary it can be helpful in showing what was purchased, when, from whom and at what cost. In addition, the cost of items and when acquired can be used as a basis to determine their replacement value when assessing the amount you insure your assets for.
  * The program can have a number of reports which are both helpful and can be adapted. For example, you can change what items are included in a report and for what period. These reports can even be exported to a spreadsheet if necessary. Some of the reports might list data (e.g. actual expenses versus a budget or the details of all expenses for a particular period), but can also be graphical (such as net worth over a period).

In South Africa there are also some on-line applications that can be used to manage finances, although I have not used them. These include Old Mutual (22seven), Nedbank (MyFinancialLife), Momentum (MyFinTrack) and Sage Pastel. There have been some concerns expressed about security regarding these types of applications as apparently they extract information from people's bank accounts and for this purpose they need to be provided with the necessary bank account details and passwords. At least one bank has responded to this concern by allowing a secondary user who is only able to access the information, without the ability to carry out any transactions.

The downside is that to get all these benefits it does require some time to keep the data up to date. Even where data is downloaded there is still a need to ensure it is correctly categorised. This is part of the discipline needed in managing one's finances. It is possible to do it once a month or a few minutes every few days; obviously it will take longer for some than others depending on how simple or complex their finances are. I am firmly of the view that the benefits of recording actual amounts have vastly exceeded the costs of doing so.

### Chapter 7 **– What money is spent on**

This chapter is not focused so much on ensuring expenditure is less than income each month, but looking at expenditure over a longer term. It looks at what the major categories of expenses should be and how they can change over time. This can be helpful in the setting of budgets and in making provision for retirement.

If a person spends all they earn in any month then they are no better off at the end of the month than they were at the beginning of the month. While it is acceptable to live on this basis for some months, if this occurs for many years, then this can be problematic in the long term.

This chapter is also concerned with net worth, which is defined as assets less liabilities. If all the income is spent then the net amount of assets and liabilities is unchanged and so an individual's net worth is unchanged. In order to increase an individual's net worth they should either increase assets or reduce liabilities or do both. Accordingly paying off debt can increase one's net worth.

When an individual prepares a budget they might focus on expenses, but if net worth is a consideration, which it should be, then the budget should also be looking at increasing assets and decreasing liabilities. Having a net worth which is increasing each month, achieved by having expenses being less than income and having the benefit of compound interest, an individual is starting to build funds needed for retirement.

As compound interest shows small amounts can grow to large amounts over time, thus increasing net worth should not be delayed on the basis that not much can be saved.

It is likely that in the early years of an individual's working life that expenses might comprise a large portion of the person's income. Hopefully this will reduce over time as the individual gets promotions and increases in excess of the inflation rate. If a person has children, then this could delay the reduction of expenses as a proportion of income.

A person is not expected to have the same standard of living throughout their working life; if they do then it is probably an indication that they are not progressing in their working life or getting promotions, which probably applies only to certain less skilled employees.

Comparing income and expenses over time

Can an individual improve their net worth and also increase their standard of living? I believe so. Even if the standard of living is unchanged they could still increase their net worth through savings and investments. When salary increases in excess of the inflation rate are received, which can include promotions, an individual can decide how to use the extra income. Based on the Law of Executive Insolvency stated earlier, hopefully they are not already on a standard of living based on this higher salary. Instead I suggest that this extra income can be partly used to increase the standard of living and partly used to increase net worth by investing in assets or reducing liabilities.

Based on this I thought it would be interesting to see how I did on this score over the years. The information used below goes up to the end of 2012. It does not include information after that as I retired in 2013, resulting in some change in expenses, such as using less petrol by not going to an office each day. Accordingly the tables reflect expenses for a working person.

The table below shows the following:

  * Expenses as a percentage of salary, which for this purposes excludes bonuses, sometimes exceeded 100%. In some cases this followed moving to a new house, which is indicated by the vertical lines. There were also specific reasons for the amounts being more than 100% in some years, such as an overseas holiday, leasing a new vehicle and tax, where at once stage large amounts were paid as provisional tax and so the timing of payment affected the percentage. Fortunately in all these cases if bonuses were included the amounts were less than 100%, illustrating the comment above about using bonuses for specific issues.
  * The average percentage while I was in my 30s was 95%, 91% in my 40s and 78% in my 50s. The lower percentage in the 50s was due to our children becoming self-supporting as well as realising when I retired that my income would be lower than I earned previously so I needed to ensure my level of expenses was appropriate; but more about this in a later chapter.

Table 7.1 – Expenses as a percentage of salary

Comparing categories of expenses over time

I then thought analysing my expenses into its major components would be illuminating. For this purpose expenses exclude tax and giving.

Table 7.2 – An analysis of expenses over time

This chart has 12 categories, with the largest over the thirty year period at the bottom, namely, expenditure on motor vehicles, followed by interest and housing, with clothing, presents and communication, the smallest over that period at the top.

For the purposes of the chart the portion of expenses in each category for each year was calculated, then the average for each percentage over the 30 years was calculated. The ranking on this basis was used to prepare the above chart. If the chart had instead been based on the cumulative amounts spend over the years, then the order would be different as they would be weighted towards the later years as a result of inflation. The difference between the two approaches, as illustrated below when discussing children and interest, can be quite marked.

In this chart children includes education, extra mural activities, vehicle running costs (including insurance), pocket money and living when studying in another city but excludes food, clothing (until they were given pocket money to buy their own clothes) and amounts spent on electricity and water while living at home.

The chart above shows the following:

  * Over the years expenditure on our children has marginally been our biggest cost when looking at actual expenses for the whole period, but only the sixth biggest category when looking at the average of the percentages for each year. Although the last of our three daughters had arrived by my mid-30s, their portion of total expenses was fairly small for many years, but increased when we acquired vehicles for them and carried their running costs while they studied after leaving school. In my 30s this accounted for 2.0% of expenses, 10.5% in my 40s and 16.7% in my 50s. In one year in my 50s they accounted for nearly 25% of expenses but this decreased as they become self-supporting and I approached retirement; but more about that in a later section.
  * In my 30s interest was a large expense, comprising nearly 25% of my expenses, largely being interest on a mortgage bond. In two years in my 30s it was about 30% of my total expenses! This reduced over time as the bonds were paid and then increased in my mid 40s as we bought another home as an investment and in my early 50s when we moved home again. In my late 50s it was negligible as I prepared for retirement. Overall interest was the second largest category based on the average of the percentages for each year, but only fifth based on cumulative actual expenditure.
  * Expenses on motor vehicles, which excludes insurance, was about 18% of expenses for a large part of the 30 years covered by the above table, but was less in my late 50s as I changed from leasing a vehicle to buying one in anticipation of retirement. This category was the largest category based on average percentages and third based on actual expenditure.
  * For most of the years housing accounted for about 10.5% of expenses; it only increased in my 50s when the home we had bought as an investment became a holiday home. Expenditure on housing was the third largest category based on average percentages and second based on actual expenditure.
  * Over the years, the three biggest categories of expenses, based on cumulative expenses, namely expenditure relating to children, housing and motor vehicle running costs each accounted for just over 14% of total expenses and approximately 43% in total. Based on average percentages these amounts were 9.5%, 12.5% and 16.4%, making a total of 38.4%.
  * Expenditure on insurance, which includes motor vehicle insurance, in my 40s and 50s was just over 11% of expenses, while in my 30s it was under 8%. This was due mostly to taking out life cover when I was about 40; I suppose I was relying on group life insurance before that.
  * Over time the percentage spent on food, which was the fourth biggest category based on average percentages, but surprisingly was only the sixth biggest category of expenses based on cumulative expenditure, dropped; in my 30s this was 12.1%, in my 40s 11.2% and in my 50s it was 8.3%. This is due to food comprising a smaller portion of household expenditure as household income increases, which was noted in section 4 on the CPI, but also as our children left home when I was in my 50s.
  * The category 'other' accounted for less than 8% of expenses, but this was higher in my 30s. This covers items such as bank charges, books, CDs, DVDs, TV, entertainment, meals, hair, toiletries, jewellery and unallocated amounts. Some unallocated amounts were later given their own category which is probably why this percentage was higher in my 30s.
  * Medical expenses, the largest component of which is the monthly contribution to a medical aid scheme, has increased proportionately over the years, reflecting increases that have often exceeded the CPI. In my 30s it was 5.2% of expenses, 7.3% in my 40s and 8.9% in my 50s, even though in the second half of my 50s we only had one child on our medical aid.
  * While expenses on holiday and travel accounted for just over 5% of expenses, it was volatile. In my 30s it was less than 2% due to having young children, but it increased to 15% in one year when my wife and went overseas and 29% in the year we took the children to experience Disney World and London.
  * Expenditure on clothing in my 30s and 40s was fairly constant at just over 4% of total expenses, dropping to just under 2% in my 50s as we gave our children their own clothing allowance as part of their pocket money and as we aged we probably had less need for new clothes.
  * Over the years expenditure on presents and communication was less than 4% of total expenses.

Comparing change in expenses to change in CPI

I also thought it would be interesting to compare how expenses have increased in comparison with the previous year and the CPI index.

Table 7.3 – Comparing the change in CPI with the percentage change in expenses

This table shows that in twelve of the thirty years the increase in expenses was less than the CPI increase. This together with the first table in this section (table 7.1) reflects that even though in many years my expenses did increase by more than the CPI they were still less than my earnings, showing that my standard of living was increasing, but I could afford this. For example:

  * A number of the large increases in expenses are due to interest on mortgage bonds, when moving to a new house, along with extra running costs
  * A few large increases in expenses are due to higher lease payments when a more expensive car was acquired
  * The large amounts spent on overseas travel also impacted amounts in certain years
  * Acquiring another home for investment, where the rent didn't cover the costs also impacted the increase in expenses one year
  * Sometimes more than one reason caused expenses to increase significantly in a year, for example the acquisition of a house for investment and an overseas trip occurred in the same year, as did a house move and acquiring a new vehicle. In another year there were large amounts on repairs both on our home and vehicles and a large increase in medical aid premiums.
  * The biggest increase in expenses was due to moving cities, which included acquiring a new larger home, acquiring a new vehicle as well as unexpected higher insurance premiums.

The above table has been prepared based on actual expenses, but as noted above, in the section on budgets, if large unusual expenses are anticipated, such as overseas holidays, amounts could be set aside in anticipation of this.

In some cases expenses may have increased, but not necessarily to a higher level for long. For example, in one year there was a large increase in expenses due to an overseas trip, but with this not reoccurring in the following year there was a reduction in costs in that year. In another case an increase in expenses was due to a new mortgage bond which resulted in a decrease in interest costs some years later as some of the bond was repaid.

Towards the end of the period shown in the table above, in many years the increase in the CPI exceeded the increase in expenses as I anticipated retirement: namely children becoming self-sufficient, paying off bonds and acquiring instead of leasing a motor vehicle.

It is also interesting to consider to what extent some categories of expenses increase in line with CPI or not.

Table 7.4 – Price changes over time compared with price changes for selected expenses

The above table shows the following:

  * The relative costs of internet use have been increasing less than inflation even though usage has increased significantly over the years. If started off with a dial-up service, then changed to ADSL and at some stage the possible data usage was doubled without much change to the cost.
  * The expenditure on my cell phone was getting relatively cheaper over the years, which helped to justify obtaining a smart phone with its higher costs. Even with a peak in costs in one of the later years which was due to extra usage rather than price increases, the relative cost of a cell phone has increased by less than CPI over the years, while the quality and functions obtained have increased significantly over the years.

In other cases some expenses increase by more than the CPI.

The table below shows the following:

  * While for a number of years the increase in expenditure on electricity did not vary significantly from CPI, in recent years it shows a steep increase as Eskom has been awarded large price increases, with a cumulative increase over 12 years of approximately 1.8 times the CPI. This is based on the amounts paid and thus takes the amount of usage into account.
  * While the price of petrol can be an emotional issue, for many of the years its change in price hasn't varied significantly from CPI. It is only in the latest year that it shows an increase much larger than CPI as the Rand/US dollar exchange rate took a tumble. For many of the intervening years the Rand has been fairly strong, which has shielded the country from some of the increases in the dollar price of crude oil. At some stages the cumulative change in price increases has been less than the inflation rate. It is possible that price increases make headlines, but price decreases are overlooked and quickly forgotten. Again the table takes price and usage changes into account.
  * Amounts paid to a medical aid fund have also increased by more than the CPI. This increase would have been higher if adjusted for the number of people covered; it went at the beginning from my wife, I and three children, with two children coming off the scheme over the years. The amounts were also impacted during the middle years included in the table, by changing to an option which didn't have a savings component and then changing later to have a savings component included in the medical aid contribution.

Table 7.5 – Price changes over time compared with price changes for selected expenses

Volatile expenses

As noted when discussing budgets, some expenses can be volatile. The table below shows how costs for some of the expense categories are more likely to vary from year to year, as a large part of these costs cannot be controlled as they can arise unexpectedly. This table shows the extent to which costs vary from the average over a five year period. It shows the following:

  * Medical expenses in the third year were 16% of the previous year's expenses. In the other three years expenses were much the same
  * For motor vehicle expenses, the expenditure in the last year included in the table was nearly 6 times higher than the second highest expenditure
  * For repairs and maintenance costs for our home only in one year were the costs similar to the average for the five year period; for two years they were about 50% higher than the average, while in the fifth year it was about a third of the average.

Table 7.6 – Comparison of costs for selected costs over a five year period

Summary of analysis of expenses

What does all this information show but the following?

  * As families grow and upscale expenses are likely to increase by an amount that exceeds the CPI, which can be a challenge if salary increases and promotions are inadequate for this
  * As families mature and children flee the nest expenses might decrease or increase at a rate that is less than the CPI
  * Expenses in some categories can increase by more or less than the CPI and some can consistently do so for many years
  * Expenses can be volatile, both on a short term and on a longer basis, this can be due to the following:

  * Price increases – e.g. impact of exchange rates
  * Extent of usage –e g. extra travel from living further from work or going by car on holiday instead of flying
  * Planned unusual expenses – e.g. holidays, planned acquisitions
  * Unplanned expenses – e.g. repairs, medical expenses 
  * Making trade-offs –e.g. short holiday in a hotel vs longer holiday in self-catering accommodation; also flying vs travelling by car
  * Up or down scaling – e.g. acquiring a TV for the first time, acquiring a more expensive vehicle, children's education complete and the child being removed from the parent's medical aid.

The above information shows that the setting of budgets and controlling of costs can have its challenges.

Using income for investments

Table 7.1 above shows the extent to which my salary was used to pay for expenses. In most years my expenses were less than my salary. So what did I do with the excess of income over expenses?

The charts below summarise what investments I made. For this purpose I have split the information into two parts, because some of the information is not clear if a combined table is given. For the purposes of this table the impact of inflation has been removed by adjusting the amounts for inflation; in addition all the amounts over all the years have been adjusted assuming that the total amount for investments in 2012 was R100,000. When reading the table be aware that in part 1 the top amount is R30,000, while in part 2 it is six times that at R180,000.

Table 7.7 – Analysis of investments

Before commenting on the table, an explanation of what it includes is necessary to understand it:

  * Required savings, the bottom block in the graph, are contributions to pension or provident funds that were required as part of my employment conditions. This includes amounts my employer paid on my behalf.
  * Voluntary investments, the second block from the bottom in the graph, include acquiring shares, lump sum and monthly contributions to unit trusts or exchange traded funds and contributions to retirement annuity and endowment policies.
  * Wasting assets are assets whose value decreases over time. This includes motor vehicles, furniture, equipment and appliances. These are items needed to live comfortably, which last a few years and which need to be replaced periodically.
  * As noted earlier in this section you can increase net worth by paying off liabilities, so settling liabilities is a form of investment. This largely consists of paying off mortgage bonds.
  * When a home was acquired it was normally partly funded by a mortgage bond. For the purposes of this table the amount included as an investment in a home is the cost less the amount raised as a mortgage bond. For example, if a home cost R500,000 of which R400,000 was financed by a bond, then the investment amount for the home was R100,000. In addition in some cases investments were sold to acquire a home; again in this case the investment in less proceeds received from the realisation of investments.
  * Loans comprise assistance to family members. This is the top block in the 1993-7 and 2003-7 in the graph.

Part 1 shows that before 1993 investments were fairly low when compared to the other years. This was due to expenses as a percentage of salary during those years averaging 97%. In part 2 the larger investments were made in the later years. This is due to expenses as a percentage of salary from 2007 to 2012 averaging 62%. Accordingly as would be expected the larger investments were made in those years where there were more amounts available for investment.

Comments I noted on looking at this table are as follows:

  * Investments in houses, which only occur periodically, match the increase in related expenses, mentioned in table 7.1 above. The other large investment was a major renovation of a house in the 2008-12 period.
  * Required savings occurred throughout the period covered by the table, but became proportionately smaller as amounts available for investment increased. As a result voluntary investments only really started featuring in about 1993, with the largest amounts in the final years as expenses as a percentage of salary decreased. The voluntary investments were also impacted by other investment decisions; for example, voluntary investments in some of the later years were low as they were impacted by a decision to buy a new home and to renovate another.
  * It is preferable to invest in assets that increase in value, but it is necessary to acquire wasting assets, particularly motor vehicles. For many years I leased a vehicle, but we acquired vehicles for my wife and children and this is reflected in the periodic spike in this category of investment. In one of the later years I also acquired a vehicle for myself in anticipation of retirement.
  * During the 1980s about 84% of investments were spent on houses and required savings, with little used to settle debts. Settling liabilities only became possible when there were amounts available for this; this occurred in the 1990s when the bond was repaid and after another home was acquired in 2004. In the 1990s 33% was spent on houses and required savings, while 20% was spent on settling liabilities. For the period from 2000 these percentages were 45% (of which housing accounted for 20%) and 12% respectively.
  * On a few occasions funds were available to assist family members financially when they needed it.

Taking expenses and investments together in my 30s when expenses were increasing in excess of the CPI this was due to my family increasing in size and increasing my standard of living, which I was able to afford. In that period the only significant investment I was able to make was in homes, which in itself was both increasing my standard of living as well as being more costly.

Voluntary investments only became a significant investment from my mid 40s and continued until retirement.

Cash balances

Table 7.1 above shows expenses as a percentage of salary. Does this plus the investments shown in table 7.7 equal 100% of my salary? No. The reason for this is a follows:

  * For the purposes of table 7.1 salary excluded bonuses, while investments included investment of my bonuses
  * In addition to my salary I have also earned other income, mainly interest and dividends on investments, but also, as indicated in the budget shown in section 6, other income and reimbursements of expenses
  * In some years I might have increased my cash balances by realising some of my investments.

Accordingly the net result is that over the years my cash balances increased or decreased. In addition, cash balances include interest bearing savings or money market accounts, which are also a form of investment but have not been shown as such in the above tables.

The final table in this section deals with the extent of cash balances at the end of each year. As noted in section 6 in discussing budgets, it was mentioned that having a reserve fund for unexpected expenses is desirable. While some have suggested having a three month buffer, I thought this to be quite high, therefore the table below shows the extent of cash balances at the end of each year as a percentage of that year's salary.

Table 7.8 – Year end cash balances as a percentage of salary

This table shows that during the first half of the period covered by the table that cash balances were on average less than 6% of my salary, representing about three weeks income. The table also shows that in some years the amounts were negative, indicating cash was tight and that I went into overdraft.

The first time savings reached a three month level (25%) was in 2003. With the balances increasing from 2001 to 2003 it enabled me to put down a large deposit when we moved home in 2004.

The percentages in the later years are high due to bonuses being received shortly before the year end which were only reinvested early in the following year. The amount in the final year was also due to proceeds received from a sale of a house, previously being rented out, shortly before the end of the year.

This again shows that in the 30s in particular having much available cash can be an issue, but as one approaches retirement that this can be less of an issue.

Making payments

While what money is spent on is important, how payments are made should also be considered. In this regard there is not just one way to spend money. In some cases the use of cash is appropriate, while in other cases the use of debit or credit cards, stop or debit orders, as well as electronic funds transfers (EFTs) may be appropriate. In this day and age the use of cheques, while still legal, is fading away.

While cash can be used there is the issue of security as it could be stolen, or increase a person's chance of being attacked, particularly if it known that the person might have substantial cash on themselves. This risk has also led to me limiting the amount of cash I can take out of an automatic teller machine (ATM). Accordingly I only use cash for relatively small purchases. Because I want to keep track of my expenses it is easier to do so if the use of cash is minimised. Also be aware if when making a purchase of a large item and the buyer insists on being paid in cash, it may be that they want to avoid the paying of tax, either income tax or value added tax.

The use of a debit or credit card helps to reduce the amount of cash that needs to be carried around, as well as helping to keep track of what amounts are spent on. As the next section explains, a credit card can be a benefit or a curse, depending on how it is used; therefore if a person battles with self-discipline they should avoid using a credit card. While using a debit or credit card might be used as just different ways to pay for items or services, a debit card has the benefit that it can only be used if there are funds available, while on a credit card the holder may not know whether they will have sufficient funds in the bank when the credit card becomes due for payment.

People can also become liable to pay amounts on a regular basis. This includes items such as rent, car payments, life insurance, household insurance, rates and electricity. Some of these might be fixed amounts, such as life insurance, others might be fixed for a period (e.g. household insurance might only change once a year), while others, such as electricity, change monthly. In some cases in order to receive the services you might be required to sign a stop or debit order. This effectively gives the other party the right to take the amount owing out of your bank account each month. While this has the benefit of ensuring you don't have to remember to make the payments, on the other hand you have to ensure there are sufficient funds in the bank account when payments are due. It's for this reason that EFTs are useful; you can make sure you have the necessary funds when making payment, but the downside is that you can forget to make a payment.

Personally I prefer to make EFTs, as it gives me more control over my finances, but this is helped by the personal finances software that I use as it reminds me of what payments are due. The other reason is that I don't always trust the other party. In my city there have been horror stories of amounts charged for electricity and water, where by signing a debit order it could result in a person having to pay and then argue for a recovery later.

When making EFTs be careful to ensure the correct account details are used. It seems the banks don't check whether the account name and account number tie up and only really use the account number for payments. If the payment is made to the incorrect bank account it might not be possible for the bank to recover the amount paid. A number of years ago I changed two numbers of an account number around and so when the other party asked me when I was going to pay I said I had, to which they replied that they wanted proof of payment. When printing out the proof I noticed the mistake in the account number. Fortunately the bank recovered the amount paid to the wrong bank account as the recipient hadn't spent the money.

However, in some cases the other party might not be willing to provide you with a service unless you sign a debit order. In this case, you need to decide whether you are prepared to agree to these terms or not. Recently my cell phone provider charged an amount to my bank account even though they hadn't replied to my query on the account. The amount involved was substantial, namely about 4 times my credit limit, while my normal monthly account was about 10% of my credit limit. Accordingly when my contract comes up for renewal I will consider moving my account elsewhere as one of my unanswered questions was why my account wasn't suspended when my credit limit was reached.

Accordingly, a person should consider which method of payment is appropriate for the various types of payments. In making these decisions the related bank charges might also have an impact. Accordingly a person should understand how they are charged by the bank for services. In some cases they might pay a set amount for a certain level of services and extra costs when this level is exceeded. In this case knowing what these limits are is important. For example, you might be allowed unlimited EFTs but only 8 ATM withdrawals a month. When withdrawing cash, banks can charge more when withdrawing from another banks' ATM and so using your bank's ATM should be the preferred approach.

You can alternatively also elect to be charged by transaction. You will need to decide based on your profile of transactions, whether this option is preferable. How banks charge fees might also lead you to change how you make transactions. For example, a cash withdrawal from an ATM might have a minimum fee of R4 per transaction. If you are withdrawing say R100 per day by way of cash from an ATM, you might be paying a total of R120 per month by way of minimum fees. If this was changed to withdrawing R500 every fifth day, the minimum fee reduces to R24 per month. There might also be a variable fee in addition to the fixed fee. If this fee is 1% of the amount withdrawn then this will not change if large or small amounts are withdrawn. In the example above the total fees for ATM withdrawals will be R150 (120 + 1% of 3 000) when withdrawing R100 a day, but R54 (24 + 1% of 3 000) when withdrawing R500 every fifth day. Accordingly how you operate a bank account can have a big impact on bank fees.

Banks can also offer rebates on fees; this normally requires a minimum amount to be kept in the bank account during a month.

Some could consider just having a savings account instead of a current account for their income and expenses, but there could still be fees incurred and restrictions on certain types of transactions. Accordingly the costs and benefits of such an approach need to be understood should this option be considered.

While people can get uptight about the fees they pay the bank, this might not always be appropriate. It could be due to their own actions and how they operate their bank account. I suspect sometimes that some quibble about bank charges of say R150 per month, but think nothing of regularly spending large amounts on themselves, for example buying clothing at exclusive boutiques. 

### Chapter 8 **– The use of credit**

The use of credit can be a benefit or a curse.

For many in South Africa the use of credit has ended up as a curse even though when they obtained credit they thought it would be a benefit. Generally it has been fairly easy to obtain credit in South Africa in recent years, but this has unfortunately resulted in many having an impaired credit record. Importantly, if a person has difficulty handling credit early in their working life this can have long term negative effects. It can impact on job prospects and limit the ability to obtain finance for a house or vehicle. For some this can be a lifelong issue and so it is advisable to know soon after leaving school on how to manage credit.

Accordingly credit needs to be handled with care.

Having credit also has its benefits. Showing that one is able to manage small amounts of credit can help a person obtain credit for large items, such as vehicles and houses.

Obtaining credit

If you want to obtain credit from companies such as a bank, retailer or cell phone company you would be expected to provide them with information so that they can assess whether to provide you with credit or not. These institutions are required in terms of the National Credit Act to ensure you are able to afford any credit provided.

For this purpose the credit providers might require you to provide them with information to ensure you can afford credit. They may ask for your pay slip and recent bank statements to see whether it appears you have regular income and are living within your means. They might also check your credit records with one of the credit bureaus that keep records of defaults, judgments and liquidations. For large amounts, such as a mortgage bond, they might also want details of your assets, liabilities, income and expenses before deciding whether to provide you with credit.

If you don't keep up regular payments on any account this can be reported to a credit bureau and so this could affect other credit applications. Accordingly, keeping a clean credit record is in a person's long term interest from a financial perspective.

Interest on credit

Some short term credit (up to six months) might not be interest bearing, but long term credit (e.g. loans for houses and mortgage bonds) are typically interest bearing. As the previous section shows interest can be a large expense and thus reduces amounts available for other categories of expenses. Accordingly, if one is able and willing to delay expenditure by saving for future purchases it can result in a more favourable financial position on an overall basis. However, this requires the person to have patience, but adverts make easy credit hard to resist.

Those who battle with credit can also have another problem, namely higher interest rates. Financial institutions typically consider the risk of them not getting their money back and so the higher the risk, the more they charge by way of higher interest rates. Those who don't need credit can be offered low interest rates, while those who use credit to survive pay high interest rates. For example, at present these rates can be less than 10% p.a. for those with good credit records, while being more than 20% p.a. for credit cards and even higher for micro loans.

Further issues relating to interest are dealt with below when dealing with credit and compound interest.

Paying back credit

The problem is not obtaining credit but paying it back. If a person uses credit just to survive in one month, what is going to happen in the next month that is going to help pay back the amount borrowed – won't they end up in a worse situation? Assuming their income and expenses are unchanged from the previous month, they will also need to use credit to survive that month, but in addition they will also need to repay (in part or in full) the amount borrowed in the previous month.

Accordingly one should only borrow if one knows how it will be repaid; meaning it shouldn't be a case of 'that is next month's problem,' 'I hope to win the lottery,' 'it is time for a salary increase' or 'I am sure it will work out.' If the issue giving rise to obtaining credit is not faced upfront it can become a much bigger problem later, including having debt default judgments. What might seem a big problem initially could be a small problem when viewed later. In addition, the initial issue might be under the person's control but could become out of their control later. If a person needs to borrow new amounts every month because their expenses exceed their income, then they shouldn't delay dealing with the issue; immediate action is needed because while it can be easy to obtain credit, it can be quite difficult to get out of a debt trap. It can also lead to stress, arguments with spouses and lying to those who want their money back about prospects for repayment. They can promise payment without having the faintest idea about the source of funds to be used for payment. Therefore approach the use of credit very cautiously.

Initial use of credit

It is best to practice with the use of credit before it is actually needed. For example, obtain a store card for clothing. This can be interest free, with repayments over six months. If this is managed responsibly this credit record can possibly be used to obtain a cell phone contract at a later date, followed by a loan for a vehicle and a mortgage bond for a house. This store card can have other benefits, such as cheaper movie tickets, flights, car hire as well as offering road side assistance when vehicles break down or are in accidents for a small monthly fee. This can be in addition to paying the same price for clothing whether it is paid in cash or over six months.

Let's look at some examples on the use of credit.

Use of credit – example 1

You have applied for a credit card and have been given a card with a R10,000 limit. Congratulations! You receive it at the beginning of month 1 and decide to reward yourself by buying some luxuries, including some smart clothes and taking friends to fancy restaurants. You are not required to make any payments before the end of month 2. By the end of month 1 you have spent R10,000 and then find when your credit card is declined a few times that the limit is not a monthly limit but the total amount owing at any point. Oops! This means you can't spend anything on your credit card until you make a payment and you don't intend to do so before you need to. Unfortunately this means you can't use your credit card in month 2. At the end of month 2 the minimum payment you need to make is R300, so you only pay this. So now you wonder how much you can spend on your credit card in month 3. You then find that the bank has charged you interest of R175 because you didn't pay your credit card in full. This means that the limit of R10,000 was only reduced by R125, because R175 of the R300 you paid has been charged as interest. You now realise that you can only spend R125 on your credit card in month 3 and that your expenses have increased as a result of more than half of the new monthly payment for the credit card being for interest. Suddenly having a credit card is not the joy you thought it would be.

Now let's consider an alternate way to use the credit card. You realise that you should only be using the credit card for items that you previously paid in cash, such as food, some clothing, household items, presents and for your hair. You realise that your credit needs to last until you make a payment, which in this case is at the end of month 2 and that if you pay the amount owing in full no interest is charged. Accordingly, you decide to spend no more than R5,000 on your credit card in month 1. In addition, you realise that your cash expenses in month 1 will be R5,000 less than normal as a result of using the credit card. You decide to transfer this R5,000 at the beginning of month 1 to a savings account instead. You make a similar transfer at the beginning of month 2 as you didn't have to pay any amount then into the credit card. At the end of month 2 just after you receive your salary you pay R5,000 into your credit card, being the full amount owing at the end of month 1. At that point you were close to your limit of R10,000 but with the payment no interest was charged and you can spend another R5,000 on your credit card in month 3. Your expenses haven't changed because no interest was charged, you have the funds to pay off the credit card if necessary and also benefit by earning interest on the amount in the savings account. The R10,000 in the savings account plus interest doesn't represent savings in expenses, but the effect of delaying payment of expenses without incurring interest. That is how credit should be used.

Use of credit – example 2

You decide it is time to replace your television set and you decide you can afford to pay R300 per month for a new one. You go to a store and come home with your fancy new set and after 24 months it is paid off. What you don't realise is that over the two years you paid R7,200 for a television set that would have cost R5,000 if you had paid cash. If you had studied the contract you signed you would have noted that they were charging you an interest rate of 21% per annum plus credit risk insurance and administration fees of close to R50 per month.

Now let's consider an alternate approach. You decide to save for a new television set and decide to save R300 a month, even though the interest rate on your savings is only 4% p.a. After 16 months you have paid R4,800 into your savings account and with interest have nearly the R5,000 necessary to buy the television set. Even if the price with inflation has increased to R5,500 you will have enough after 18 months to buy it. When compared with the first approach you will have R300 per month for the rest of the two year period, namely R1,800, to spend on other items or to use as savings for your next appliance.

Alternately if you saved R200 per month for two years you would have R5,000 at the end to buy your television set, so paying for it ahead of time (namely R200 per month into a savings account) is a third cheaper (namely R100 per month) than if paid for after it was purchased. Accordingly there can be benefits by deferring acquiring items. In addition, with the rate of change in technology you might get a better television set for the same price at a later date.

Practical use of credit

When using a credit card there are some issues you need to be aware of. As mentioned in the above examples interest is charged if the amounts purchased in one month are not paid in full by the end of the next month. The maximum credit period is likely to be just over seven weeks, from about week 2 of month 1 to the last week of month 2. This means that there will be seven week of credit for items purchased at the beginning of week 2 of month 1, but only four weeks of credit for items acquired at the end of week 4 of month 1. While a card has a benefit of obtaining interest free credit, it doesn't apply to all items charged to a credit card. Interest free credit applies to purchases of items, but not cash advances, so for advances interest is charged from the date of the advance. In addition, a credit card might offer a budget facility to finance larger items which can be paid over a period, up to a few years. In this case you essentially pay interest for using that facility, but other purchases don't attract interest if paid in full at the end of the month following the purchase. When using the budget facility interest is charged from the date the item is charged to the credit card. There are some items that cannot be bought using a budget facility, such as petrol and foreign exchange. If you use your budget facility it might reduce the amount you can use on your credit card (e.g. you have a credit card limit of R10,000 and use R2,000 to buy a coffee machine using the budget facility. This would mean you only have R8,000 of your facility available for other purchases, unless you have a separate budget facility).

Credit and compound interest

Many use credit to buy vehicles and houses. This is an area where compound interest, which we looked at earlier, has an impact.

By way of example, let us say you have bought a house and have a mortgage bond of R1,000,000. You are given a twenty year bond at an interest rate of 9% p.a. and will be required to pay R8,997 per month excluding life insurance and insurance on your house. If interest rates don't change you will have paid R1,079,640 after 10 years, but how much do you still owe on the bond? The actual amount is R710,259 as a result of R789,899 of the total payments going towards interest. That means that after paying for 10 years, which is half the bond period, 71% of the bond still remains outstanding. This is because in the early years of the bond most of the payment goes towards interest, with the amount of the capital that is repaid being small. The amount of capital repaid increases towards the end of the bond, when interest gets progressively smaller.

Table 8.1 – Amount owing on bonds with different terms (bond of R1 million, 9% interest rate)

The above table shows that on a 10 year bond, half of the amount owing is paid in the last four years. For a 20 year bond this is just over six years, while for a 30 year bond it is seven years. This table also shows that during the first part of a loan period that large amounts are paid towards interest.

Now there are a number of issues that should be considered in relation to interest bearing loans. For this purpose we will consider housing loans, but the same principle applies to other loans, such as loans for vehicles.

1. Period of loan

Typically mortgage bonds have a repayment period of 20 years. If this was extended to 30 years, would it make the monthly repayments a lot less? The table below shows the monthly repayments, using the same information as above, namely a R1 million bond at an interest rate of 9%.

Table 8.2 – Monthly repayment on a R1 million mortgage bond, using a 9% interest rate

The table shows that by extending the repayment period by 50% from 20 years to 30 years, the monthly repayment hasn't reduced by much more than 10% from R8,997 per month to R8,046 per month. At the same time the total payments including interest have increased 34% from R2,159,342 to R2,896,650. This also shows that on a 20 year loan the interest of R1,159,342 is more than the capital of R1 million. On a 30 year bond you pay nearly R2 interest for every R1 of capital, while on a 10 year bond you just over 50 cents interest for every R1 of capital.

As interest can be such a large expense and can mean less amounts are available for other expenditure, a balance is needed as to what can be afforded on a monthly basis. Using the above example, does it make sense to save R951 per month in repayments, if your total payments are going to increase by R737,218 if a thirty year bond was taken instead of a twenty year bond?

2. Interest rates

Interest rates have a big impact on the monthly payment. Many mortgage bonds have interest rates that are linked to the prime interest rate. Accordingly when the Reserve Bank changes interest rates they can have the result of increasing or decreasing the monthly repayment.

I had the unfortunate experience in the late 1990s of the interest rate on the bond increasing three times between agreeing to buy a home and when the bond was registered a few months later! A possible change in interest rates is something that should be considered when a bond is obtained. Often a house might be bought that is close to the limit of what one can afford, so what will be the source of funds for any increase in repayments?

The table below shows the effect of a change in interest rates, using the same information as used in the previous table.

Table 8.3 – Monthly repayment on a 20 year R1 million mortgage bond

This table shows the following:

  * A 1% increase in interest rates from 9% to 10% results in the monthly repayments increasing by R653 (7.3%) while 1 % decrease to 8% results in the monthly and total repayments decreasing by 7.0%
  * At an 8% interest rate the amount of interest paid over 20 years is much the same as the capital, while at an interest rate of 15% the interest is double; this increases to triple at a 20% interest rate 
  * As monthly bond repayments can be one of the largest monthly expenses, a large increase in the monthly repayment can be a challenge.

It also needs to be appreciated that different types of loans can have different interest rates. It is not only how risky a person is considered to be, it is also the type of loan that affects the interest rate. If you have a mortgage bond the bank can sell your house if you don't repay your loan. The same applies to the loan for your motor vehicle, but as it is easier to make a vehicle disappear, vehicle loans typically are regarded as carrying a higher degree of risk and thus a higher interest rate. If the bank gives you a loan without any security then the bank is relying on you to pay the money back and hasn't the same ability to sell the assets obtained with the amount borrowed and so such loans carry the highest interest rate.

The interest rate can also be impacted by the amount borrowed. For example, if you want a bond for 90% of the cost of a house, you are likely to pay a higher interest rate than if you only want a bond covering 50% of the cost.

Interest bearing loans can have fixed or variable interest rates. When interest rates vary, they normally vary in accordance with the interest rates set by the Reserve Bank, which is the rate it charges the banks to borrow from the Reserve Bank, termed the repo rate. When the Reserve Bank changes its rates, the banks typically change their rates to the same extent. For example, if the Reserve Bank increases its interest rates by 1%, the banks increase their rates by 1% as well. Most mortgage bonds have variable interest rates, but for shorter period loans fixed interest loans can be obtained. Fixed interest loans can be obtained for mortgage bonds, but this would typically only be for a certain period, say up to 3 years, and not for the whole bond period. Loans for vehicles can be either fixed or variable.

If you take out a bond at a time when you expect interest rates to increase, then taking out a fixed interest bond might make sense, as it will mean that for a period you won't have to pay increased bond payments if the general bond rate increases. However, while this makes sense it needs to be realised that the fixed rate might be higher than the current bond rate as the bank will also be anticipating a higher interest rate over the period of fixed interest and takes this into account in setting the rate. Accordingly, you have to balance paying a lower monthly payment which can increase against a higher amount which doesn't change.

If you take out a fixed interest loan there is also the danger of interest rates decreasing instead of increasing and so you could end up paying more than if you had taken out a variable interest loan. This means you need to decide whether you want the security of a fixed payment amount or whether you can live with the variability of changing interest rates.

When the period of fixed interest rates for a bond expires, the interest rate would typically revert to the then current bond rate, but the bank might offer an option of a new fixed interest rate, based on the market conditions at that time. The bank might allow you to change a fixed interest rate to a variable interest rate, but it is likely to come with some additional charges if you elect that option.

Regulations in terms of the National Credit Act specify maximum interest rates for various types of loans. These vary from mortgage bonds, where the maximum rate is 2.2 times the repo rate charged by the Reserve Bank (currently 5.75%) plus 5% to unsecured loans where the rate is 2.2 times the repo rate plus 20%. Accordingly the maximum interest rates for these types of loans are 17,65% and 32.65% p.a. respectively. However, for loans below R8,000 and which are to be repaid within six months the maximum interest rate is 5% per month (which equates to an annual rate of nearly 80% p.a.).

The table below gives an example of possible interest rates.

Table 8.4- Examples of possible different interest rates

Accordingly, managing your finances well can have its rewards, namely being offered lower interest rates on credit than those with poorer credit records.

3. Changing repayments

It is not always appreciated that a relatively small increase in a monthly repayment can have a relatively large impact on the period it takes to repay a bond.

The table below shows how long it takes to repay a bond, assuming different monthly repayments, but again using the same information as used earlier.

Table 8.5 – Period to repay a 20 year R1 million mortgage bond, using a 9% interest rate

The table shows that an increase in monthly repayments of around R50 a month takes 4 months off a bond, while an increase of R1,000 a month takes about 4 and a half years off a bond.

Another way of looking at increasing repayments is to keep repayments unchanged when interest rates decrease. For example, if the interest rate was reduced from 9% to 8% but the monthly repayment remained at R8,997, the new repayment period would be 16 years 11 months, a reduction of 3 years one month. This assumes the interest rate changes when the loan commences, but as this normally occurs during the term of the loan the reduction in the repayment period will be less than that shown above.

It is for this reason that it can make good sense to pay part of a bonus into a bond and to increase monthly repayments when increases in salaries are received.

The above tables show that a change in interest rates can have a substantial impact in required monthly repayments, and an increase in monthly repayments can have a substantial reduction in the repayment period. Those who have bonds need to be aware of this as part of managing their finances.

4. Other costs

When paying off loans there may be other amounts charged to loans that need to be considered. There may be an initial fee charged when the loan is granted to cover the costs of obtaining the loan and then there may be monthly charges for administration of the loan and insurance. Insurance could cover the asset (e.g. home) or insurance to cover the person should they die or be retrenched before the loan is repaid. These costs need to be taken into account when considering a loan as the provider of finance might require insurance, especially where the asset being acquired is a house or vehicle.

Credit and household debt

If you read articles on finance you might read that there are those concerned with the level of household debt which has increased over the years from about 50% of annual disposable income to about 75%. This is not as alarming as it sounds in a period of low interest rates, as the reductions in interest rates have had a large impact as illustrated below. For developed countries with lower interest rates than South Africa, this ratio is generally higher.

Imagine that in the year 2000 you had a mortgage bond of R1 million. At that time interest rates were about 15% and so your monthly bond payment would have been about R13,200 per month. If these payments were 30% of your salary, your monthly salary would have been about R44,000 per month or R528,000 per annum. Your debt would then have been 189% of your annual income.

Now assume the interest rates drop to 10% and that you can still afford the bond payment of R13,200 per month. Now suddenly you can afford a bond of approximately R1,368,000, resulting in your level of debt increasing to 259%. With you paying less interest you can afford more debt. Without your monthly payments changing you are able to afford a higher debt level.

When interest rates were reducing in the early 2000s this had an impact on the price of houses, Buyers were prepared to pay the same amount monthly to buy a more expensive house and so sellers asked for higher prices resulting in large price increases. The standard of the house for which a person was prepared to pay R1million in 2000 might have been the same as a house selling for R1,37 million four or five years later, but as both could be afforded with bond repayments of R13,200 per month there was little pressure on price increases.

Accordingly if interest rates increase it can impact on the price of houses. They could even drop and remain at a level for a while before increasing and then increase slowly. The other impact of higher interest rates is that it can be difficult to afford higher repayments and so it might not be affordable to maintain a high debt to annual income ratio. It might also be difficult to reduce this ratio, because it may be difficult to sell a house; it might even have to be sold for less than it could have reached a year or two earlier.

This means that when buying a house (or obtaining another loan with variable interest rates) it shouldn't only be considered whether you can afford the repayment at that time, but also whether the repayments associated with interest rates can be afforded in the future.

If the level of household debt remains unchanged when interest rates increase it will indicate that the finances of households are becoming more strained. While it makes sense to pay off debt early when interest rates reduce by keeping repayments unchanged, there are those who borrow more at a lower interest rate than they could afford at a higher interest rate. The problem is those who borrow at the lower interest rates might become financially challenged when interest rates increase. Thus when they should be looking to reduce the percentage of household debt they might have difficulty doing so.

Credit and the use of surplus funds

Suppose you have some surplus funds. Should you use those funds for investments or to reduce a loan? While the discussion above makes a case for reducing loans, is there a case for making investments?

If you intend to invest the money in an interest bearing account, such as a savings or money market account, then it would be expected that it would be best to pay the amount into the loan. This is because the interest you will earn on the investment is likely to be quite a bit lower than the interest you are paying on a loan. For example, you might only earn 4% interest but might be paying 9% interest on a mortgage bond. In addition, the interest you earn could be taxable if it is more than the amount you can earn tax free, while the interest saving on a loan is tax free. This is because it is unlikely that the interest on a loan for most people will be tax deductible and so by paying less interest this will not by itself affect tax and thus it is the equivalent of earning a tax free amount. Remember, as stated earlier, an increase in assets and a reduction in debt both result in an increase in net worth.

However, there may be cases where it might be better to use the funds for investment instead of reducing a loan. This is when the likely gain on the investment is more than the interest saving. This could occur where the surplus is invested in shares or unit trusts. In this case tax also needs to be taken into account, which is most likely to be capital gain tax. Accordingly, the likely gain, less tax, needs to be compared with the interest saving which has no related tax. For this purpose the expectation is that the increase in share prices needs to exceed the interest rate on a loan by a few percentage points to cater for the tax. As share prices can be volatile it is difficult to know whether prices will exceed interest rates to that extent; in addition recent large price increases are no assurance that the price increases will continue. Accordingly, there is a fair amount of risk associated with this approach as against a sure saving on interest and so an individual must make an assessment as to whether this risk is worth taking.

For most people it probably makes more sense to use surplus funds to repay loans than to make investments.

Paying extra into a bond can be a form of saving as the interest rate on a bond is normally a lot higher than received on a savings or money market account. In addition, many bonds have the facility to withdraw extra amounts that have been paid in. For example, you can get a reduction of interest expense of 9% p.a. instead of receiving 4% p.a. interest on surplus funds. If extra amounts are paid into a bond it can even allow the monthly repayment to be reduced, but this might result in the bond repayment period not being reduced, which should be one of the objectives of paying extra into a bond. Ideally the bond repayment amount should not be reduced, but there obviously might be reasons to do so, such as needing funds for other purposes, such as necessary repairs.

Debt management

If you have a number of loans at different interest rates, you can look at consolidating your loans. It doesn't make much sense to pay 20% interest on a bank overdraft if you have paid more than required into a mortgage bond with a 9% interest rate. Instead it will reduce your interest costs if you take a re-advance on the bond and use it to repay the bank overdraft. However such an arrangement is not always possible; for example you might not have paid in amounts in excess of what was required, or even where such excess amounts have been in, you might not be able to obtain a re-advance, as could occur in the case of a vehicle loan. In this case you should prioritize paying off loans with the highest interest rates first, without neglecting paying the amounts required for other loans when they become due. Be aware if paying off loans ahead of time as there could be penalties involved; for example, there could be penalties if the loans are repaid within a certain period of the commencement of the loan or a certain period of notice of repayment might be required. This is more likely to apply to fixed period loans than loans with no fixed period of repayment, such as bank overdrafts.

If you have a number of loans with different interest rates, it makes sense to use funds to reduce the loan with the highest interest rate as an alternative to consolidating debt. If you have a mortgage bond with a 9% interest rate, a vehicle loan at a 12% interest rate and a bank overdraft at a 21% interest rate, then the bank overdraft should be paid off first. However, if you are likely to need the funds again in the near future then your decision as to which loan to reduce should also take into account whether you can borrow again any amounts paid into a loan.

The other way to use surplus funds in a bond is to use it to get a lower interest rate on another loan. For example, you might need a loan to acquire a new vehicle. It is cheaper to pay interest of 9% p.a. on a re-advance on a bond than an interest rate of 12% p.a. which can be charged on a vehicle loan.

Now here is a wonderful possibility – buy a replacement vehicle without increasing your monthly payments! If you have paid extra into a bond, which is sufficient to buy the vehicle you want, and you haven't reduced your monthly bond payments for the extra amounts you paid into the bond, then you can take a re-advance on the bond to buy the vehicle. In this case your monthly bond repayment would be unchanged and you wouldn't have to pay anything extra for the vehicle you acquired, other than extra running costs, such as insurance and security.

Even if you haven't paid enough into a bond to buy a vehicle, so can still reduce your monthly repayments, by taking a re-advance from the bond to the extent allowed and then to finance the rest of the vehicle by way of a vehicle loan. This means that to the extent that you have paid extra funds into a bond the greater the extent to which the vehicle repayments can be reduced.

In both making an investment or reducing a loan it should also be considered whether the funds can be accessed if necessary. If the funds were used to reduce a mortgage bond it might be possible to obtain a re-advance, but not necessarily for the full amount. As shown in table 8.1 the capital amount is expected to reduce over time, so you might only be able to access the difference between the expected capital amount at the date of re-advance and the current capital balance. In some loans, such as vehicle loans, it might not be possible to obtain a re-advance.

The same applies to investments. If the investment is for a fixed period (e.g. one year) it might not be possible to obtain the funds before the end of the expiry period. While unit trusts and listed shares enable you to sell them and obtain your cash in a few days, it can take a long time to obtain cash for shares not listed on a stock exchange, as buyers might be few and far between.

Accordingly, using credit can be an important part of your financial health, but is also the one area that can significantly affect your health negatively, which is why it needs to be handled with care.

### Chapter 9 **– Housing, vehicles and appliances**

After paying for living expenses, expenditure on non-financial assets, such as housing, vehicles and appliances are often more important in most people's mind than investing in financial assets, such as shares and retirement funds.

Whether to buy or rent a home

One of the important questions when looking at housing is whether it is better to rent or buy a house. While this is a simple question it is not necessarily easy to answer.

Let's first consider why a house should be bought. Firstly, a home can be a way to accumulate wealth while living in it. However, it needs to be appreciated that house prices do not always go up. It is possible that they may not show much increase over a substantial period, then may increase slowly or substantially, which can be followed by price reductions, or other permutation of these changes. When looking at wealth accumulation there is normally more certainty that prices will increase over the long term than over the short term. Prices can be impacted by the general economic circumstances in the country or globally, by comments from politicians, changes in legislation (or suggested changes in law which affect the political climate) and interest rate changes. For example, when interest rates were dropping in the early 2000s house prices increased substantially. This is because for the same monthly payment a more expensive house could have been afforded.

A number of intuitions publish information on house prices. The average annual house price inflation in the table given below for the years 2002 to 2014 was published by FNB. This was used to prepare an index with 2001 as 100. At the same time the CPI index was changed to 2001 being 100.

This table shows that over this 13 year period, house prices went up 240% while CPI only went up 110%, which was a good reason to own property. If you missed the boom years of 2004 and 2005 and bought a property during 2005, average house prices increased by 60% to 2014, while the CPI increased by 74% in that period. The table also shows than in 2009 house prices decreased which is a risk of owning property; also this was the only year in which property prices dropped over that period. At the same time property prices elsewhere, particularly the US, dropped more substantially than in South Africa.

Table 9.1 – Comparing house prices and CPI (2001 = 100)

The second reason to buy a home is to provide accommodation when a person retires. Having a fully paid for home means less cash outflow when compared to renting at a time when income is likely to be less than it was before retirement.

To come back to the original question of buying or renting, simplistically it seems it is generally cheaper to rent a home than to buy one. If you were to buy a home for R1 million with a 100% bond, the monthly bond repayment is likely to be about R8 700 for a twenty year bond. However, if you were to rent out the same house you might only get a rent of between R5 000 and R6 500 per month.

Based on a house of this value it is initially cheaper to rent than buy. Looked at another way if you have a certain amount set aside for housing each month, you can afford a better class of house if you rent than buy.

In the early days of one's working life one might not be able to obtain a 100% bond, nor have sufficient for a deposit for a house and so renting might be common. This might also be influenced by where a person was brought up as they might not be able to afford a home in an area close to where their parents lived; even if they were able to afford a house it might be in an area that is far away from their present location, job and friends and so renting close to their current location is probably the logical choice. In addition, if a person is not sure whether they will move jobs or not, they may rent until they have more certainty on that issue, unless there are a number of job opportunities close to the person's existing employer.

While there is merit in this approach it needs to be appreciated that if interest rates don't change that bond repayments can remain unchanged while rent is likely to increase annually. Based on an initial rent of R6 500 per month and an annual increase of 6% it would take about five years for the rent to increase to the bond repayment amount of R8 700 per month. With a starting rent of R5 000 per month it would take about 10 years for the rent to increase to R8 700 per month assuming the same annual increase.

After the end of the five or ten years, it is possible that a similar approach could be taken, namely to move to another rented property where it is cheaper to rent than buy.

The above compares rent to a bond payment, but that may not be an entirely fair comparison. While renting, as with owning, you are likely to also be responsible for paying electricity and possibly water and sewerage and day to day maintenance, but you are less likely to have to pay for rates and major repairs (e.g. painting premises or replacing carpets). These other costs can add to renting being cheaper than buying a home initially.

An approach which could be considered, but which I suspect is rarely ever done when renting is to take the difference between the rent and the theoretical bond payment and invest that amount. When renting one does not share in the increase in the value of the house rented and so an alternate investment could be to invest the difference between the bond and rent payment.

While from a cash flow perspective it can initially make sense to rent rather than buy, this can be at the expense of capital appreciation. Take, for example, the house mentioned above with a 100% bond. After 10 years if interest rates hadn't changed and only the required bond payment had been made, the outstanding balance on the bond would be about R700 000. If the price of the house had increased by 6% per annum the house at that stage would be worth close to R1 800 000. At the beginning of the ten years the house and the bond would offset each other, but after ten years the net worth of the house would be about R1 100 000 (value of house of R1.8 million less bond of R0.7 million).

If only rent was paid the person would not have a similar asset. Even if the difference between the rent and the bond payment amount was invested the value of the investment is unlikely to be close to this amount. It is for this reason why it is suggested that acquiring a home makes sense in the long term if it can be afforded.

Because of the possible capital appreciation it is suggested that while renting might be appropriate in the early stages of one's working life, one should aspire to owning a home as soon as one is able to do so. While cash flow considerations are important initially in one's career, as increases and promotions occur the cash flows should be reconsidered to see if they can accommodate a bond payment instead of rent.

Issues to be considered when owning a home

In the section on CPI above it was noted that the CPI does not take actual costs of owning a house into account; instead an owners' equivalent rent basis is used, which is the opportunity cost of owning a house (i.e. what an owner could rent the house for is regarded as an expense). As mentioned above renting a house can be cheaper than buying one, so in this respect the CPI does not track actual costs. Regarding renting being cheaper than buying, from information I have seen on this it appears that this applies to most categories of properties except cheaper properties. It appears for properties worth R500 000 or less than this general principle does not apply; thus for these properties where the rent is R3 500 or less per month it is possible that it could be cheaper to buy than to rent a property.

As a person's standard of living increases they could look to move homes. Does it make more sense to move than to upgrade a property? It has been said that it is better to acquire a house that it is relatively cheap in a particular area than to overcapitalise an existing house. This would suggest that moving might be better than renovating, but this is not a general principle.

It needs to be appreciated that moving can be relatively costly. Even if one is just moving from one house in a particular area to another of similar value in the same area it can result in substantial costs being incurred. If the intention is to live in the new home for a considerable period of time then incurring these costs can be justified, but it might be more difficult to justify if the intended period of occupation is short, as the costs incurred might not be recovered.

Given below are the type of costs that are incurred when moving from one house to another, both worth R1 million. Although amounts for all categories are not provided, it is clear that these costs could easily exceed 10% of the value of the properties (i.e. exceed R100 000); with this percentage increasing for higher house prices.

Table 9.2 – Costs of moving home

If a person buys a house from a property developer they are likely to have to pay VAT on the purchase price of a house instead of the transfer duty mentioned above, which will be more than the transfer duty.

If a person occupies a house before transfer of ownership occurs then the person is normally expected to pay occupational rent until transfer occurs. Thus the owner of the house would receive this occupational rent if they allow the buyers to move in before transfer occurs and would pay occupational rent if they move into the home they have purchased before transfer occurs. It seems this might be occurring less frequently than previously due to the risk of the buyer not taking transfer and the difficulty in evicting people. Accordingly, this should only be done when the seller is sure the transfer will take place.

Often a person will be required to pay a deposit in acquiring a home, as the bank might not be willing to give a person a mortgage bond for 100% of the cost of the home. When looking at what they can afford a person also needs to consider whether they can also afford these other costs mentioned above as normally the bank will not be prepared to finance them, or if they do it might have to be financed from a separate loan which would be expected to carry a higher interest rate than a mortgage bond.

As a rule of thumb your monthly bond repayment shouldn't be more than 30% of your take home pay, although the banks have their own affordability criteria.

Buyers should be aware that there are different types of ownership, the normal types being freehold, leasehold, sectional title and share blocks.

Freehold ownership often allows you to own a home with the least restrictions. This normally applies to residential houses, including those in some complexes. Leasehold ownership occurs where you rent land, typically from the government or municipality, and are allowed to erect a building, possibly subject to restrictions. In South Africa this is not common in cities and towns, but there are some areas where this occurs, such as Clifton in Cape Town and the Durban beachfront. In some countries, such as Hong Kong, this is the only way to own property and in these cases the leases are normally for a long period, such as 99 years and can possibly be renewed.

In a sectional title development the owner owns a particular unit, but there is also property owned by all the owners collectively, termed common property. Common property typically covers roads, gardens, sports and recreational facilities as well as security facilities. Share blocks companies are similar to sectional title developments except that you own a share in the share block company which entitles you to occur a particular unit.

Share block companies are often used for timeshare developments where one share allows you to use one unit for one week a year. Sectional title developments over the years have become more common than share block companies.

For both sectional title and share block companies there is also a levy that becomes payable to a body corporate to cover the running costs of the developments. This can cover costs relating to the common property, such as rates, repairs, security and insurance. It could also cover electricity and water where the municipality charges the development for these costs and where the development recovers these costs from the owners.

Some housing complexes might provide for owners to own their units on a freehold basis; this would typically require homes to be freestanding (i.e. not where there are multi-storey flats), but in this case there would also be a home owners' association who owns the common property. A levy would also become payable for the costs incurred by the homeowners association.

If a person intends to buy a home in a complex, sectional title or share block they need to be aware that this levy will become payable and should find out the financial status of these body corporates or home owners associations. In some cases new owners have had an unpleasant shock regarding these funds; amounts for electricity and water might not have been collected and paid over to the municipality, special levies might become payable to cover major defects or repairs, some funds might have been misappropriated or some owners might not have paid their levies. It is therefore wise to ensure these funds are well managed and to find out, if possible, what the future levies are likely to be. There are also rules that may need to be adhered to; this can include what types of changes can be made to a person's property, including paint colours, what types of pets are allowed, when noises shouldn't be made, allowing visitors on the premises and restrictions on show houses when selling. Accordingly, a buyer should acquaint themselves with these rules.

Moving needs to be compared with renovating an existing home. While it might be cheaper in financial terms to renovate it can be more costly in terms of stress. Unfortunately many have stories of unpleasant experiences of renovating; the quality can be suspect requiring work to be redone; the contractor might have to be replaced; costs could exceed expectations; security during renovations can be a problem: it can take longer than expected and one can live in dusty or cramped conditions if alternate accommodation is not used. Another consideration is that one might not be experienced in doing renovations as some people might only do it once in their life. Some people might do renovations on a 'do-it-yourself' basis, with some being better able to do so than others. Accordingly for some people doing a renovation is something they can cope with, while for others they should be looking to avoid this.

One home we acquired didn't have a garage as the original garage had been changed into a room. When we decided to add a garage we contracted a company who seemed to build many garages. The workers worked periodically and my wife often phoned to find out when they could next be expected to be on site. As is common, we were also required to make progress payments. The garage was eventually completed but took longer than expected and we were satisfied with the quality and price. We didn't realise how fortunate we were with our experience despite the many frustrations, until we heard that the contractor went into liquidation a few weeks after our garage was completed. The other consequence of this experience was that a neighbour had to file plans for changes being made to their house without approved plans, as a result of the building inspector coming to inspect the work being carried out on our property.

The issue of when to buy and sell a house is also an issue for consideration. The really important decisions can be when you are buying your first home and selling your last home. Ideally you don't want to buy your first house when house prices are expected to decline and then to sell your last one when significant increases are on the horizon. However, a person doesn't always have the luxury of being able to defer such decisions or know what prices are likely to do. In addition, if the period between these two transactions is long enough then it might not make a significant difference in the long term. If you are buying and selling at much the same time in between these dates then the effect might be less significant. If you don't want to sell when prices are fairly low remember purchase prices are also low; in addition if selling prices are high then the same applies to purchase prices. Where it might make a difference is when a person is up scaling or down scaling. For example, if a person wants to down scale then it is better to do so when the prospect is for prices to drop and not when they are expected to go into a period of large increases.

Some decisions to sell can be impacted by financial circumstances. If a person has a large bond they might find that if they were to sell their house that instead of getting money out, they might have to pay money in. For example, if the selling price is close to the outstanding bond amount, then when taking other costs into account the net selling price could be less than the bond amount. Obviously this is more likely to occur when house prices are dropping, but can also occur if a person increases the value of their bond or takes re-advances of amounts paid. Accordingly, if a person wants to have flexibility about when to sell their home it makes sense to make a deposit when buying a house or to repay extra amounts into a bond (or both, which is even better).

It should also be mentioned that even some of the wealthiest persons who could afford to acquire an expensive house have not done so and have continued to live in a fairly modest house. These include Sam Walton, the founder of Wal-Mart the world's largest retailer (he resisted some improvements his wife wanted when they had to rebuild their house after it burned down); Warren Buffet the wealthy chief executive of one of the largest and most admired investment companies, Berkshire Hathaway, who has lived in the same house for over 50 years and Anton Rupert the wealthy South African industrialist who also lived in the same house for over 50 years. Accordingly just because one can afford to upgrade their standard of housing does not mean that this should be done.

Another issue to consider in relation to housing is whether to acquire a new or existing house. It seems generally that an existing house is cheaper than a new house. Accordingly, one needs to weigh the pros and cons of each approach. For those who are fussy they might have difficulty finding a house that meets all their requirements and so designing an ideal home might be the way to go. However this might result in additional unexpected costs due to impractical (or constantly changing) ideas or issues that hadn't been anticipated. Finding a suitable property and contractor might also be a challenge. Some find it difficult to envisage how a plan might work out in practice and so for these people buying an existing house might be the right approach to take. A new house might come with teething problems, while problems might be inherited when an existing house is bought, some of which the buyer might be aware of while others might only become obvious later.

When buying a house some can cope with and would want to renovate a house, while others want to just move in and live. This needs to be taken into account when buying a house; what is right for one family would be rather stressful for another.

Choosing a town and suburb to live in can also be important. One needs to decide what is important. It might be an area that is already well known, where family and friends live and is close to work and which is likely to be a popular area which can be afforded. Often not one area meets all requirements and so it might be necessary to make compromises. For example, one might be prepared to spend extra time and costs travelling to work and back so that family and friends are close, as living close to work might lead to seeing friends less frequently.

This means that when making decisions about where to live, costs other than housing costs, such as transport costs might have to be taken into account. Popular areas might have more expensive houses, but can result in less travel costs, while areas further out of town could result in lower housing prices, but higher travel costs and longer travel time.

Over time some areas can become more popular than others and so their prices might increase more than others. It might be desirable to live in such areas, but it isn't always easy to predict in which areas prices will increase more or less than the average. Some of this could possibly be anticipated, but others will only occur later. The reason for these differentiated increases can include new shopping centres, roads, train stations, new industries and mines, closing of factories etc.

When buying and renovating a house its ultimate sale should be considered. Rarely will buyers think it will never be sold, so they need to consider how easy it will be to sell a house. The more a house departs from a norm the more difficult it might be to sell. Before we bought our current home my wife went to look at a house whose kitchen she regarded as inappropriately small in relation to the rest of the house. The arrangement of rooms in a house might also make it difficult to sell. In our first house you went to the third bedroom either via the second bedroom or via an outside door, but fortunately this unsatisfactory arrangement did not result in us having much difficulty in selling it later. Recently our family was discussing the home of one of my mother's neighbour's where the main bedroom had been incorporated into the lounge and the only remaining bedroom was fairly small, which might be acceptable to a bachelor as the neighbour was, but not to a couple when the house is eventually sold. The colour of the paint, curtains and carpets can thus affect a selling price as well as other factors, such as the general upkeep of the property, the type and aesthetics of renovations and the important aspect of location. When considering these issues home owners should not only be looking at their own desires but also whether these desires are likely to appeal to others or not. If money is not an object then the fact that there might be a smaller pool of possible buyers meaning that a likely sale could take longer than average might not be an issue, but for most people these are important issues which should be considered.

When buying a house buyers often seem to buy a house at a price close to or just over the limit they set for themselves. While it is appropriate to determine a limit, buyers normally look at houses above that limit on the assumption that they can drop the price. As mentioned above, not all costs of acquiring a home might be adequately considered and so the initial period of owning a new home can be stressful financially.

When we moved cities we didn't find any suitable house before moving, so decided to rent for a while. On the first Sunday after moving we identified a number of show houses to look at. After looking at the first one on our list my wife and I agreed that this the one we wanted. While we were there another potential buyer was making an offer which was subject to sale. We had already sold our previous house and so our offer was just subject to obtaining a bond. So the question we had to answer was what amount to offer to ensure it was accepted. The amount we decided upon was a few thousand Rand over our self-determined limit. Our offer was accepted but in the three months between the acceptance and transfer the bond rates went up three times, meaning some of the intended changes we wanted to make had to be delayed a few years.

Selling of houses

After living in this house for many years we moved home and rented it out for a number of years. When one of our tenants gave notice we had to decide whether to sell it as it was, to continue to rent or to renovate before selling. Renovation could probably have resulted in the costs of renovation being less than the additional value being added to the house but would have meant having to deal with the stress of renovating. We decided we would be likely to sell it in the next few years in any event and so before deciding on whether to renovate or not we allowed an agent to show the house to those on her books, but not to actively market it. We were fortunate in that there were a number of interested buyers, one of whom wanted to renovate it and as the price being offered was towards the upper end of what we were looking for, we agreed to sell it even though we could possibly have made a bigger profit if we had done the renovations.

When selling it is easy to believe it is worth more than the market value and so there is a need to be realistic. If too high a price is wanted it can become known in the market that it is not selling and so there is the possibility of the eventual selling price being lower than what could possibly have been achieved if the initial asking price had been more realistic.

While it can be beneficial for people to make repairs to a house before selling it in order to improve its attractiveness to potential buyers, in some cases these costs might be high if the property has not been regularly maintained. In some cases changes are made which the owner could have enjoyed, but is not able to do so as they were only done to sell the property. Accordingly there might be merit in making these changes earlier so that the owner can enjoy them as well for a period of time.

Regarding selling a house, some prefer not to use an agent on the basis of saving on commission. I suspect this is false economy. Firstly, the seller is unlikely to have a good feel of a likely selling price. Secondly, if a buyer knows there is no agent they are likely to think that with no commission being payable that they will reduce the offer price by the approximate commission amount. They will think that a person wants to increase the net amount they receive from selling their home and react against this. Thirdly, as a house is possibly the biggest asset a person has, it is easy to become emotionally involved when selling it and so an estate agent can help the buyer to make rational decisions.

Owning a motor vehicle

Motor vehicles are an area where males might be more prone to over indulge than females as they try to portray a macho image to attract females. Accordingly the type of car purchased and how often it is replaced might be more dependent on trying to impress others than on an individual's needs.

I think the most important aspect is for a vehicle to be reliable; then if the person has a family, whether it is suitable for their needs. In this day and age motor vehicles are typically reliable, but if they break down there can be the issue as to the availability of spares. Just because a car is sold in this country doesn't necessarily mean a full range of spares is available in this country. Also if a car is getting old it might be more difficult to obtain spares when needed.

It seems some buy cars not based on what it is typically needed for, but for possible irregular use. For example, a family might go on holiday once a year to game reserves and so this is what determines which vehicle is purchased. While this is one approach, it seems that an alternate approach of possibly renting a vehicle for such a holiday is not often considered. It is possible that such an approach might be cheaper in the long run than buying a more expensive vehicle capable of being used off road.

There is also the issue of whether to acquire a new or second hand vehicle. In one's early days of working a person might not have sufficient funds to acquire a new vehicle and so might be more likely to acquire a used vehicle. Even later in one's working career even though one could afford a new vehicle, it doesn't mean that acquiring a pre-owned should be excluded as a possibility. The reason for this is that other than for investment vehicles, vehicles generally decline in value over time and this decline can be fairly substantial immediately after acquiring a vehicle. Accordingly acquiring a demonstration vehicle or one that is a year or two old can be a viable option.

When acquiring a pre-owned vehicle a buyer should understand why the vehicle is being sold; one doesn't want to inherit problems and so should have a preference of buying from a reputable dealer who provides a guarantee and should also consider having the vehicle checked by a qualified mechanic or organisation that provides such a service. While this is likely to come with a cost, this might save possible unexpected future costs.

Many vehicles these days are sold with a maintenance plan which means that some or all of the regular service costs might be covered for a period of time. To benefit from this the buyer needs to adhere to its terms, which typically specifies when the vehicle should be serviced and by whom. It doesn't make financial sense to pay for such a plan and then not to benefit from it. The terms of the plan should be understood as it is not likely to cover all items (e.g. it is not likely to cover the costs of replacing tyres); also the period of the plan needs to be understood (e.g. it could last for 5 years or 100 000 kilometres whichever comes first) and the extent of payment (e.g. it might pay 100% of the initial services with a reducing percentage in later years). Even if a person buys a pre-owned vehicle they might be able to continue with the original plan if it has been adhered to and the change of owner is notified to the manufacturer. Having a maintenance plan which is included in the purchase price means that some or all of the maintenance costs are being paid monthly rather than as a large amount, say every twelve months or less, which can make it easier to finance.

As this country doesn't have a well-developed public transport system many couples need to each have a vehicle. This can add to the challenge of balancing needs with the available finances.

As noted in the section on the use of credit most families are likely to need finance to acquire a motor vehicle. Sometimes it seems a purchasing decision is based on what monthly repayments are offered without fully understanding the underlying finances. In this regard the following should be considered:

  * What interest rate is charged and whether it is fixed or variable. It should be understood what interest rate is being charged and whether this seems reasonable or not. In the section on the use of credit the alternate option of obtaining a re-advance on a bond, if this is at a lower interest rate, is discussed. Sometimes when dealers want to encourage sales they might be offering interest rates that are even less than a bond rate. This can be a good option but be aware whether there are any catches that come with this offer. For example, the option of not paying an amount for the first month or two normally means extra interest and higher payments over the remaining loan period. If interest rates are variable they are likely to vary as the Reserve Bank changes interest rates and so the likelihood of such changes and the ability to afford such increases should be considered. If interest rates are likely to decrease then that might be a good prospect to consider. If a fixed interest rate is being charged it will protect a buyer from increases in interest rates, but might come with the negative of being higher than a variable interest rate loan.
  * The period of the loan. The longer the loan the lower the repayments will be, but could mean that the loan is not repaid when the buyer wants to replace a car and as noted in the section on the use of credit the amount of interest paid can amount up. A loan period could typically be between 36 and 72 months. For example, if a person buys a car for R100 000 and obtains a loan for 36 months at an interest rate of 12%, the monthly repayment is R3 321 per month. If the loan period is doubled to 72 months, the monthly repayment doesn't half (i.e. R1 660 per month) but is 41% less at R1 955 per month.
  * Residual or balloon payments. This is where the whole amount of the loan is not paid over the period of the loan. The assumption is that the vehicle is likely to be worth a certain amount at the end of the loan period and so this can be paid from selling the vehicle then. The risk is that the vehicle might be worth less than this amount and so the owner might still owe an amount when the vehicle is sold at the end. For example, taking the above example of acquiring a vehicle for R100 000 and paying if off over 72 months, the monthly repayment will drop to R1 669 per month if a residual of R30 000 (i.e. assumes vehicle can be sold for this amount after 6 years) is included in the loan. In some cases a dealer might be prepared to guarantee the buyback amount and so the buyer might be able to eliminate the risk of the residual being less than the then market value. Making use of a residual means that when the vehicle is replaced there might only be a little amount available for a deposit for the replacement vehicle.

Vehicles can be purchased or leased. Most people buy vehicles, even though they need to obtain funds to finance their acquisition. Leasing can be very similar to a purchase, but often people might use this approach to claim the monthly payment for tax purposes where this is allowed; namely where the vehicle is used for business purposes. If a vehicle is leased the person might still be liable for any difference between the amount owing at the end of the lease period and its then market value. However in some leases the provider of finance takes this risk and will offer a person a vehicle for a certain amount per month and at the end of the period the person just hands the vehicle back. In this case there might be a limit on the amount of travel that can be undertaken, with an amount payable for each kilometre over this limit.

Over the years I have acquired both new and pre-owned vehicles. As my standing of living has increased the standard of vehicle acquired has also increased, but what I did was to compare the monthly payment to my take home pay. By doing this I ensured the standard of my car wasn't increasing too much in relation to my standard of living.

Table 9.3 – Motor vehicle – monthly repayments as % of salary

When motor vehicles should be replaced is also an issue that needs to be considered. Some might replace their vehicle every three years, while other might use their car until it is no longer reliable. There are advantages and disadvantages to these different approaches. Selling a car after a relatively short period means you are always likely to have a reliable car, but might come with a cost, namely that with such cars the monthly payments are always based on a car being fairly new and thus higher than if cars were owned longer. At the other end the owner might have to pay substantial amounts when the car starts to become unreliable, and might have to adjust to suddenly paying a new monthly repayment amount with little notice, but on the other hand might have been paying a lower monthly amount (or even no monthly amount) for a reasonable period of time.

Accordingly, a buyer needs to balance some objectives, namely what can be afforded by way of monthly repayments, being able to adjust to new repayments (i.e. both the actual amount and how soon this becomes payable), having a reliable vehicle and not losing too much on a vehicle. It is for this reason that some might replace their vehicle when it has done about 100 000 kilometres or when it is about 5 or 6 years old, as after that it can become less reliable and its value might start to drop at a more rapid rate.

When a vehicle is replaced the previous vehicle is generally sold. While a vehicle could be sold for more privately than being traded in there are other issues to consider. A person might need the proceeds from the sale of a vehicle as a deposit on a new vehicle and so might need to sell a vehicle before obtaining the new one, which might be a challenge. There is also the risk that the buyer might not be genuine and the seller could risk thinking they have been paid when this turns out to be false. I also experienced selling a car for cash and being concerned about being mugged taking the cash to the bank. You are likely to receive less if you trade a car in, but this has the advantage of not having to find and deal with a buyer, as well as dropping off one vehicle and driving away with the new one.

Accordingly, people will buy different types of vehicles with different needs in mind, hold them for different periods and dispose of them differently. There is not one correct approach, and so people should consider which approach they are most comfortable with as they come with different cash flow and risk implications. In addition, as noted earlier, some people should also consider how much of the cash flow is due to needs as opposed to the cost of one's ego.

Acquiring appliances

These days there are so many appliances one can possess – kettle, toaster, clock, stove, microwave, washing machine, dish washer, tumble dryer, food processor, fridge, freezer, coffee machine, vacuum cleaner, iron, hair dryer, radio, television, home theatre, personal video recorder, DVD/Blu-ray player, personal computer, printer, laptop, hard drive for back up, modem, tablet, cell phone, digital camera, video camera, electronic reader, digital picture frame, shredder, game console, fans, air conditioner, heater, electric blanket, lawn mower, drill and sander are among a growing list of items that is not complete.

Looking at this list I have most but not all of them, which I have acquired over time, while others could have additional items. But what was interesting to me when looking at this list was how many we had when we were first married. We didn't have a washing machine until a few months later, a television set was acquired a few years later, a microwave many years later and some items only became available much later (e.g. cell phone, PVR, digital picture frame, tablet). I have been able to acquire these items over the years while some couples now seem to regard many of these items as essentials when they marry. This has an impact on their finances as it can lead to a higher standard of living at the time of marriage, with the necessary cost implications when compared to couples marrying 20 or more years ago.

Fortunately the costs of many of these items have generally decreased relatively over time. Nevertheless when individuals or couples are looking to acquire these types of items they should be considering whether they are needs or wants. In addition, this can be an area of extravagant spending where people want to have the latest and best gadgets, spending amounts more to impress others than because their current model is inadequate.

When acquiring items we also need to be aware that there may be other unintended costs. When we last replaced our computer the previous printer wouldn't work with it as the necessary drivers were not available even though I looked for them on the internet. Accordingly I had to buy a printer as well even though that wasn't on my original shopping list. When replacing our PVR it became apparent that I needed to replace the existing cabling, which I hadn't initially anticipated.

These days it seems that appliances are repaired less than previously. While this might be due to increased reliability, it might also be because they are more difficult to repair and so it might be cheaper to replace than fix. When acquiring an appliance this can be a consideration; with many items being imported there is the question as to whether spares are kept locally and whether there are those who are qualified to repair them. When I accidently dropped and damaged my digital camera recently, even though I thought it was a fairly well-known brand, I found there was only one place in my vicinity that offered a service to repair it, when I thought many camera places would be able to provide that service.

The other area of spending that needs to be considered is obtaining leading edge appliances. While people can impress others with these items, they often are relatively expensive and become more affordable later as they become more popular. In some cases people seem to be prepared to pay a lot for a brand name, when a less well-known brand might be a lot cheaper and produce much the same or even better quality or performance.

The issue of diminishing returns should be considered – if I buy an item for double the price of another item will I get double the size/quality/lifespan etc? In some cases there might be more functions or options available, but realistically how many of them will I need or use regularly?

Therefore, while appliances are part and parcel of modern life, the number we have, their quality and how often we replace them should be taken into account when looking at what we can afford. This means we should be doing our homework before acquiring them and we should avoid buying them on a whim after seeing an advertisement or our friend's latest acquisitions.

### Chapter 10 **– Children**

_Parents learn a lot from their children about coping with life_ – Muriel Spark

Having children is what many couples desire, but like childbirth itself, however much a couple try to prepare for it, it can be different from expectations. In addition, it is easy to focus on the positives of having children without fully appreciating some of the negatives. As much as they can bring joy, there are also the costs involved in bringing up children.

Whether mothers should work when their children are young?

One of the issues to be considered is whether the mother should return to work after the child is born. While for some couples there is probably no choice in this area as finances might dictate that they can't live on one salary, for others this might be an option.

While politicians might want women to occupy 50% of all top positions, I question whether this is appropriate. Before you consider me a male chauvinist let me explain myself. I think ideally it is better for children to be brought up by their parents instead of care givers and I think some mothers want to do that as well. For those who want to do that and are able financially to do so I think they should be free to follow this route. This being the case, they might want to take a break from employment or take a less demanding position while their children are young. Accordingly, there might not be an equal number of males and females for top positions and therefore I think it is acceptable for top positions to reflect this. I don't think women should be made to feel guilty because they are at home looking after children as children are the future and parents should be given as much opportunity as possible to raise their children.

I suspect that some couples who can afford to have a parent at home looking after a child elect not to do so, not because they can't afford this, but because they don't want to reduce their standard of living even though this may still be affordable.

I have had mothers working for me fulltime in a professional capacity, others that work six hours a day, while I had another who eventually agreed with her husband that he would stay at home looking after their child. At one stage my department consisted entirely of women in their 20s and 30s, but when some went off on maternity leave I thought I should endeavour to have a better gender balance in my department in order to reduce the proportion that might be on maternity leave. Even for those who didn't work full time, I didn't think their promotion prospects were diminished as a result and accordingly they were doing their best to balance a career and being a mother.

For those mothers who stay at home looking after their children, this might just be a phase of life as they might be willing and wanting to continue with their career at a later stage.

Costs of having children

During pregnancy some of costs of having a child start. This includes visiting a gynaecologist, including having regular scans. There can also be costs involved if there are complications, including where the wife battles to become pregnant. The birth itself can also be expensive, with the hospital costs, doctor's costs and theatre costs if a caesarean is required.

Babies can be susceptive to becoming ill and first time mothers in particular can become concerned about the health of their infant, leading to a number of visits to doctors and paediatricians.

Depending on which medical aid the couple are a member of will determine what costs they will pay and the extent of what they will pay. When a baby is on the way a couple should be considering whether their medical aid choice is appropriate or whether to change which option they chose previously.

Other expenditure at that stage are the costs of setting up a nursery, which can be fairly simple from having a cot and place to change a baby to more elaborate set ups fitted with new furniture, furnishings and décor. Obviously the necessary clothing and items such as disposables (called nappies in my day), powders, soap etc. are also needed, but some of these might be provided by family and friends by way of a baby shower.

A pram, carry cot and car seats also need to be considered when the child travels with their parents, and some of these can be fairly expensive. Accordingly some will buy these as new, while others will acquire these second hand or borrow them from family and friends.

If you have a number of children then some additional costs may have to be incurred; for example, to make renovations to the home or to move home as well as replacing a vehicle, so that they are more suitable for the size of the family.

Obviously regular costs for food and disposables will be incurred, but I wonder to what extent couples look to whether they can afford these costs before agreeing to have a baby.

If both parents are working then costs are likely to be incurred on having a nanny or au pair or sending children to crèches or nursery schools. Some children might have grandparents who volunteer to look after the children which can be a cheaper option.

Once children get older there is the cost of sending them to school. While an increasing number of children seem to be attending private schools there are still many good quality government schools. One of our children attended a private school where the fees were higher in the higher grades and so each year as parents we had to contend with not just an increase in fees due to inflation, but also a higher fee for a higher grade. More children seem to be home schooled presently than previously and so this is an option which parents can consider, taking into account the pros and cons of this approach. One of the pros is that it can be cheaper but requires a parent to do the teaching during school hours; and even then the parent should be suited to this role.

School fees, particularly private schools, can be a financial burden to parents. Some schools prefer parents to pay fees in advance and might offer discounts to encourage parents to pay annually in advance. In some cases parents would be better off if they could afford to pay the fees on this basis, but this is not always the case. Parents could look to use any annual bonus or a re-advance on a bond for this purpose. If the discount for an annual payment is more than 5% then it might make financial sense to make this payment if it can be afforded; but this percentage would need to be higher if an unsecured loan, which carries an interest rate of 12% or more, was used to make this annual payment.

Preparing children for financial health

As our children grew older we gave them pocket money. Initially this was a small amount but increased over time. In some years an additional increase was given because we expected them to do their own buying instead of us providing the items for them. This included presents for parties, cosmetics and clothing. The children knew what amount they could expect to receive monthly. We were modelling what life is like for a salaried employee; they knew what amount they would receive and what this had to be spent on and they had to learn to live on this basis.

We wanted our children to live financially healthy lives and so we were teaching them to do so from a young age. Accordingly, we didn't subscribe to the approach of some parents who gave their children whatever amounts they wanted or liked.

We went even further and expected them to obtain a part time job in the later years of school. The money they earned this way was for their own use to cover items not covered by pocket money. The other benefit was that it gave them work experience which we believed would help them to get a job later and to be realistic what work was all about. There was also the discipline aspect in that they were expected to work certain hours and couldn't just avoid work if they didn't feel like it.

We also taught them about savings. Shortly after they were born we deposited a small amount each month in an individual savings account (later a unit trust account) for their use when adults. With the benefit of compound interest these modest amounts accumulated for over more than twenty years into a reasonable amount. One daughter used part of her amount to acquire her second vehicle, while another used it to furnish her home when she acquired one.

We also encouraged them to have their own savings account. To save an amount out of their pocket money and part time jobs helps to start a habit which should make it easier to continue saving when they start to work full time.

Post schooling costs

I discovered that one regularly repeated 'truism' wasn't as true as portrayed, namely that it is necessary to save for a child's post school educational fees. Two of our children completed their schooling at a government owned school while the youngest completed her schooling at a private school, when we became concerned about the government owned school when it was not allowed to expel a student (who happened to be a cabinet minister's daughter) for theft. In the case of our children who went to university their tuition costs were actually lower than their school fees. Our eldest daughter's fees were reduced because of her good matric results. Her first year university fees were about 80% of the fees for her sister who was still at school. For my daughter who was at a private school her first year fees at university were a massive 60% less than her previous year's school fees. Accordingly there was no need to save for these fees as it wasn't more than I was already paying, but what I hadn't anticipated was an even bigger cost, namely transport costs. With public transport not being a viable option this meant having to acquire vehicles for our children.

With the age gap between the youngest and oldest being five years, it meant I acquired three vehicles in five years, which can be a challenge if not anticipated.

While bursaries can be obtained for studying, we didn't follow that approach as there were more worthy recipients from a financial perspective than our children. For university we found that the fees varied according to the university as well as to what course was being studied.

With the number of possible careers these days it is not easy for children to pick one which they might enjoy doing. For this reason we let our children know there would be limits on changing what they wanted to study. As it happened all of them did change. Our eldest daughter knew when she was in her final year of study that she didn't want to practice in the field she was studying in, but she completed her studies and then did another degree aligned to one module she had enjoyed during her first degree. Another daughter changed degrees after her first year at university and after completing the second course eventually went back to complete her first course of study.

We also encouraged our children to participate in sport, whether at school or externally. They had success in sports such as tennis, hockey, athletics, netball and cricket at school while also achieving provincial colours for gymnastics and diving. This again showed them that discipline is necessary for success and that it doesn't just happen.

Contributions towards living costs

Our children knew from their school days that if they were still living at home when they started working that they would be expected to contribute towards the cost of living at home. This 'rent' was pegged as a percentage of their salary. This approach was followed not because we needed the money, but to help them to adjust to having a salary. We wanted them to become used to paying part of their earnings for accommodation, so when they eventually left home, they would be used to that, although the amount could differ. We also wanted them to have their own place to live in when they could afford it and didn't want a rent free existence to be a hindrance to that. On this basis the more they earned the more it made sense for them to acquire their own home. This only occurred with one of our daughters, as the other two moved to another city to study.

As our girls started working we also expected them to take over some costs we were incurring on their behalf, with the idea of them being self-supportive once they earned a reasonable salary. This meant that costs such as medical expenses, including the medical aid premium, car running costs (petrol, insurance, repairs and licence) and cell phone costs were taken over by them over time. I didn't want to end up in the same position as someone I know who is battling financially but who is apparently still paying for some of their daughter's costs even though she has a reasonably paid job. While we love our children, sometimes for their ultimate benefit we need them to take their own responsibility for financial issues and not take the easy way out and continue to treat them as children.

As a parent that doesn't mean you are not there to help and advise them. In a time of crisis this can include financial support, but there is a fine line between helping them through a difficult period and helping them when they haven't been financially responsible. If a child has an accident in a vehicle which is uninsured, how willing will a parent be to assist the child, if the child was advised to obtain insurance?

Weddings

Having children also means there is a prospect of a wedding. These days the expectation is a more lavish affair than when we were married. Accordingly, the costs of a wedding can be substantial, particularly for daughters, and if this is a prospect then how it is going to be financed needs to be faced. This can include starting to save for it a number of years or obtaining a re-advance on a bond. For parents with sons this might be less of a concern as they might be expected to carry fewer of the costs of the marriage, depending on the customs among those marrying.

When one of our daughters was planning to get married we gave her a budget, so she knew how much she had to spend. This also meant she knew the budget wasn't open ended. The budget was based on what we thought was a reasonable amount from speaking to parents whose children were getting married at that time.

As my daughter was marrying a farmer's son my suggestion of having the wedding at the farm with a barn dance was derided. Nevertheless there can be ways to manage costs. For example, there might be an informal tea at the wedding venue immediately after the wedding when there are a large number of invitees, which can be followed by a much smaller formal reception later. The venue costs might also be less if the wedding is not held at popular times over the weekend. Sending out electronic invitations is cheaper than sending or giving out printed versions. Some couples might prefer a more informal wedding and reception as opposed to others having a more formal wedding. A couple can look at ways to stretch available resources and then decide on what are the really important aspects of the marriage to spend money on.

Peer pressure can play a large part in what is regarded as being acceptable to a couple. Thus costs can be determined more by what their friends would think of them than what they want. I sense that if a wedding is different and those attending it enjoy themselves then this is likely to have a more lasting impression rather than how lavish the wedding is. This means that parents and their child should have a discussion about the wedding as to what is financially viable with the objective to limit as far as possible the inevitable stress and even arguments that can occur before the actual wedding. In addition, such discussions should not be left to the last minute. If the parent and child have realistic expectations and know how the other views the various options then that will help.

Children related costs

As noted in section 7 above expenditure on children has been one my biggest costs over the years. The graph below shows the movement in some of these costs over a 30 year period, showing that the majority of the costs were incurred when they were in high school or in their 20s, even though the amounts have been adjusted for inflation.

Table 10.1 – Costs related to children

This table shows the following:

  * The costs of education were initially low, but increased as our children went to high school and then reduced once they went to and completed university.
  * Motor vehicle costs, as can be expected, only started when our girls turned 18 and had their own vehicle
  * There are two peaks for living away from home; the first started when one daughter moved away from home and stopped when she married, while the second started when another daughter moved away from home. These amounts are largely rent
  * 'Other' largely includes pocket money. When one daughter left home she was earning enough to cover her food costs, but when our second daughter moved away from home her pocket money included an allowance for food. This amount started to decrease when our eldest daughter started to work, but peaked a few years later when our daughter married as these wedding costs are included in this category.

The costs included above only include certain direct costs that were recorded in my records as being applicable to our children. For this reason it excludes the following amounts:

  * Medical costs, including medical aid premiums
  * Clothing costs before these were incorporated into their pocket money
  * Food costs
  * Amounts relating to their use of electricity, water and telephone (including cell phone costs until they reimbursed us for these costs)
  * Additional costs relating to taking them on holiday with us or on outings.

The table below shows the impact on expenditure on food, electricity and water when our children left home.

Table 10.2 – Costs relating to food, electricity and water

The vertical lines represent when two of our daughters left home. When they left home there was an obvious effect on the total amount we spent on food and more when the second daughter left home. When the first daughter left home the mouths to feed dropped 20% (i.e. from 5 to 4) but 25% when the second daughter left home as the four being fed dropped to three.

It is also interesting to note that when they left home there was no discernible impact on electricity and water, with the only reduction being due to moving home rather than a child leaving home.

When couples start having children they will learn many lessons, largely through experience, and one of those that will only be answered many years later is what type of role model they will be for their children regarding the managing of finances.

### Chapter 11 **– Savings for goals and retirement**

Once a person is in a position that their expenses are less than their income, they are then able to save. Whilst savings might not have any specific goal initially it can also be for something specific. This could be so that one has sufficient funds to buy an item at an appropriate date (e.g. birthday, anniversaries or Christmas), an item that is larger than that purchased on a regular basis (e.g. tablet or curtains), on an overseas holiday, a deposit for a car or house or an investment for the future.

Whilst these may be voluntary savings, namely that the person is able to decide the purpose of the savings, there can also be compulsory savings. If a person is an employee they might be a member of a pension or provident fund, which is regarded as compulsory savings. The required monthly contribution would be paid to the appropriate fund by the employer. These amounts can be deducted from a person's salary and thus reduce a person's take home pay as might occur in the case of a pension fund, or might not be deducted from the take home pay in the case of a provident fund. While on this basis it might suggest that having no deduction is the preferable approach, the reality is that it is likely that both approaches are likely to result in the cost of the different possibilities to the employer being the same and that the salary would be adjusted accordingly. For example, a person's cost to company might be say, R10 000 per month. On a pension fund basis the employee might have a salary of R10 000 and a deduction of R1 600 for a pension fund, leaving R8 400 per month before deducting tax and unemployment insurance. Alternatively, the company might say it will pay R1 600 to a provident fund for an employee and thus the salary might be R8 400 per month before deducting tax and unemployment insurance. While the employees might have different salaries, their contributions to a retirement fund and take home pay could be the same. Not all employers require their employees to be a member of a pension or provident fund, in which case employees need to save for retirement themselves. Saving for retirement is dealt with in more detail in section 14.

When a person saves they should be looking at when amounts are likely to be needed to determine how to accumulate their savings. If amounts are likely to be needed in a few months then a savings account is likely to be appropriate, but if it is going to be needed in a number of years in the future, then investing in shares or other assets is likely to be appropriate.

Saving accounts

When using a savings account the interest rate will depend on a number of factors, namely the current economic conditions, the length of time the amount is to be invested for and the amount invested. If the amount is in an account so the person is able to access it at any time then the interest rate will be lower than if the person invested an amount for say six, twelve or twenty four months.

A person might have a number of different goals and so might have more than one savings account. They might have a call account which can be used to deposit any surplus funds and to have emergency funds, while having another account to save for a deposit for a house.

Amounts invested for a fixed term can be reinvested at the end of that term. The other option is to have a notice deposit where the expiry date is not specified, but where a period of notice is required to be given before the funds can be accessed, say one or three months. Banks might allow funds to be accessed before their expiry date, but where this is allowed it would come with some type of financial penalty to discourage this type of action.

It is not considered wise to invest these amounts with organisations other than banks or insurance companies. Sometimes adverts might offer much higher interest rates, but there is the risk that they are very risky or are not legitimate. As has been said, if the interest rates seem too good to be true, they are too good to be true. While banks might be offering, for example, an interest rate of 5% per annum, scams might offer interest rates of, for example, 10% per month (not year) and say it is guaranteed while the guarantee is not worth the paper it is written on. The higher the interest rate being offered, the more likely it is that the offer is coming from an organisation that is not a legitimate deposit taking organisation. Just because an organisation says it is registered with some body authorising advisors or investing, doesn't mean the claim is correct.

One of the biggest risks in investments is being taken for a ride by unscrupulous advisers. Over the years there have been a number of schemes which have collapsed leaving investors destitute. These advisers might target those who need extra income and so will offer a higher return, which might actually occur for a while before payments stop. At that point the promises of how easy it will be to realise the investment prove to be false. It is for this reason that investors should be on the lookout for possible scams and invest with large, reputable and long established financial institutions. Any investment with other organisations should only be done after consulting a trusted broker and advisor and probably also after discussing it with friends and family.

Investing in a savings account with a bank is one of the safest investments that a person can make, in that there is low risk that they will default on paying amounts owing, due to the regulation of banks, although this is not unheard of. Savings accounts can be given different names including call accounts and money market accounts. With these investments being one of the safest investments it means it carries less risk, thus a person can be fairly sure they will get their investment back plus interest, but the interest might be less than the return that could be earned from other investments. Often the interest rate is less than the inflation rate and so where this occurs a person's investment in real terms will not keep up with inflation. This can get worse when the interest is also taxed.

The banks can offer different interest rates and so a person should also determine whether there are different terms being offered before investing in a higher interest rate investment.

Bonds

After saving accounts the next type of investment that is commonly considered are bonds. This is where the government, municipalities, major state owned companies (e.g. Transnet, Eskom) or companies borrow amounts. The interest rates on these are normally higher than on savings accounts, with bonds issued by the government typically being regarded as less risky and thereby having a lower interest than bonds issued by other organisations.

However these investments are not easily accessible for the man in the street because they are normally sold in large denominations (e.g. a minimum of R1 million). They are more likely to be held by retirement funds on behalf of their members.

There is also a difference between bonds and a fixed term savings account. While a bond might say that they will pay the holder R1 million at a future date and interest every six months, that doesn't mean that the bond would be sold for R1 million. The bonds often have a fixed interest rate and can have long terms. For example, a government bond might be due to expire in 10 years and carry an interest rate of 9% per annum. This interest rate might be higher than the current interest rate due to interest rates declining in the intervening period. As this rate is higher than the current rate an investor would be prepared to pay a higher amount than R1 million. The present value of the amount to be received in 10 years and the interest payments over that period at the current market interest rate might be, for example, R1,15 million, which is what it could be sold for.

If interest rates change the value of the investment will change. If it is expected that interest rates will increase then the value of the investment is expected to decline. Accordingly, it is better to acquire bonds when interest rates are expected to decline and not when they are expected to increase. If interest rates are expected to increase it is better to hold bonds that have a short period until they mature and not those with a long maturity.

In contrast fixed term savings accounts are not sold in the market and so their value doesn't change as interest rates change. While the owner of a fixed term savings account doesn't change over time, with a bond it is likely to have multiple owners over its term.

This doesn't mean that there aren't bonds that are available to the man in the street. One of the best investments at present is RSA Retail Bonds issued by the government which offers interest rates that are higher than those offered by the bank. For example, a bond with a two year term offers an interest rate that is much the same as the inflation rate, while a 5 year bond offers a rate that exceeds the inflation rate by about 1%. While these rates are attractive it does mean that the funds are not accessible during that term. As these bonds can't be sold to other parties, they are not subject to changes in value as other bonds as noted above are.

The government also offers inflation linked bonds, so for example if you are prepared to invest funds for three years, they will pay interest based on the inflation rate plus say 1%, or 2% if invested for 10 years. In this case the value of the investment is increased by the current inflation rate twice a year, while the interest in excess of the inflation rate is paid to the investor at the same time. This is an attractive investment for those who don't want their investment to lose value and are able to invest amounts for these lengths of periods; this might apply to retirees and those close to retirement. Again, like savings account interest, tax on the interest earned will reduce the return received.

Properties

The third major category of investment is property. For most people their own home is their major investment, but there can also be other type of property investments. A person could rent out a house they own but don't occupy, own a holiday home or investment with others in property.

As noted above in the section on housing, acquiring a property and renting it out might initially mean that the rent is not sufficient to cover a bond, particularly if the bond is 100% or close to 100% of the value of the property. It seems that this is not the same for lower value properties (e.g. properties worth R500 000 or less). In other cases a person might need to pay a substantial deposit in order for the rent to cover the bond repayments or have sufficient funds to absorb the excess of the bond repayment over the rent received.

Renting out a property also comes with a number of challenges – will the tenant pay on time, will the tenant look after the property, will there be funds to pay for any repairs that might be necessary and how to evict a tenant that doesn't pay their rent. These need to be faced before carrying out such an investment. Some people are better able to deal with these types of issues than others. My experience is that I have had more bad tenants than good tenants. I have had to replace a kitchen because it was in such a poor condition and in another case a tenant who always seemed to battle to pay the rent gave notice and left even though they still owed some rent and had covered up some damage they caused. This later case was probably fortunate in that I probably lost less by them leaving on their own accord than if I had tried to evict them for non-payment of the rent.

This type of property investment is also one of the more illiquid types of investments in that it can take some time to sell a property. The same applies to having a holiday home, which should only be considered if one's finances are in a healthy situation. Typically the holiday home costs money in that the rent received for renting it out when the owner is not using it might be nil or negligible. Having such a home could result in a saving in holiday costs as the home might be used instead of having to rent other accommodation. A non-financial consideration is that a holiday home might result in other parts of the country being overlooked during holidays. Having a place that isn't too far away can mean it could be used more than if it is further away. The savings in having a place to use for holidays might be less than the costs of maintaining the holiday home, in which case the home could be justified on the basis of it being an investment which will increase in value over time.

An easier way to invest in property is to invest in a property unit trust, or real estate investment trust (REIT). These are listed on the stock exchange and would normally own a number of properties that they administer. They have the benefit of spreading the risk of owning property between a number of properties and can be easily bought or sold. These funds also cover different types of property (e.g. commercial, industrial, retail) and different areas.

The returns from these property investments can increase as rents increase. The returns can also be affected by whether the trusts borrow funds to acquire properties or not. Over the years it seems that on average the returns on property is better than returns on cash and bonds but less than returns on equities.

Equities

Shares or equities evidence ownership or part ownership in a company. Companies can be listed on a stock exchange which enables the public to easily buy and sell shares. Companies can also be unlisted when their shares are not included on a stock exchange; in this case shares might not be available for sale or it might be more difficult to find buyers and sellers of shares.

Companies can have any number of shares in issue and the price for each share cannot be compared with the price of another share, as the number of shares needs to be taken into account as well. For example, a company's share price might be R10 per share and if it has 10 million shares in issue it is worth R100 million in total. Another company might have a lower share price but more shares in issue (e.g. price of R1 per share but with 150 million shares in issue gives it a value of R150 million in total).

As a shareholder in a company you have certain rights, such as to receive the company's financial statements and to attend annual general meetings and other meetings when voting is required on issues such as appointing directors, acquisitions and disposals and the issue and buyback of shares. If a company declares a dividend out of the profits it earns you will receive your portion. Sometimes the company might need to raise funds to make acquisitions, fund losses or capital expenditure or to repay loans and shareholders could be offered an opportunity to invest further amounts in a company when the funds will be raised by issuing additional shares.

A company's share price can vary due to many factors such as the prevailing economic conditions, the profits and prospects of the company, how attractive a particular industry is, the company's solvency, success or otherwise of acquisitions, the quality of directors (including recent appointments or resignations), law suits against a company, its exposure to other markets, currencies and interest rates. Share prices can be volatile and cyclical and while some might be increasing, other might be decreasing. Some sectors have longer cycles than others and some might react quicker than others to changing economic conditions.

Thus those owning equities need to accept that values will change and that they can go down as well as up. This means that equities are riskier than other types of investments, which also means that over time the return on equities would be expected to be higher than other types of investments. Among the various companies some are more risky than others (e.g. might be more exposed to labour unrest, exchange rates, interest rates etc.), while others might be in sectors that are currently in or out of favour (e.g. mining, banking, retail etc.).

Those who want to invest in equities can be daunted by the number of companies listed on the stock exchange and not knowing which companies are good prospects and those which aren't. While some will obtain sufficient information to be able to invest confidently, most would prefer to rely on others. Some like to buy and sell shares on a regular basis, but others, like Warren Buffett, like to hold shares for long periods of time.

Some share prices increase over time by more than the average, while other price prices might over time lag the average and so some investors will attempt to invest in those likely to outperform the market. They might or might not achieve this objective, while others would be comfortable in achieving a market related return. Thus investors must decide what approach they are comfortable with.

After I started working one of my colleagues suggested we buy shares in a particular company. As this would be my first purchase I was cautious and a week or so later agreed we should buy some shares at their then current price of just over 20 cents each. He contacted the broker only to discover the shares had been suspended. The suspension was lifted later that week and the new share price exceeded 70 cents. I could have kicked myself for being too slow and thus missing out on a large increase in the share price, but I consoled myself that was a learning cost.

Over the years I have bought and sold a number of individual shares, but mostly I prefer to invest in unit trusts or exchange traded funds (ETFs). The benefit of such investments is that you can invest a set amount each month and let someone else decide what companies to invest in. Lump sums can also be invested and units can be sold on short notice.

An investor still needs to decide who to invest with and what type of unit trust or ETF to invest in. For example, they could concentrate on industrial shares, financial shares, property investments, foreign shares or money market funds. There are also funds which hold units in other funds (termed fund of funds) who make changes depending on which funds they believe will achieve the best returns. Deciding on who to invest with based on who is achieving the best returns at present is not always the best decision as a top performer in one year is no guarantee that this performance will continue in the future; it seems it is not unknown for the top performer in one year to a bottom performer in the next, or vice versa.

In addition, some asset managers actively manage funds they look after by regularly changing the shares they hold, while others are passive investors, holding shares that mirror a particular index. The costs associated with active managers are normally higher than those of passive managers, but the active managers like to believe they can achieve a better return even after all costs are taken into account. There is a robust debate between active and passive managers between the merits of the different approaches, but it seems few active managers consistently beat the average market return.

For those who want low investing costs, investing in ETFs which are a form of unit trust which typically aim to achieve a return that matches that of an index, is an appropriate investment. It can be quite easy to start these types of investments and can be done largely through using the internet.

There are generally two types of costs incurred when investing in unit trusts or EFTs. The first is an initial fee, which can range from zero to 5.7% of the amount invested. If a person invests through a broker then an initial fee is normally charged, but some unit trusts still charge an initial fee if a person invests directly through them, whereas others don't. On a unit trust where the initial fee charged is 5% plus VAT (namely 5.7%), the number of units received would increase by that percentage if no fees were charged. This would the same impact over the long term. While the number of units 'lost' to fees would always equal 5.7% in this example, there would also be a 'loss' of 5.7% when distributions are reinvested, so the 'total loss' remains at 5.7%. So while the fees have a compounding effect on distributions, as a percentage of the total units the percentage is unchanged.

The other costs relate to the cost of running the unit trust. These costs can be charged to the unit trust resulting in it having less to distribute, meaning they are less obvious; alternatively the costs can be charged to each unit holder in which case they are more obvious. These fees can generally range between 0.5% p.a. and 3% p.a. of the value of the investments. The fees at the lower end are often tracker funds, which aim to achieve a return close to market indexes, where the equities held match those included in the index, where little investment knowledge is required. The fees at the higher end often include performance fees, where the unit trust managers take their own investment decisions and aim to achieve a return that exceeds that of market indexes and when this is achieved part of the excess is paid to the managers by way of a performance fee.

What is not always appreciated is that while these costs appear to be fairly low, over a long term they can have a large impact on the value of a person's investments. This is illustrated in the table below, in what is termed a reduction in yield.

Table 11.1 – Reduction in yield for a monthly investment

If the annual return on an investment is 10% and the costs are 1% on an annual basis, then the actual return achieved will be 9% p.a. In this case the reduction in yield is 1%. This table shows if a person invested the same amount each month for 10 years and the annual return before costs was 10% that the value of the person's investment would be 5.9% less than if the annual costs were 1.0% p.a. hadn't been incurred. This difference increases to 13.8% if the investment period is 20 years. This is the difference between achieving an annual return of 9% and 10% over the investment period.

In reflecting on this table the following comments are made:

  * The reduction in yield has a bigger impact as the annual cost, rate of return and number of years increases. This again illustrates the impact of compound interest
  * Investors could save the annual cost if they did their own investing, but they might not achieve a better return, as they might acquire equities that do not achieve a return that equals those acquired by unit trusts. In addition, they might also incur their own costs in deciding in what equities to acquire or sell. Therefore it may be better to rely on professional investment managers as the return achieved, after costs, might be more than most individuals could achieve by themselves. As will be seen in tables 11.4 and 14.7 the actual returns achieved, after costs, by unit trusts can exceed the inflation rate by a reasonable margin.
  * The reason why the annual costs can have an increasing impact, while the initial fee doesn't also needs to be understood. While the initial fee might be fixed as a percentage of a monthly investment, when the fee is compared to the value of the investment each month, it decreases, while the annual cost as a percentage of the monthly investment stays the same. This means, for example, that if the initial fee was 5.7% the impact of this on a reduction in yield is 0.45% for a 20 year investment achieving a 10% annual return.

Sophisticated investors would look to invest in more exotic instruments to either protect their investments or to magnify possible returns. For example, instruments can be acquired to protect oneself from a decline in interest rates, or having an option to buy shares at a fixed price in the future with the expectation that the share price will exceed this price. These instruments are termed derivatives and should only be used by those who fully understand them. Some support the view of Warren Buffett who referred to derivatives as 'financial weapons of mass destruction' and he made this comment before derivatives caused havoc and played a large part in the financial crisis of 2008.

The table below compares the prices for units for general equity unit trusts operated by two different asset managers over a 20 year period. This shows that their performance can differ. At the end of this period the price for the units of the one manager was 36% higher than the other on a comparable basis, although at one stage when prices were dropping in 2008 the difference was only 6%. The increase in prices in 2014 was 10% for Manager A and 20% for Manager B while in 2012 it was 22% for Manager A and 15% for Manager B, which shows that while the choice of an asset manager can be important, they can at times have quite different performances.

Table 11.2 – Comparison of prices of general unit trusts

The next table compares the price of the poorer performing of the above asset manager (i.e. Manager A) for a general equity unit trust with the prices for a general equity unit trust investing in foreign shares over a 16 year period. Financial advisers recommend investors have a portion of their investments in foreign markets but for a number of years this hasn't paid off. While this suggestion is partly based on the Rand being expected to weaken, this hasn't happened to the extent it seems they expected. At the end of the 16 year period the price of the foreign based units was only 62% of that of the local based units. Again performance over different periods can produce quite different pictures; if the last two years were looked at the price of the foreign based units increased by 102% which is about triple the increase in the price of the local based units of 33%.

The graph below also shows that when prices drop, this normally takes place over a shorter period than when prices increase. In 2008 prices of the local based fund dropped by about 50% in less than a year, but took about three and a half years for the price to reach its previous high. This also shows the extent to which prices can drop. In 1998 prices in this fund dropped by about 40% in four months and took nearly two and a half years to recover, while in 2002 prices dropped 30% in about a year and took about a year and a half to recover.

Table 11.3 – Comparing prices of units investing in local and foreign investments

It is logical that it is best to buy shares when their prices are low and sell when prices are at their highest. However it is difficult to predict what share prices are going to do and so advisors don't believe this can be achieved consistently. Often the worst scenario occurs, people buy shares when everyone else is buying shares because prices are going up and then when prices start to go down they hold them for a while hoping for prices to rebound and then when this doesn't happen, sell them, which later proves to be near their lowest price.

Advisors believe the amount of time that an investor is in the market is more important than trying to time the market. Many also support Rand cost averaging for regular investing, which means that when prices are high you get few units for a certain investment, but more when prices are low, resulting in an investment where the average cost is the average over the investment period. If the prices have generally increased over the period then the price at the end of the period would be expected to exceed the average cost price. While there is a place for Rand cost averaging, that doesn't mean that an investor shouldn't consider selling investments when share prices seem to be rather high and the prospects of them falling increases.

It is also worth considering how investments perform in relation to inflation. The next table adjusts the prices of the poorer performing asset manager in table 11.2 by inflation. The horizontal straight line is the latest price and so if the adjusted prices are below that then prices have been increasing by more than inflation. This shows that prices have been increasing by more than inflation, except for a two month period at the end of 2007. If the same graph had been prepared at the end of 2012 when the prices were about 200 then for a period of nearly two years from the end of 2006 to the middle of 2008 the prices had not increased by inflation by the end of 2012. Prices achieved at that time have recovered since the prices dropped as a result of the worldwide recession that occurred in 2008 and 2009 and even the peak prices before the recession have almost fully increased by the inflation rate since then. Units acquired at the beginning of the period shown in the graph are now worth more than double the amount they would have been if they had just increased in line with inflation, showing the benefit of investing in equities.

Table 11.4 – Prices adjusted by CPI

It should be appreciated that the above graphs, which are based on the prices on units, does not take into account that by holding units the unit holder normally receives distributions of interest and dividends and thus the actual return received from holding units exceeds just the change in value of units. For example, for two unit trusts which consisted of an unchanged monthly investment the extent of additional units received as distributions also increased the longer the investment as shown in the table below.

Table 11.5 – Extent of extra units received by way of distributions

This table shows that in addition to the value of units increasing the number of units increased as a result of reinvesting distributions. In the case of Fund B the number of units was 27% higher after 15 years as a result of reinvesting distributions. This increase was helped by one particularly large unusual distribution, which increased the number of units held by 10.7%. This also shows that the distributions received from the fund investing in local equities were higher than that received from the fund investing in foreign equities. Part of this may be due to some foreign companies not paying dividends and thus building up their cash reserves from their profits. Some companies may in addition also buy back their own shares from these cash reserves.

Distributions can be received in cash or can be reinvested by being used to purchase additional units. Distributions typically occur twice a year. Reinvestment is generally considered the best option if the person doesn't need the cash for other purposes. It is a method of applying compounding to investments. Using the same information as used in the previous table the extent of extra units obtained as a result of reinvestment of distributions is given in the table below.

Table 11.6 – Extent of extra units received by reinvestment of distributions

While distributions would have received if they had been reinvested or not, this table shows that for Fund A 5.2% more units were held after 15 years if the distributions were reinvested than if the distributions had been received in units but had not been taken into account when determining future distributions. For Fund B this percentage was 2.8% after five years and 12.6% after 15 years. As in table 11.5 the amounts for Fund B are higher than Fund A because of the higher distributions received from Fund B.

As the value of the units typically increases over time, so does the value of distributions. In the case of Fund A after 10 years the value of the bi-annual distribution exceeded the monthly investment in the fund and after 15 years exceeded two and a half months investment. In the case of Fund B it exceeded a monthly contribution after 7 years and after 15 years exceeded six month's investments.

If these distributions are taken into account the average return over the period for Manager B in table 11.2 is 14.6% while that of the foreign fund in table 11.3 is 11.3%. Over that time CPI averaged 5.8%, so the real return (i.e. return in excess of CPI) was 8.8% and 5.5% respectively. These real returns are also relevant when saving for retirement and table 14.6 below shows that they can vary significantly over time.

In doing these calculations I realised again how doing them slightly differently can produce quite different results. The calculations in the previous paragraph show what the return was taking into account the amounts that were invested, which is the best way of doing it. However if we just compare the beginning and end price (and ignore what happens in between, including reinvestment of distributions) and calculate what the average return is then quite different results can be arrived at depending on the beginning and end dates. If the start and end dates are as used in the table then the average return was 10.1% for Manager B and 7.6% for the foreign units. However if the start date is just two months later the returns are 12.8% and 9.2% respectively as the prices dropped over 30% for Manager B and over 20% for the foreign units in that two month period. This effect is probably unusual but illustrates the differences that can occur if investments are made at different dates.

Tax free investments

With the aim of encouraging individuals to save the government has, with effect from 1 March 2015, allowed tax free saving schemes. These schemes are now offered by banks, insurance companies and investment schemes. This allows individuals to invest up to R30 000 per year in certain types of investments, the most common of which are bank deposit accounts and unit trust funds. Such investments cannot be used to invest in just one specific company as it needs to be exposed to a number of companies, which is why a unit trust is an appropriate investment. This is because the tax authorities do not want individuals to be exposed to excessive risk. Individuals do not receive a tax deduction when they make these investments; essentially these investments are from assets on which tax has been paid or is payable.

There is also a lifetime limit in that at present individuals cannot invest more than R500 000 over their life in such schemes. This means that if the maximum amount is invested each year they will reach their limit after 17 years.

Individuals will be allowed to realise part or the whole of such investments whenever they wish, subject to an appropriate notice period. For example, for a 30 day notice deposit they would only receive their funds 30 days after giving notice, but with a unit trust they can expect to receive their funds in a few days. However, once an amount is realised this does not affect the maximum amount of investment allowed. For example, if R30 000 is invested on 1 March 2015 and realised on 31 January 2016, then it cannot be invested again in the 2016 tax year as the maximum amount has already been invested in that tax year and is not reduced by any amounts realised. The amount realised could however be used in the 2017 tax year as part of the amount invested in that year.

Investments can be made monthly (i.e. maximum of R2 500 per month for 12 months) or be made by way of a lump sum. Institutions might specify minimum amounts to be invested. If the amount invested in any year is less than R30 000, this does not mean that more than R30 000 can be invested tax free in a later year. The value of such investments can change as any other investment and is not guaranteed. If a person invests more than R30 000 per year they will pay tax on the excess. Information on such investments is likely to be given to the tax authorities by the various financial institutions to prevent individuals trying to exceed the limit by having a number of investments with different entities.

These tax free investments mean that the income earned by these investments will not be subject to income tax or dividend tax and any gains made on realising these investments will not be subject to capital gains tax. Accordingly these investments only become beneficial from a tax perspective once interest exceeds the current annual exempt amount of R23 800 or the capital gains exceeds the current annual exempt amount of R30 000 when taking other interest and capital gains into account.

It should however be noted that such investments are not exempt from estate duty if a person has such investments when they die. In addition, such investments can be required to be realised if a person is liquidated in order to pay outstanding debts. This differs from retirement investments, such as retirement annuities, which do not form part of an individual's estate, nor can be attached by creditors. On the other hand a retirement annuity cannot be realised before a person is 55 years of age, while a tax free investment can be realised at any age. In a retirement annuity there is a limit as to how much can be realised as a lump sum, whereas for a tax free savings investment there is no limit as to how much can be realised.

Other investments

While the main types of investments are mentioned above, there are other types of investments. This can include those noted below. This list excludes insurance related investments which will be covered in a later section:

  * Foreign currencies
  * Antiques
  * Investment vehicles
  * Art work
  * Stamps
  * Coins and notes
  * Books
  * Collections
  * Gems and jewellery

These can be the most risky type of investments, which can result in high rewards, but also large losses. Accordingly these types of investments should be for those who are knowledgeable about these investments as there is a risk of being defrauded. Sometimes these investments might grow from hobbies started at a young age. With these types of investments, items might be unique and so it can be difficult to know what their market value is, also there may not be many buyers and it can take a while to sell items.

Accordingly these types of investments are best left to those can manage these risks.

I have a complete collection of Guinness World Records, starting with the first edition in 1955. I obtained a copy or two while in high school and a few more in later years and so decided to see how many I could collect. I managed to find a number at second hand book stores at bargain prices. I also managed to swop some duplicates with others until I had a full set. I don't know what it is worth or whether anyone would be interested is acquiring it, but I am not looking to sell it. This is why some amounts spent on these types of assets might not be investments in that the person might get attached to the asset and decide not to sell them, which calls into question whether they should be regarded as an investment at all.

In conclusion:

  * Investing is best based on the advice of others
  * Advisors recommend a spread of risks and so the relative weighting of the various types of investments and even sectors or individual shares should be reconsidered over time
  * Investors should only invest when understanding the risks associated with investments and decide what approach they want to follow (e.g. active vs passive management and the extent of risk which can also change over time)
  * Investors should not be greedy.

### Chapter 12 **– Insurance**

For most people insurance is a necessary purchase but which they regard as a grudge purchase. While they are content to enjoy the benefits of being able to claim amounts when losses occur, they resent having to pay premiums for periods when no claims occur.

While some can afford to not have some insurance, this means they need to have sufficient funds available to fund losses when they occur. Accordingly, a few might self-insure some of their risks by paying the equivalent of a premium into an investment that can be used for any losses. This requires discipline which not many have. In addition, the timing of losses is not known beforehand and so there is no assurance that a loss will not occur early on when the investment is not sufficient to cover the loss; which is why this is not recommended for most people.

When items are bought on credit the credit provider can require insurance to be taken out. Accordingly when finance is obtained to acquire a house or vehicle, these assets would be required to be insured. In addition, the provider of finance could also require life insurance or insurance against being retrenched or being injured to be taken out when acquiring these types of assets or when using credit to acquire other items.

Insurance relies on the law of averages, namely that some will have more or bigger losses than others and as we cannot be sure as to what end of the spectrum we are likely to be on, we share risks with others. While we may be able to sustain small losses, it is the big ones we are not able to cope with without financial assistance. This can be a motor vehicle accident or a major medical operation. While a person might believe they can cope if their vehicle is destroyed in an accident, they might have to repay any remaining finance owing on the vehicle; they might be sued by other parties involved in the accident and there is a high risk that other parties involved in an accident do not carry any insurance.

Insurance is broken down into the following categories, each of which is regulated by a different regulator:

  * Short-term insurance which covers insurance of assets such as vehicles, homes, household contents and hospital plans
  * Medical aids which cover medical costs
  * Long-term or life insurance which covers people for health and disability as well as investment products of insurance companies.

Medical cover

Because of the risk of major medical expenditure people should be looking to have medical cover. Many people are a member of a medical aid, which means not being reliant on state medical resources. This can be a requirement of employment, but not necessarily so. Others don't belong to a medical aid but opt for insurance cover which pays out in case a person ends up in hospital.

Younger people might not want to join a medical aid on the basis that they are healthy and that a medical aid does not discriminate between younger people who might claim less than older people who might claim more than the average. Thus their premium is based on an average of the expenses of all members and not their likely expenditure at that age. While a person can join a medical aid later in life, this is likely to result in a penalty if the person is over 35 years of age. This can include not being able to claim for a period even though premiums have been paid and from paying an ongoing higher premium by way of a late joiner penalty of between 15% and 75%.

Even though a person might be young, there is no guarantee that they will not incur substantial medical costs incurred during a pregnancy, suffering from an accident or major disease. While having an insurance product that is a hospital plan is cheaper than belonging to a medical aid, a person should weigh up the benefits and disadvantages of the different approaches before making a decision as to join a medical aid or a hospital plan. It seems for many the decision in mainly a financial one based just on the monthly premium which is not necessarily the best way to make a decision. Among the disadvantages of just having a hospital plan that is not a medical aid is that the cover might only start after the third day of being in hospital and is normally limited to a certain monetary amount and is unlikely to specifically cover the costs of any major operation.

Some people have both a medical aid and a hospital plan, which might also be called gap cover, as the medical aid might not cover all costs of being in hospital.

Medical aids can have a number of possible schemes, with the more comprehensive schemes obviously having a higher premium. For the less comprehensive schemes there can be limits set on certain amounts, such as having a specified limit per claim or an annual limit; in addition certain amounts might not be covered. One of the cheaper options might not cover day-to-day expenses, but just major expenditure including time in hospital. While medical aids are required to cover a list of prescribed minimum benefits, including expenditure on items such as cancer and strokes, they might not pay the full amounts and there could be annual limits. For some options the medical aid might specify which medical practitioner a person is required to visit. Medical aids would typically also require pre-authorisation for major medical expenditure, including hospitalisation.

Some medical aids offer an option for a savings account, which requires a higher premium. This can enable a person to have a more convenient way of managing their finances. If a medical practitioner is not contracted in, meaning they charge more than the rates paid by the medical aid, a person is normally required to pay the account and then claim back from their medical aid. With a savings account the medical aid might reimburse the full amount of the amount paid within a relatively short period of the person paying the claim, with the amount that is in excess of the amount paid by the medical aid coming out of the savings account. If there is no savings account then it is possible that there might not be any reimbursement. While a savings account can be used to pay for certain medical expenses, there is a danger that the savings account could be fully utilised during the year and that for the rest of the year no reimbursements will be received. The problem is that people are not always aware of this and so it can catch them unawares.

At one stage I had a savings account which was accumulating as our medical costs were not high and so I decided to cash it in, only for a family member to incur significant expenditure the next year and with the medical aid initially not paying for certain expenditure I was out of pocket for quite a while before the medical aid agreed the costs were part of the prescribed minimum benefits.

As I reached retirement I again opted for a savings account on the basis that as I get older my medical costs could rise and so having a savings account will help to absorb costs in a period of having a lower income than when I was employed.

Medical schemes can encourage healthy living by having rewards for those who carry out certain activities, such as participating in sports and being a non-smoker. In addition, these benefits could also translate into lower premiums for life insurance products for companies linked to the medical scheme. Accordingly, members of such schemes should find out what benefits are available and assess whether they want to use them.

Life insurance

When a person has a mortgage bond they might be required to have more than one insurance policy. The bond holder would require the property to be insured in the case of it being destroyed or burnt down. This can be separate to insurance for the contents of the house. In addition, the bond holder could require the person to have life cover in case the person dies before the bond is paid off. In this case the amount of the cover could reduce over the period of the bond.

Life cover only pays out when a person dies. A person might also have other life insurance without being aware of it; some employers have a group life scheme which will pay out a multiple of a person's earnings, with a possible maximum amount, if they die while being employed. This could be paid by the employer or out of the monthly contribution paid to a pension or provident fund and so employees should enquire as to whether they have any such cover. Such group life cover is cheaper than if the person took out the same cover with an insurance company.

Life cover is offered by licenced life insurance companies. These companies can also offer other types of insurance, such as insurance in case a person is retrenched, unable to work due to disease, disabled or able to work but unable to carry out their previous job. For some of these policies the risks and need for cover can change over time and so a person might determine what their needs are periodically and change their cover accordingly. For example, for a single person without dependents having life insurance might be less important than for a husband with a young family. In addition, having life cover is probably more important when parents have young kids than when approaching retirement.

Insurance companies might offer insurance products that have both an investment and insurance component. For example, an endowment policy might include life cover. An endowment policy is a policy for a fixed period and will pay out an amount at the end tax free, or upon death, if earlier. For example, a father might want to have an amount for his child's university education and could take out a policy which pays out an amount when the child turns 18 years old. Such a policy needs to have a term of at least five years for it to pay out a tax free amount. Although the policy has an insurance component, the largest part of the premium will be used for the investment component.

Short term insurance

As noted above a vehicle owner could be sued for substantial amounts if they are involved in an accident, even though their vehicle might not be worth much. Accordingly, a person should not drive a vehicle without any insurance, even if it just covers claims from other parties. People should also be looking to insure their home and its contents, particularly if they have expensive equipment that could be stolen. If not, they need to be able to replace the items with other funds or be able to live without them.

As noted below in the section on claims, a person needs to be aware that if their amounts are not insured for the correct amount, that they might not be paid out the amount claimed if that was to occur. A person also needs to determine what value is being insured; is it replacement value, such as in the case of a television set, or market value in the case of a vehicle. In the case of a motor vehicle the market value could be the trade-in value which is lower than resale value.

For insurance cover people might obtain different quotes to see who offers the lowest premium. While this is appropriate, choosing an insurer based purely on the lowest premium is not necessarily the best approach.

A number of years ago I was having lunch with some colleagues and one mentioned that he had accessed his bank account that morning to find an unexpected deposit in the account. The reference details were those of his insurance broker and upon contacting them they confirmed they had paid for his claim he had submitted that morning. A similar incident happened to me a few years later involving the same insurance broker. My bicycle was being transported to another city for a race and some boxes in the truck carrying the cycles caught alight on route and my bike was burnt. The transporter phoned to inform me and initially I thought it was a joke; I mean who ever hears of a bike burning? Anyway I contacted my broker and after completing the claim form I submitted it the next morning. Later that day as I was preparing to fly to the other city for the cycle race I looked at my bank account to see how much money I had in case I bought a replacement before the race, only to discover that my claim had already been paid.

While insurance companies might advertise that they offer the lowest premiums, the above examples show that sometimes the quality of the service can be more important than the lowest premium. Those offering the lowest premium could compensate and be the stickiest in paying claims. Choosing an insurer based purely on the premium offered might not be the best approach in the long term.

Some insurers can reward policyholders if they don't claim for a period and this should also be taken into account when comparing premiums. For example, an insurer might give a discount or cash back if a person doesn't claim for a period, say three years.

With insurance there can be excesses, namely the portion of the loss that the insured person will have to bear. For a vehicle it could, for example, be 5% of the claim with a minimum of R5 000 but if the driver is under 25 years of age this could be increased.

If a person is prepared to accept a higher excess they could be offered a lower premium; the same could apply if the premium is paid annually instead of monthly. I was recently offered a 16% discount on the total premiums for the next year on insurance for my home if I paid it in a lump sum upfront. As I could afford it and as it worked out to be a savings in excess of 30% in terms of the present value of the amount paid, I accepted the offer.

In some cases insurance can be sold with other products. In essence if a person buys a maintenance plan with a vehicle, this is a form of insurance in that the manufacturer will pick up certain costs. As noted previously this can cover costs for a period or a certain number of kilometres and could cover all costs except certain specified costs or may cover a diminishing portion of the maintenance costs over the period of the cover. Like other insurance there can be conditions that need to be adhered to, such as having the vehicle serviced at the specified interval.

Conditions attached to insurance and claims

All insurance comes with conditions, often termed the small print. People might not read these conditions and then get upset when their claims are repudiated. For example:

  * A motor vehicle claim might not be paid because the driver was drunk at the time of the accident or the tyres were smooth and the car was accordingly not regarded as being roadworthy even though it was stationery at the time of the accident
  * A burglary claim might not be paid because there is no sign of forced entry
  * A motor vehicle or burglary claim might not be paid because there was no alarm system in place when the policyholder had said there was such a system in place
  * A death claim might not be paid because it was due to a disease a person was suffering from when the policy was taken out, but this wasn't disclosed to the insurance company at that time.

Some policyholders might also get upset when the total amount claimed in a burglary is not paid out. This can be due to what is termed averaging. A person might claim R50 000 for items stolen but to an insurance company this is not the only important amount; they also take into account the total value of the person's goods and the value it is insured for. If a person has goods worth R1 million but if this is only insured for R800 000 then they are not fully insured but insured to the extent of 80%. This means that only 80% of claim, namely R40 000 will be paid out. If the goods were insured for more than they were worth, say R1.1 million, then the insurer will only pay out the value of the claim, namely R50 000.

When a person has a claim they need to submit all the information required by the insurance company. For a vehicle this can include the details of the accident, the other party involved, a number of insurance quotes and the number of the accident report from the police station where the accident was reported. The insurance company might also want to carry out an inspection to ensure the claim conditions have been met, such as forced entry in the case of a burglary and proof of purchase for expensive items claimed. In the case of a medical aid the original doctor's account could be sufficient.

When one of our geysers burst we were fortunate that the water was running down an outside wall and that we could call our insurer to come and replace it before further damage was caused. As it so happened this geyser was linked to another one and not much more than a month later we had to repeat the process when the other one also burst. While insurance cover was obtained in case the house was destroyed there can be other benefits that one might not initially be aware of, such as certain repairs as in this case. In the case of a car accident insurance could cover the costs of hiring a replacement vehicle until it is repaired or for travel costs to get home if the accident happened out of town.

A recent newspaper article quoted a report which stated that 16% of insured admitted to have exaggerated a claim and saying they would do so again; while 18% believed it was acceptable to 'pad' their claims by adding items and 44% believed it was acceptable to overstate the real value of loss or damage. If this is correct, and there is no reason to believe it isn't, it is a sad indictment on our society and we shouldn't be surprised if claims are queried by insurers. It is an example of the innocent suffering and paying for fraudulent claims.

Actual insurance expenditure

Table 12.1 – Expenditure on insurance

The above table shows the amount spent on insurance over a seventeen year period, adjusted for inflation. It excludes 2013 as I retired in that year and some life insurance premiums were discontinued. This information is slightly different from the amount shown as insurance in section 7 above, because in that section medical costs include the medical aid premium, whereas in this chart the medical aid premium is included, but not the amounts not covered by the medical aid.

This table shows the following:

  * In 2000, 2005 and 2011 I had large increases in my life cover, the third block from the bottom in the graph, but in the intervening years the premium decreased when inflation is taken into account, as a result of not increasing the amount of life cover in those years.
  * Medical aid premiums, the top block in the graph, have increased by more than inflation due to medical aid inflation being higher than the average inflation rate. Over the period covered by the table inflation increased by 6.0% on average each year, while the medical aid premium increased by 9.3% per annum and would be even higher if it took into account that in the early years it covered 5 of us and 3 of us towards the end. Medical aid premiums dropped in 2005 as a result of two daughters coming off our medical aid. The medical aid premiums increased from 32.3% of total insurance expenses in 1996 when it covered 5 people to 38.7% in 2012 when it covered only 3 people.
  * The vehicle insurance, the second block from the bottom in the graph, which excludes insurance paid on my children's vehicles, also had a large increase in 2005 as a result of my vehicle being replaced.
  * Insurance for other assets, the bottom block in the graph, also increased in 2005 as a result of acquiring another house.
  * Over the years covered by the table expenditure on insurance, excluding medical aid premiums, increased by 22% when inflation is taken into account. This is not much more than 1% per annum and is due to additional assets and more valuable assets being acquired, including vehicles, as well as increasing life cover by more than the inflation rate.

Over the period covered in the above table expenditure on insurance, excluding medical aid premiums, averaged about 10% of total expenditure. If the medical aid premiums are included this increases to over 16%, showing that insurance can be a substantial monthly expense. Thus it is a category of finance which should receive the appropriate amount of attention.

### Chapter 13 **– Taxes**

In section 7 which deals with what money is spent on, it mentions that the analysis of expenses does not include tax. The reason for this is that tax can be such a large expense that is warrants its own section. In addition, it is not so much a voluntary amount, but is a compulsory amount as we are required to pay it whether we like it or not and is a 'piggy back' amount in that the amount we pay is dependent on what we earn and spend.

For this purpose taxes doesn't only include income tax but also other taxes we might pay, but we will start with income taxes.

Income taxes

If you earn a salary then your employer will deduct income tax from your income and pay it over to the tax authorities on your behalf. If that is the only income you earn and you don't receive a travelling allowance nor claim some allowable expenditure, then the tax deducted should be sufficient to cover your tax liability.

If tax is deducted from your salary, you would also be expected to submit a tax return annually, except that for those who earn income below a certain amount and only have income as outlined in the above paragraph, they would not be required to submit a tax return. However this doesn't mean that income taxes can be completely ignored because when a person is required to submit a tax return in later years, they can be required to provide information for some previous years to show that there were no unpaid taxes for those periods.

Tax returns can be submitted to the tax authorities either electronically or in paper form, with more and more submitting it electronically. The tax authorities will assist people to submit tax returns if they visit the South African Revenue Services (SARS) offices. Others will consult tax practioners or submit the tax return themselves. For those who submit the tax returns electronically, they have a later date of submission than those who submit it manually.

When completing a tax return electronically a person needs to register on the SARS website (http://www.efiling.gov.za). For this a person needs to know their tax number, which is a number obtained from SARS when one starts paying tax and is used for life, and needs a user name and password. When a person wants to complete their tax return the website will ask some questions (e.g. did you earn any investment income, receive a travel allowance, sell any asset etc.) and from the responses SARS will produce a customised tax return. This return can have some information prepopulated. If the person has previously submitted a tax return then their personal information will be carried forward and can be edited if it has changed.

The tax return will include salary information as the employer is required to submit this to SARS. For tax purposes taxes are based on earnings for a financial year ended on the last day of February of each year, even if this differs from the employer's year end. The employer has a few months to submit salary and tax deduction information to SARS and so people can only submit their own tax returns from about July in each year once SARS has obtained the relevant data from employers. Taxpayers have to submit their tax returns manually by about the end of September, or November if submitted electronically. For those who pay provisional tax the submission date electronically is about January of the following year, with SARS announcing the submission dates each year.

Other tax related information for an individual can also be submitted by third parties to the tax authorities, even though this is not included in the tax return generated by SARS; this includes investment income and profits and losses on sale of financial instruments. SARS can use this information to query information included in tax returns.

In South Africa residents are taxed on their worldwide income and not just on income earned in South Africa. This includes those who are ordinarily resident in this country even though they may be a citizen of another country. On the other hand it excludes South African citizens who are out of the country for more than 183 days in a tax year (of which more than 60 days were continuous). To ameliorate the impact of being taxed twice on the same income, if a person pays foreign tax on their non-South African income, they can deduct this from their taxes owing to the extent of the tax payable in South Africa on this foreign income.

Once a tax return is submitted a tax assessment is issued showing whether taxes have been under or over paid. These days the assessments can in many cases be issued almost immediately after the return is submitted. If taxes have been overpaid they will be refunded shortly thereafter, except if the amount is minimal. If taxes have been underpaid then the remaining tax would be required to be paid within a month or two. If taxes have been underpaid then the amount owing could include interest.

If the person's taxes are complex, then it could take longer for the tax return to be assessed. In addition, if the information in the return differs from information SARS has or meets other triggers, then SARS could ask for documentation to be submitted, which can be done electronically (e.g. submit scanned documents). SARS can also ask questions as a result of audits they carry out (e.g. an increase in assets seems out of line with income submitted; they might know that a person has bought an expensive car or artwork when their tax return suggests they couldn't afford such an asset).

Documentation to support items included in tax returns is not required to be submitted to the tax authorities, except when they request it as noted above. If documentation is not requested before a tax assessment is issued, a person is still required to keep the documentation for at least five years, as the tax authorities are entitled to request the documentation at a later date.

Provisional taxes

If a person is self-employed or earns investment income in excess of a certain amount (e.g. R30 000 annually) they could be required to pay provisional tax. This is due to be paid at the end of August and February each year. The August payment would be half of the expected tax for the tax year to the following February, while the February payment would be the tax for that year less the first provisional payment. For a self-employed person or a person with only investment income this would be all the income tax they pay, but for a salaried person with investment income they are required to pay provisional tax in addition to tax deducted from their salary. When they pay provisional tax it is based on their total income and from this amount the tax paid by the employer is deducted as well as any previous provisional taxes for that tax year. Taxpayers can be exempt from paying provisional tax if their income is only salary and investment related and does not exceed the amount above which income tax becomes payable. For the year ended 29 February 2016 this amount is R73 650 for taxpayers below the age of 65 and increases to R128 500 for taxpayers who are 75 years of age or older.

At the end of February not all tax information might be known and so a third voluntary provisional tax payment can be made by the end of September to avoid paying interest for under payments of tax.

SARS is aware that some taxpayers might want to underpay provisional tax and so would expect provisional tax to be at least based on the previous year's taxable income, unless they can be convinced otherwise. SARS can levy interest and penalties if provisional taxes do not meet certain minimum requirements.

Tax rates and rebates

The income tax payable is based on rates which increase as income increases. These rates are normally adjusted annually. For the year ended 29 February 2016 the tax rate for income up to R181 900 per annum is 18%. Thereafter it increases to 26% for the next R102 200 of income and 31% for the following R109 100 of income. At an annual income of R701 300 it reaches its maximum rate of 41%.

The first portion of tax is not required to be repaid as a result of a tax rebate, which is also normally adjusted annually. For the year ended 29 February 2016 for those aged under 65 this amount is R13 257 per annum. Accordingly for a person aged less than 65 years of age with an income of R73 650 they should pay tax of 18% (namely R13 257), but as a result of the rebate of the same amount they wouldn't be required to pay tax. If the person earned R1 more they would pay tax of 18 cents; this is termed the marginal tax rate. For those who have reached the age of 65 years and 75 years higher rebates become available, namely R20 664 for those aged at least 65 years of age and R23 130 for those who are 75 years or older.

Marginal and average tax rates

Table 13.1 – Average and marginal tax rates (for those under 65 years of age)

For annual taxable income of between R73 650 and R181 900 the marginal tax rate is 18%, while for income in excess of R701 300 it is 41%. The average tax rate is the tax paid after deducting the tax rebate as a percentage of income. The above table shows that at an annual income of R73 650 the average tax rate is nil, while at R181 900 it is 10.7% and at R701 300 it is 27.9%. After that it continues to increase but never reaches 41%.

If a person receives a salary increase they could go from one tax bracket to another, but their income is taxed at the marginal rate. For example, if the annual income increases from R380 000 to R400 000 they would pay extra tax of 31% from R380 000 to R393 200 and 36% from R393 200 to R400 000, using tax rates for the year ended 29 February 2016. This means they would pay an extra tax of R6 540 on an increase of R20 000, resulting in tax being 33% of their increase. This shows that when a person goes from one tax bracket to another the higher tax only applies to the amount in excess of the higher tax bracket and not the whole increase.

An increase in annual salary from R380 000 to R400 000 is a 5.3% increase, but after tax the increase goes from R304 214 to R317 674 an increase of 4.4%. If the salary increase was in line with inflation, then the take home pay has increased by less than the inflation rate. Accordingly, a person needs to obtain a salary increase that exceeds the inflation rate for take home pay to increase in line with the inflation rate.

The above table shows that tax can be a person's largest expense. Chapter 7 shows that my biggest expense over a period was motor vehicle expenses at 16.4% of expenses, excluding taxes. Once a person's income reaches R284 100 per annum tax would be 16.2% of income and then tax could be their largest expense as 16.2% exceeds 16.4% on income less taxes (16.4% of (100 less 16.2%) equals 13.7%), assuming they spend all their income.

If a person earns an annual income of R2 million then tax would be about 36% of their income. If they also pay an amount to a retirement fund it also means that these two amounts would account for at least half the person's income, if the contribution to the fund was at least 14% of the person's income.

If a person's income exceeds their expenses, then tax becomes a larger portion of a person's expenses. For example, if a person pays tax amounting to 30% of their income and expenses are 80% of their income, then 37% (30/80) of their expenses comprises tax.

Taxable income

While this section so far refers to tax on income, actually it relates to taxable income, which can be different from actual income. Some income might be partially or wholly exempt from income, while in addition certain deductions are allowed in determining taxable income. In addition, an amount not actually received in cash could be taxed; these are normally called fringe benefits. Profits and losses on sale of assets can also be subject to tax. The information given below relates to the tax year ended 29 February 2016.

Employment related income

A person's salary would be taxable. If a person is a member of a pension fund then payments to this fund can be deducted. At present this deduction is limited to the greater of R1 750 or 7.5% of the salary. Normally the employer also contributes to the pension; this has no tax consequences until the person accesses this fund. If a person is a member of a provident fund they can't claim a tax deduction, but in this case the whole amount is normally paid by the employer and the amount is not normally included in the salary as noted in section 11 above.

If a person receives a travel allowance this is normally taxed on a monthly basis to the extent of 80%. A person needs to submit details in their tax return to justify claiming any travelling expenses. Travelling between home and work is not allowed to be claimed for tax purposes; so this claim is aimed for travelling to clients and other work related travelling. In addition, a person is required to keep a log book showing when travelling took place and the distances travelled. A person is also required to note the odometer reading on their vehicle on the first and last day of the year so their annual mileage can be calculated and from their log book what portion of the travelling is work related. This portion is then applied to actual costs incurred or on deemed costs. Deemed costs have different amounts and rates for fixed costs, fuel costs and repair costs depending on the cost of the vehicle. If actual expenses claimed are less than 20% of the travel allowance then tax will have been underpaid, while if it is more than 20% then tax will have been overpaid.

If a person doesn't receive a travel allowance, but is reimbursed instead for business travel then this is not subject to tax if the rate per kilometre is not more than the rate specified by SARS and the amount of travel does not exceed a specified number of kilometres per year (currently 8 000).

Fringe benefits

If a person is a member of a medical aid scheme, then the monthly contribution to the scheme is taxable if paid by the employer. In this case currently a person receives an additional tax rebate, with this rebate increasing as the number of dependents increases.

This contribution to a medical aid is an example of a fringe benefit that is taxable. There are a number of other types of fringe benefits, with the following being the more common ones, although in many cases employees are making less use of fringe benefits than previously:

  * Use of a company owned motor vehicle. The fringe benefit value is based on the value of the vehicle. Like receiving a travel allowance, 80% of the value is taxable on a monthly basis with the tax return requiring information on private and business usage. In certain specified circumstances exemptions to this could be allowed.
  * Low interest and interest free loans. If the interest rate is below a specified interest rate and the loan exceeds a specified amount then the amount of interest 'saved' below this specified rate is taxed.
  * An employer provides an employee with residential accommodation. The value to be taxed is based on the greater of the cost to the employer of the accommodation or applying a prescribed formula.

Other taxable fringe benefits relate to holiday accommodation, free or subsidised meals and premiums paid on insurance policies owned by the employer (e.g. group life schemes).

The following are not regarded as taxable fringe benefits:

  * Long service and bravery awards that are less than a specified amount
  * A uniform allowance where the employee is required to wear the uniform at work and the uniform is clearly different from ordinary clothing
  * Private use of business owned cell phones and computers which are mainly used for business purposes
  * Subsistence allowances paid to employees who spend time away from home on business that don't exceed specified amounts; these amounts differ between local and overseas travel.

Investment income and capital gains and losses

If a person earns investment income then depending on the type of income there are different tax treatments:

  * South African interest is taxable but only to the extent it exceeds R23 800 per annum, but in the case of a person who is at least 65 years old this increases to R34 500.
  * While tax is payable on South African dividends this is deducted when the dividends are paid to the shareholder and so are not included in taxable income. The company pays over the 15% dividend withholding tax to SARS on behalf of the shareholder.
  * Foreign interest is fully taxable in South Africa, while 37.5% of foreign dividends are taxable in South Africa. Foreign taxes that might be paid on these interest and dividends are deductible from tax payable, but only to the extent of the tax that is payable in South Africa on these amounts.
  * No income tax is payable on income earned by tax free investments (see section 11).
  * Rental is taxable, after deducting any related expenses.

If a person sells an asset any profit or loss has tax consequences. This is termed capital gains tax (CGT). Only one third of the gains are taxable, but in the case of losses they are carried forward to be set off against future gains.

Like income tax there is a rebate as the first R30 000 of capital gains is not taxed in any year. If this amount is not used in any year it is not carried forward to later years. When a person dies this increases to R300 000 as death is regarded as the date on which assets are sold. If the asset was acquired before 1 October 2001, which was when CGT was introduced, then in calculating CGT an adjusted cost can be used, which is the asset's value on 1 October 2001. There are three possible ways of calculating this adjusted cost, with taxpayers being able to select which method to use. These are as follows:

  * 20% of the proceeds
  * Actual value at 1 October 2001. A valuation would have had to have been carried out then and cannot be done retrospectively now. In the case of shares the price at that date would still be known and can be used
  * A time apportioned cost. Using this method the gain is allocated between the period before and after 1 October 2001, with the gain before that date being added to the original cost. For example, an item cost R100 000 and is sold for R200 000 twenty years later which is 15 years after CGT is implemented. A quarter of the gain (namely R25 000) is added to the cost to arrive at an adjusted cost of R125 000 and so the capital gain for CGT purposes is R75 000 and not the whole gain of R100 000.

Certain gains are also exempt from tax. These include:

  * For the sale of a primary residence the first R2 million of the gain is not taxable 
  * Most personal use items
  * Retirement benefits and receipts from long-term insurance policies (e.g. endowment policies)
  * Gains on tax free investments (see section 11).

If a person receives amounts from pension, provident or retirement annuity funds, whether a lump sum or annuity amounts, these amounts can be taxable. This is dealt with in more detail in the next section.

Tax deductions

While pension fund contributions and travel allowances have been mentioned above as allowable tax deductions, there are other expenses that can be claimed in a tax return. The common ones include the following:

  * Retirement annuity contributions limited to the greater of R1 750, R3 500 less contributions to a pension fund and 15% of taxable income other than from retirement funding employment. If a person is a member of a pension or provident fund then the salary on which the contribution is based is regarded as retirement funding employment income. This means a travel allowance and bonus might be regarded as non-retirement funding employment income as well as investment income. If an employer doesn't provide a pension or provident fund then the total income from that employer would be regarded as non-retirement funding employment income.
  * While a taxpayer can't normally claim amounts paid to a medical aid, as this is subject to a tax credit as noted above, a taxpayer can claim certain medical expenses. The amounts that can be claimed as an additional tax credit is one quarter of the following amount: medical aid contributions that exceed four times the tax credit for medical aids plus other medical expenses, but only to the extent that this amount exceeds 7.5% of taxable income (excluding retirement fund lump sums). For this purpose other medical expenses covers medical expenses incurred that are not reimbursed by the medical aid, but includes amounts reimbursed from a medical savings account. If the taxpayer, his or her spouse or child is disabled and for taxpayers who are 65 years of age or older the additional tax credit is one third of the following amount: medical aid contributions that exceed three times the tax credit for medical aids plus other medical expenses. For these persons the requirement for the amounts to exceed 7.5% of taxable income does not apply.
  * Donations to certain public benefit organisations claim be claimed as a tax deduction up to 10% of taxable income before deducting medical expenses.

Premiums paid on income protection policies (e.g. policies that pay out in case a person can no longer work due to medical reasons) are no longer tax deductible, but if a person receives a pay-out from such a policy the proceeds are now not taxable. If the employer pays the premiums then it becomes a fringe benefit in the hands of the employee.

The table below summarises the above and shows how taxable income is determined, as well as the amounts of tax payable based on taxable income. For those with complex tax affairs and those who are self-employed additional items, not illustrated below, would apply as well.

Table 13.2 – Determination of tax

 ** **

Value-added tax

While we can pay substantial amounts of income tax, we can also pay large amounts of value-added tax (VAT) although we are probably not aware of it.

If we run a business, then we can deduct VAT we pay on purchases from VAT we recover from sales and so from this know what amounts of VAT we pay, but for the man in the street VAT is part of the price we pay for goods and services and so we typically don't record how much VAT we pay.

The reality is that for most of our purchases the purchase price includes 14% VAT.

Most businesses are required to be registered for and charge VAT. Business with a low annual turnover (currently below R1 million) are not required to charge VAT. Because of this threshold we are not likely to purchase many items from such businesses, although renting a house from an individual may be a common example of where we don't pay VAT. Developers have also been exempt from charging VAT on rental for a period if they are renting property with the intention to sell it.

We are likely to pay VAT on most purchases with the exception of the following which don't attract VAT:

  * Certain food items (e.g. brown bread, rice, fresh vegetables, fresh fruit, milk, eggs)
  * Premiums payable to insurance companies in respect of life policies
  * Contributions to pension, provident and retirement annuity funds and medical aids
  * Petrol and diesel as these have their own taxes as noted below
  * Property rates (but not electricity, water and sewerage)
  * Acquiring a home from a non VAT registered party. This would normally be when a house that isn't new is bought from an individual. If the house is bought from a developer or a company then VAT is likely to be paid, except that if the company just owns one or a few properties then VAT might not be payable.

This means that VAT is likely to be paid on many purchases of not just goods, but also services (e.g. medical accounts). We also pay VAT for items such as motor vehicles if we buy from a dealer, but not from an individual who is not a dealer.

Fuel levy

As noted above we don't pay VAT on petrol and diesel but the pump price includes a significant amount that goes to the government. The fuel price from April 2015 includes the following amounts in cents per litre:

Table 13.3 – Taxes included in fuel price in cents per litre

This table shows that about R4 a litre of the fuel price comprises various taxes. For those who live inland there in an additional pipeline levy of 0.15 cents per litre.

The government normally considers once a year whether to change the amount of these levies.

Toll fees paid to use roads can either be considered a form of tax or just a usage fee.

Other taxes

As mentioned above, rates paid on residential properties don't attract VAT, but rates can be regarded as a form of tax.

If a person buys a house they are required to pay transfer duty as mentioned in section 9 above on a sliding scale.

A securities transfer tax of 0.25% of the greater of the value of shares or the amount paid for shares is required to be paid when they are acquired.

A donations tax of 20% of the value of assets donated is payable within three months of making a donation. There are some donations that do not attract any donations tax. These include the following:

  * Donations by individuals up to R100 000 per annum
  * Donations between spouses that are not separated
  * Bone fide maintenance payments
  * Donations to public benefit organisations, which is a broader number of organisations than those claimable for income tax purposes.

When a person dies they can be required to pay estate duty in additional to CGT on the deemed sale of assets as mentioned above. Estate duty is payable at the rate of 20% of the value of an estate that exceeds R3.5 million. For this purpose the value excludes assets going to a surviving spouse or a public benefit organisation and if one spouse does not fully use the R3.5 million allowance this unused portion can be taken into account by the remaining spouse. This means that if one spouse leaves all their assets to the other spouse, that the remaining spouse only pays estate duty when the value of assets exceed R7 million; also that if one spouse decides to give their assets away to parties other than the remaining spouse and their assets were worth say R2 million, that the unused allowance of R1.5 million is added to the surviving spouse's allowance, meaning the remaining spouse's allowance would be R5 million. In other words the spouses together have a R7 million allowance and this could be split between them unequally.

Other tax issues

It needs to be appreciated that this section is a summary of the tax requirements and is intended to give a person an overview of tax and is not intended to be used as a comprehensive tax guide. For example, not all items have been dealt with and even for the items dealt with not all requirements and exemptions have necessarily been mentioned, as the intention is to cover the more common areas only.

In addition, this section assumes a person's income is largely earned from employment. If a person is self-employed then what comprises taxable income becomes more complex and is beyond the scope of this section. In that case or if the business is run through a company, then there are issues of registering as an employer of any staff that might be employed and registering for VAT. As regards VAT it needs to be charged on sales, excluding export sales and VAT paid can be claimed against VAT paid (excluding VAT paid on cars and entertainment).

Some people also include some of their assets in trusts. Some of the benefits of having assets in trusts have fallen away over the years. At one stage houses were often held in trusts, but the costs of the tax treatment of them now probably outweighs those benefits. In addition, income that is taxed in a trust is taxed at a rate of 41%, which is the equivalent of the top tax rate for individuals.

While there can still be a place for trusts this is probably for those who are prepared to obtain the right advice and pay the related costs.

Thus for those who have more complex tax affairs or want to use trusts, they should consider using a person with the appropriate skills and experience.

Finally, it is worth reflecting on the total amount of tax we pay. As noted above, it is not normal to record what amount of VAT we pay, but based on a few assumptions it seems that in the past few years that VAT, fuel levy and rates probably varied between 13% and 15% of my expenses. This in addition to income tax shows that for many people a large portion of their income goes towards the various types of taxes; for some this could even exceed 50%. While we might be able to control some expenses and as such determine the amount of consumption taxes we pay, it also means that for a large portion of our expenses we have limited ability to amend them in our efforts to control our expenses.

### Chapter 14 **– Retirement funding**

A 2014 Savings and Investment Monitor produced by Old Mutual showed that 43% of the youth in this country do not have formal retirement savings. When looking at the reasons for this low level of savings, 33% of the youth believe government will take care of them and 32% believe their children will take care of them.

This is scary from a number of perspectives. While the government does provide some pensions, the amounts by themselves are inadequate for all but the poorest. Although the amount of state pensions is normally revised annually, at present it isn't much more than R1 300 per month for those who meet a means test. In addition, at the very time when families are growing and needing adequately sized housing and reliable vehicles, they are probably battling financially and so it can be very difficult to expect them in addition to now support parents as well.

Need for funds for retirement

Because of the large amounts needed to finance retirement, this is not something that can just be left to the last few years before retirement. To enable anyone to retire in a moderate amount of comfort they need to save over most or all of their working life. As outlined in section 3 above a person needs to harness the power of compound interest in saving for retirement. While some can rely on inherited wealth for retirement, this is not likely to apply to many.

In addition, when a person retires they might find that contributions to retirements fund are not adequate for retirement. At that stage it might be difficult to find another job or to do much about the value of retirement assets. Over the years a number of retirees have realised they will battle to retire comfortably and have fallen victim to salesmen offering investments with remarkable returns. They have found that they have been intoxicated by the perfume of the promised returns by overlooking the stench of the risks associated with the investments.

It is for this reason that pensioners can be vulnerable to making unwise investments and so should speak to others and not just the investment salesmen in making investments. This can include friends and family who can be trusted on financial issues and financial advisors who have been known and trusted for many years.

While some might rely on the government and family in retirement, others might believe they will never retire or die before retiring and so won't need retirement funds. Most companies have a retirement age and so it might not be possible to continue working beyond a certain age. In addition, due to improvements in medicine people are living longer than previously and so even if a person had parents who died fairly young they might live much longer than their parents.

Even those who run their own businesses might find that being self-employed is no guarantee that this will pay for one's living costs in old age. They might find that they no longer have the energy to operate as they did previously; their clients might retire themselves, move to other businesses or they might not be willing to make the necessary changes to continue operating successfully as technology and social changes occur. They also might find that family members who they hoped would take over the business no longer want to do so.

Accordingly, planning for retirement is a challenge. In your early working days you don't know when you are likely to retire and what your needs are likely to be then, but you need to start working on a plan which can change over time. For example, you might be retrenched close to retirement, you could be disabled, you might not have children or a spouse, you could have a child that is disabled or needs extra medical care, you might still have parents and children that need financial support and if there has been a divorce there could be maintenance costs or costs of bringing up children 'inherited' in a subsequent marriage.

Unfortunately many people sabotage their own efforts in having sufficient funds to retire. When a person resigns from a job instead of transferring their retirement funds to another fund they access the funds for other purposes. If a person is unemployed for a period and they don't have other funds available, then I can understand why they use these funds, but they need to realise the long-term impact of what they are doing. A person should avoid resigning without having a replacement job if they don't have the financial resources to survive a period of unemployment. They could also have considered taking out insurance against being retrenched if that is the cause of unemployment. I have heard of people who resign specifically to access their retirement funds; they shouldn't be surprised when they don't have sufficient funds to retire. It is for this reason that the government's intention to restrict access to retirement funds when changing jobs is welcomed.

Preparing for retirement

Before looking at what funds can be used for retirement and what assets are needed to retire, it is worth considering other ways to plan for retirement. These include the following:

  * Paying off a mortgage bond by the time of retirement. Even though a person may buy a house when they are in their 50s, financed with a 20 year bond, this doesn't mean they should take that long to pay it off. As noted above in section 8 on the use of credit, the amount of interest over the period of a bond can be substantial and so one should be looking to reduce this as much as possible to avoid having to pay a monthly bond after retirement. This might even mean that the price of a house that is bought financed by a bond within 20 years of retirement should also take into account whether it can be paid off by the time of retirement.
  * The principle that applies to a home can also apply to a motor vehicle. If it is being bought within a few years of retirement the aims should be to pay cash for it or have a short repayment period, even if this means downscaling from the type of cars previously owned.
  * In addition, all other debt should also be paid off by the time of retirement. Avoiding interest costs that continue into retirement should be a goal.
  * As far as possible children should no longer be supported. By that stage the goal is that children should have finished their studies and are working. Obviously if children only arrive late in life or come with a younger spouse then this goal might not be fully achieved when a person retires but should still be the goal over the next few years.
  * The standard of living might have to be relooked at. Based on projections a person might have some idea of what funds they have available for retirement and based on this what they have to live on each month. If this is less than their current expenses then it might be easier to make the necessary adjustments before retirement than after retirement.
  * Medical aid needs to be considered. As expenditure is likely to increase with age, a person should be looking to ensure they have a reasonable medical aid. Over the years medical aid premiums have been increasing by more than the inflation rate and so some retirees have unfortunately have had to downscale their medical aid at the very time they are likely to need it most. It is worth considering having an investment whose aim is to help fund future medical aid premiums. Even though medical aid premiums are included in CPI and thus may be included in projections of future expenses, the premiums can become large and so having an investment dedicated towards this can ease the burden of financing the premiums later in life. Having a savings account with a medical aid with accumulated amounts in it is also a good idea.
  * While this book focuses on finances, I think the non-financial issues can have a major impact on retirement. Some dread retirement because they don't know what they are going to do after retirement, while some eagerly look forward to retirement although they haven't considered what they will do after retirement. Thus, what one intends to do after retirement can, like finances, have a major impact on how people enjoy retirement. Some have hobbies, sports or interests, but it is better for these to be developed before retirement as opposed to looking for them after retirement; some have used hobbies to earn extra income. Some want to continue to work and this might be possible; this could be part-time or even for no payment by working for a charity. For me, I wanted to write this book for a year or so before retiring. To have a happy retirement does not just happen; like so much else in life it needs to be planned and prepared for. Accordingly both financial and non-financial aspects of retirement need to be planned for. If a person does not have any goals when they wake up on their first morning of retirement I question how long their life in retirement will be. Before my retirement I tried to work four days a week and on one of my days off I was walking through a shopping centre and I saw many older people sitting in coffee shops in mid-morning, many by themselves, and I asked myself is this was I am destined to do; my highlight of a week being going to a coffee shop so I could watch the passing traffic. Keeping one's mind active can also be important; my mother has done this by doing jigsaw and crossword puzzles among other activities.

Housing in retirement

A retiree should also be considering future housing as part of a plan of preparing for retirement. As they get older their house might be getting too big for them, the maintenance of the house and garden could become a large burden and in a double story house it might become difficult to climb the stairs. This might mean planning to move to an old age home or complex or even moving in with children, which comes with its own challenges. It also needs to be considered whether the costs of living in senior citizen accommodation can be afforded as there might be levies payable. Some of these facilities might offer frail care facilities which might be needed later. These might require a higher monthly levy or only a higher levy when the facilities are being used. There is merit in agreeing soon after retirement as when such a move would be wise as this can prevent family problems later on. Sometimes children have problems convincing parents that they should move when it is clear they are battling to cope at a time when the parents are not in the best position to make such decisions. Accordingly, if the time of a move has been agreed earlier that can ease the decision later. A person also needs to be cautious about moving to a new suburb, town or city as creating a new circle of friends later in life can be difficult.

For some retirement complexes people might be on a waiting list for more than ten years before a unit becomes available. This means people need to plan far in advance for a possible move. If a move is left to much later in life it could be an issue. For example, when my mother moved to an old age home she had to show she still had all her mental faculties and was mobile, which she fortunately was able to do.

A move to a retirement complex or old age home could also require a unit to be purchased and so the necessary funds needs to be available. For some this will mean selling their home, which could become an issue, depending on how long they are given to accept an offer to move to a retirement complex.

Retirement complexes and old age homes might have a number of different arrangements regarding ownership of units. They could be freehold units, sectional title or life rights, which give a person a right to use a unit for the rest of their life. When a person dies or leaves the unit they might receive the current value of the unit or a lower amount. For example, they might get the lower of the amount they paid and the then market value or might get what they paid for the unit plus a portion of the difference between this cost and the then market price, with the organisation running the complex getting the rest of the profit. This organisation might use this profit to fund part of the running of the complex and could possibly result in a lower levy in comparison to other complexes where owners retain the whole profit.

If a retiree decides to stay in their own home then as they get older they may have to rely more on others to maintain their home and themselves; this could include having home care for which financial provision would be necessary. Provision for health care could also apply in retirement complexes and old age homes as not all provide frail care facilities.

Accordingly, people need to be aware of the different options available for those facing retirement, including arrangements that retirement complexes and old age homes use in running these establishments as it can make it difficult to compare them. It is probably best to discuss this decision with one or more person that they trust on financial issues. This can include discussions with family members to avoid potential surprises as to the amount of proceeds that could accrue to an estate when a person dies if they were to move to a retirement home. In making a decision as to where a person intends to live in their later years of retirement, a balance might have to be drawn between what can be afforded and what is left to beneficiaries. Hopefully children are focusing more as to whether their parents are happy where they are living as opposed to trying to maximize possible inheritances.

Types of retirement funds

The normal way to save for retirement is to be a member of a pension fund, provident fund or retirement annuity fund. Employers might require employees to be a member of a pension or provident fund. The employer would pay over an amount each month to the fund, which is probably administered by an asset manager. As noted above in the section on taxes for a pension fund the employer and employer both normally contribute to the fund (i.e. employee contributes to the fund out of their salary), whereas for a provident fund the whole amount is normally contributed by the employer as the result of any employee contribution not been deducted for tax purposes, but this tax treatment is due to change after 29 February 2016.

The amount contributed to such funds might be between 15% and 17% of a person's income, although part of this might be used to cover group life insurance for employees.

There are other differences between pension and provident funds. For a pension fund the pension payable at the end is normally based on the person's salary at the time of retirement and the number of years of being a member of the fund. For example, a person might receive 2% of their final salary for each year of employment and so if they had worked for the same employer for 30 years, which is long for many employees, they will receive a pension of 60% of their final salary. When a person retires they are allowed to take up to one third of their pension as a lump sum. If a person changes jobs before retirement, the amount belonging to them can be transferred to another fund until retirement. If the assets in the fund are insufficient to pay the pension then the employer would be expected to provide further funds. As a result companies have not wanted to be exposed to this risk and so over the years the number of pension funds operating has been reducing. Companies might have closed schemes to new employees or might have converted schemes to provident funds.

Some pension funds have had surplus funds and so might have used these funds to encourage members to move to provident funds. At one stage companies used to pay medical aid premiums for retirees, but because of changes in how to account for these in company's annual financial statements, companies have been looking to stop this practice. Again it might no longer be offered to new employees or companies might have used surplus funds in pension funds to provide more amounts for employees in provident funds, with the objective that the employee is responsible for paying their own medical aid premiums after retirement. As a result there are only a few companies now that provide this benefit.

The big benefit for a provident fund has been that when a person retires they are entitled to take the full amount as a lump sum. The problem is that few are able to manage their own finances adequately and so may use these funds within a short period and then be financially destitute. Having access to the full amount made provident funds attractive to trade unions, which made conversions from pension funds to provident funds easier as the unions have been in favour of this, even though this was rarely in the best long-term interests of employees. Even if a person takes no lump sum or a small lump sum and take a pension with the remainder, the retiree and not the employer is responsible to ensure the funds last until death. Many have found too late that these funds are not adequate for retirement and that companies no longer take responsibility for the retiree's pension.

The government has been concerned about people having sufficient funds upon retirement and is considering the following possible changes to deal with this issue, which could occur at the earliest in the 2017 tax year:

  * Some differences between pension, provident and retirement annuities will be removed.
  * For provident funds, people will not be able to take all their funds upon retirement, but like pension and retirement annuities will only be able to take a lump sum of up to 1/3 of their funds upon retirement with the rest to be used for an annuity. This will only apply to contributions made after the changes become effective, so for contributions before that date the related assets can still be taken as a lump sum after retirement.
  * If an employer contributes any amount to a pension, provident or retirement annuity fund then the government is looking for these to be treated in the same way for tax purposes. All contributions on behalf of an employee will be taxable in the employee's hands as a fringe benefit, but a deduction of up 27.5% of taxable income will be allowed for the total of all contributions to these funds. The amount that can deducted will be limited to R350 000 a year.
  * The government is looking at curtailing the amounts that can be accessed if an employee leaves a company as well changing the default option from being paid out the amounts in pension and provident funds on resignation to preserving these amounts and so thus not having to pay tax on the funds at that stage.

Some companies have combined elements of a pension and provident fund, by having provident funds that limit the amount that can be taken as lump sums to, say, one third of the amount available on retirement. This requires an employee to receive a monthly pension, which can be in the best interests of employees, but still means that the employer is not responsible should the pension be insufficient upon retirement.

Not all companies offer a pension or retirement fund. In this case the employee is responsible for their own retirement funding. This can be done by making contributions to a retirement annuity fund. For employees who want to top up amounts paid to pension and provident funds, they might also make contributions to a retirement annuity fund. Like a pension fund, lump sums paid out of retirement annuity funds are limited to 1/3 and a pension is required to be taken for the remainder. In addition, if a person is self-employed then they should be looking to join a retirement annuity fund. However, it is more difficult to access these funds as they can't be accessed before a person is 55 years of age, unless they die, even if they change jobs.

If a person is a member of a pension or provident fund, contributions stop if a person resigns, but the same doesn't necessarily apply in the case of a retirement annuity fund. This has caused problems as insurers levied large penalties if monthly contributions to retirement annuity funds were stopped. The Minister of Finance intervened some years ago and the penalty has been reduced. This not only applied if a person resigned, but also applied if a person was retrenched, no longer able to work, but also if a person working for a company that didn't have a retirement fund moved to a company with such a fund. However, there are now retirement annuity funds available that don't charge penalties if monthly payments stop; these are retirement annuity funds that operate on a similar basis to a unit trust where monthly payments can be changed without penalties. Accordingly, if a person joins a retirement annuity fund they should be looking to join a fund which doesn't levy penalties if a person is no longer able to contribute, especially where the reason is outside the person's control.

Taxes on withdrawals from retirement funds

As noted above, too many unfortunately withdraw some of their retirement funds when changing jobs. This withdrawal can have tax consequences. If the funds are transferred to a new pension or provident fund there are no tax consequences, but the amount retained by the person is taxed on a cumulative basis over a person's life. This means that if a person takes out amounts from these funds before retirement then any previous withdrawals in previous years are also taken into account as follows:

Table 14.1 – Tax on withdrawals from pension and provident funds

This table shows that based on the tax rates applicable to the year ended 29 February 2016 that the first R25 000 of the withdrawals are tax free, but this can only be obtained once in a person's life. Also as can be seen from the next table below, a person starts paying tax much sooner than if a person was retiring, which should be a disincentive to withdraw funds upon changing jobs, but doesn't appear to be much of one.

When a person retires from a pension, provident or retirement annuity fund, then again tax can be payable on amounts received, but the taxes are less harsh than on withdrawals. Again taxes are paid on a cumulative basis, so if a person is a member of more than one fund and retires from them in different years, then these need to be looked at collectively. For example, a person might be a member of their employer's pension or provident fund as well being a member of a retirement annuity fund in order to top up their pension and so when they retire from work that doesn't mean they are also required to retire from the retirement annuity fund; this could occur on an earlier or later date. The tax rates are again those applicable to the year ended 29 February 2016.

Table 14.2 – Tax on lump sums from pension, provident and retirement annuity funds

As mentioned above in the section on taxes, there are limits on amounts that be claimed for contributions to pension and retirement annuity funds for tax purposes each year. The amounts that cannot be claimed in the annual tax return can be claimed when a person receives a lump sum.

To the extent that a person does not take a lump sum from a pension, provident or retirement annuity fund, the remainder of the amount in the fund is to be used to purchase a monthly annuity. This annuity, which is also termed a pension, is taxable in the same way as a salary is.

While it is normally advisable for a person to minimize the amount of a lump sum in order to maximize the amount of the monthly pension, this should be reconsidered in light of the above tax tables. If no lump sum is taken then the whole pension is taxable, even the portion paid out of the amount that could be received tax free. As the lowest tax rate on taxable income is 18% it can make sense to take a lump sum of up to R700 000, as up to that amount the tax rate on a lump sum is also 18%. Those who are taxed at a higher tax rate may benefit tax-wise from taking a higher lump sum. This is dealt with in more detail in table 14.22 below.

As noted above, the maximum amount that can be taken as a lump sum from a pension and retirement annuity fund is 1/3, so if a lump sum of R700 000 is taken the person needs to have at least R2 100 000 in their fund at retirement, while for a provident fund the whole fund can be taken as a lump sum.

Use of lump sums

If a person takes a lump sum the question becomes what they are going to do with it. As noted above a person should be aiming to retire with no debts, including loans for houses and vehicles, and so if they haven't achieved this goal they should be looking to use the lump sum for this purpose.

Ideally the person should be looking to invest the lump sum so that it can be used as part of their pension. For example, they could invest it in a unit trust or ETF and then withdraw amounts when needed. Any gains on these withdrawals will be taxed, but as a capital gain, meaning that only 1/3 of the gain is taxed as opposed to the whole proceeds.

Another option is to purchase an annuity from an insurance company. While the whole pension from a pension, provident or retirement annuity fund is taxable, the same doesn't apply to a purchased annuity. In this case as part of the amount invested is paid back each month, that portion of the annuity is not taxable. For example, a person might have a lump sum of R100 000 to invest at a time when their life expectancy is 25 years. The insurance company might estimate that a person will receive R2.50 for each R1 invested until they die. On this basis the person will be taxed on R1.50 for each R2.50 received, namely 60% of their pension will be taxed. This is better than having the whole amount taxed if no lump sum was taken upon retirement.

Other assets for retirement and related tax

Some might provide for retirement funds wholly or partially by making use of investments other than pension, provident or retirement annuity funds. They might have investments such as those noted above in section 11 on investing.

When they realise those investments they could be required to pay tax. If equity or property investments are sold, then capital gains tax is likely to be paid. As tax is only paid on 1/3 of the gain instead of the whole proceeds, this means that the tax is far more favourable than being taxed on an annuity from a pension, provident or retirement annuity fund. It does however need to be appreciated that property or equity investments are paid from amounts that have already been taxed, whereas for the normal retirement funds tax is being saved by making the contributions, with the tax occurring instead at the end when annuities and lump sum are received.

In the case of interest bearing investments there may not be any tax payable when the investments are realised as interest would normally be taxed when it is added to the investment and not when it is paid out and so tax would already have been paid. In addition, interest is taxed at the normal tax rate after deducting the amount of interest that is exempt from tax. The same applies to interest reinvested in a unit trust. If a person has invested in bonds then in addition to interest, they would also be taxed on the change in value of the investment, other than interest, upon its disposal.

Dividends received from equity investments, unit trusts or ETFs are taxed when the related company pays the dividend and are not included in the individual's tax return as mentioned in section 13 above. This does not apply to dividends from foreign companies which are taxed in the hands of the recipient.

Can retirement funds be adequate for retirement?

People also need to consider if they contributed to a pension or provident fund for their whole working life whether this would provide sufficient funds upon retirement. For this I modelled amounts based on making contributions over 20 and 30 years using the actual inflation rate for the past 30 years and arrived at what the assets in the fund were at the end of the period as a multiple of the salary in the final year. For the 40 year column inflation was assumed to be 5% a year for the last ten years. The returns over the period were assumed to be the inflation rate plus either 3% and 6%, with the salary increasing in line with inflation as well as inflation plus 2% to assume for promotions and for the contribution to be both 15% and 17% of salary. The multiples are included in the table below.

Table 14.3 – Assets in retirement fund as a multiple of annual salary

The above table assumes that the amount of the contribution available for investment for retirement is reduced by 20% to cater for the part of the contribution that is used for administration costs and insurance premiums for death and disability benefits. These amounts could be between 3% and 4% of the contribution. This means that if 3.4% of a 17% contribution is used for these costs and premiums, that these amounts comprise about 20% of the total contribution and 80% is available for investment. This means that the actual multiple in the above table could be slightly more or less as the portion available for investment could be between 74% and 82% of the contribution.

As would be expected the factors increase as the contribution increases and the growth rate increases. The highest factor after 30 years is that assets would equal 10.8 times the last year's salary if the contribution was 17% of salary; the growth rate of assets was inflation plus 6% and the person's salary tracked inflation. If instead the person's salary was inflation plus 2% p.a. but other factors stay the same, the factor drops to assets being 7.8 times the final salary.

The lowest factor over 30 years is assets only being 4.4 the final salary; this applies when the contribution was 15%, the growth rate was inflation plus 3% and the person's salary increased by inflation plus 2%. This shows that the highest factor is more than double the lowest factor meaning that it can be difficult to predict whether retirement funds will be adequate upon retirement, as factors such as the extent of salary increases and growth rates can be difficult to predict over such a long period.

The table also shows that making contributions over the last 20 years before retirement and not 30 years makes a large difference. While 20 is 2/3 of 30 years, in some cases the factors for 20 years are less than half those of 30 years. For two of the 40 year factors they are four times the factor for 20 years, when 40 years is double 20 years.

While people might argue that they could possibly save more in the last 20 years to compensate for the shortfall, the reality is that this is going to be difficult, because if they are not already used to contributing to retirement funds as those contributing over 30 years are, it is going to be doubly difficult to now not only adjust to contributing to the same extent as the '30 yearer's' but to also go substantially beyond that, as they need to go from zero to say 25% in one step.

Before answering the question as to whether the multiples in the above table are sufficient for retirement we need to consider some additional issues before coming back to the question in the section on assets needed for retirement below.

Returns on assets

It is also worth considering whether returns of inflation plus 3% or 6% are achievable. For this purpose the same initial data as used in table 11.4 above was taken and instead of increasing the price by the CPI it was increased by CPI plus both 3% and 6%. The table shows that if an investment was made each month that for 86% of the monthly investments the growth in unit value from date of investment to the end exceeded CPI plus 3%, but for only 56% of the months did it exceed CPI plus 6%. In the graph below where the top two lines are below the horizontal line then the return exceeds CPI plus 3% or 6% respectively.

Table 14.4 – Prices of local units increased by CPI plus 3% and 6%

It should also be realised that the units included in this graph relate to those of Manager A in graph 11.2 above. In that graph the price of units for Manager B had generally performed better than that of Manager A and so would have achieved a return exceeding CPI plus 3% or 6% more often than that of Manager A.

Table 11.3 above compares the performance of the units of Manager A with units holding foreign assets. The table below looks at the price of those units holding foreign assets with CPI plus both 3% and 6%.

Table 14.5 – Prices of foreign units increased by CPI plus 3% and 6%

In this case, the performance of the price exceeded CPI plus 3% in 67% of the months, but only 47% of the time did it exceed CPI plus 6% and most of those have been in the last six years.

In section 11 when investment performance was discussed, it was noted that the value of the units on which these graphs are based excluded income (interest and dividends) received and that if these were taken into account the performance would be better. Chapter 11 also indicated that the average return taking reinvestments into account for one of the local unit trusts was CPI + 8.8%, while that of the foreign units was CPI +5.5%.

It should also be appreciated that the average return can vary significantly over time. The table below shows the average annual return, including reinvestments, over various periods, using the same starting point. The investments in this table are the better preforming investment in table 11.2 (Manager B) and the foreign unit trust in table 11.3.

Table 14.6 – Average annual return on investments

This table shows that over long periods returns are not always favourable. For example, over a twelve year period while the average annual returns for a local unit trust were inflation plus 7.4%, for a foreign unit trust it was inflation minus 5.0%. Over the next four years these average annual returns improved to inflation plus 8.8% and 5.5% respectively.

Table 14.7 – Returns on investments in excess of the inflation rate

While these may be average returns, they can vary considerably from year to year. Taking the prices used in tables 14.4 and 14.5, the above table shows the actual returns achieved in excess of the inflation rate, excluding reinvestments. If the returns include reinvestments it is likely the returns would be between 0.5% and 2% higher. This table also differs from the previous table in that table 14.6 looks at average returns at four different dates including reinvestments, whereas this table looks at returns at the last of these dates, excluding reinvestments, but instead of just looking at the average returns over 16 years shows how the returns vary over periods longer and shorter than that. The above table shows the following:

  * For a nine year period from the end of 1996 the return on local units exceeded inflation plus 4%, while for the foreign units this was only achieved in the last three years of this period
  * At times the returns were negative; for local units this occurred at the end 2007
  * These returns were calculated to the middle of 2014, so they would be different if another date was used, but the shape would not change. In other words, if another date was used the line indicating a zero return would move either up or down.
  * It should also be noted that the graph does not include information after 2008; this is because if this information was included it would detract from the earlier years and with retirement investments the long term return is more important than returns on a short term basis. With the strong recovery of the markets in the years since 2008 the return on both local and foreign units was above 10% for four consecutive years, barring a few months, while for foreign units it even exceeded 30% for one of these years.

This might suggest that returns of CPI plus 3% and 6% are possibly understating past performance, but it needs to be appreciated that the investments in the previous graph are mainly equity investments, when the reality is that retirement funds can hold considerable investments in cash and bond investments where the return is likely to be less than inflation. If these are taken into account the returns will decrease. For example to take a very simplistic calculation, if 70% of the investment is in equities which can achieve CPI plus 6% and 30% in investments achieving 80% of CPI then the overall performance is likely to be close to CPI and not even CPI plus 3%.

As the graphs show returns can be volatile and that while returns of CPI plus 6% are possible, they are less likely than CPI plus 3%. In addition, it needs to be appreciated that historic returns are not necessarily an indicator of future returns. Therefore while different possibilities are provided in this section, it would be better for planning purposes to use the lower returns. Planning on a conservative basis is a better option; it is better to have remaining assets when one dies than becoming destitute in one's final years.

Types of annuities

Before looking at whether any of the above amounts would be sufficient for retirement, we need to consider the different types of annuities or pensions people could receive, as they might have to make a choice in this regard. These annuities are payable from pension, provident and retirement annuity funds from the funds available after taking out any lump sums as discussed above. Members of pension funds might not be able to choose what type of annuity to receive as noted below.

The first type of annuity is a **level annuity** , meaning the person receives the same amount each month. The problem with this type of annuity is that with inflation it can buy less and less each month. For example, a person might have received a pension of R10 000 per month twenty years ago, which was probably a fairly good pension at the time allowing the person to live comfortably, but in today's terms that amount is the equivalent of R2 800 per month now. The pensioner would have to consistently see their standard of living dropping which might not be easy to do, or rely more on their children for support. Accordingly, this type of pension should be avoided, if possible, due to its long term effects.

The next type of annuity is an **increasing pension**. This can be a fixed percentage increase each year (e.g. 3%, 5% etc.) or can be an inflation linked increase. This means that the standard of living can be maintained, or decreases at a slower rate than a level annuity. The downside of this type of pension is that it starts at a lower level than a level annuity which is why it is not always attractive in the beginning, although after a period it starts paying a higher amount than a level annuity.

Another type of annuity is a **'with-profits' annuity** which means that the increase in the annuity depends on the performance of the assets the funds are invested in. Again it starts at a lower level than a level annuity, but if markets do well it could provide a higher pension than an increasing pension. However the extent of the increase can be less predictable and can be nil when markets perform poorly. This type of pension is only for those who are willing to accept the risks of volatility that come with this type of annuity.

The next type of annuity is a **living annuity** which has become popular in recent years, although this is regarded as a dangerous type of annuity. In this type of annuity a pensioner decides on their own annuity within limits. The pension can range from 2.5% of their capital to 17.5% of their capital and this can be changed each year. With the reduction in interest rates in recent years it has meant that annuity rates for level annuities have dropped and so people who have retired recently have been getting lower level pensions than those who retired earlier having the same investment. As a result people have been looking to see how they can obtain a higher pension and so a living annuity has been attractive.

The problem with living annuities is that people can decide on a level that is in line with their expenses and this might mean that they are eating into their investment, because the growth on the assets is less than their pension. This problem can become even worse because with a living annuity a person may continue to take out a pension that exceeds the growth in the value of assets and may in a short period of time have a much reduced value of assets and flowing from this a much reduced pension. Thus a living annuity can result in people becoming destitute. It seems advisors recommend that the pension should not exceed 5% of the value of the capital in any one year for the fund to provide sufficient funds until death.

There are a number of other issues people need to be aware of in relation to annuities. For most annuities when a person dies the annuity dies as well, meaning that the person's estate does not receive any further funds from the provider of the annuity. This does not apply to a living annuity where the remaining funds can be left family or other parties. This is another reason why living annuities are attractive to people.

People may be concerned about dying shortly after taking out an annuity and their estate losing out, but insurance companies offer options for this, with the cost of these options impacting on the amount of the pension. For example, they will guarantee that a pension will be paid for 10 years, even if the person dies before this; also they will agree to pay a pension to a surviving spouse for the rest of their life after the pensioner dies. In addition, in relation to the remaining spouse the pension could be same as that paid previously, or, say, 2/3 of the previous pension. If there is a remaining spouse it should be questioned whether the same level of annuity is required as some expenses (e.g. medical, food and clothing costs) would be expected to reduce.

In the case of a pension fund a person might not have a choice of what type of pension they will receive. The Pensions Fund Act now requires pension funds to target a minimum pension fund increase (it seems this is often 75%). There may however be some funds, including those who not governed by this Act, where the rules might only provide for a level pension, a pension with a specified increase or a 'with profits' pension where the pensioner might not know the extent of future increases. A member of a pension fund may in some cases be able to transfer their funds to an insurance company, in which case the various annuity options noted above may be available.

When making a choice of pension the person needs to consider who is going to bear the various risks as noted in the table below.

Table 14.8 – Who bears the risks associated with annuities?

This table shows in the case of a living annuity that the pensioner bears the risk of living longer than expected and hence not having enough funds at that stage for retirement, whereas in the other annuities the insurer takes this risk. In the case of a living annuity and a 'with profits' annuity the possibility of market returns being better than expected is not a risk but a benefit, whereas for a level annuity and an increasing annuity the insurer benefits if the market returns are better than expected. While dying early means that a person has received a lower pension than if it was known when they would die, in the case of a living annuity this is not so much of a risk as the person's estate will benefit. If a person thinks they could live longer than the average person do they want to bear that risk is a question they should also be considering in making a choice of annuity.

In deciding on the type of pension a person should consider the above risks; do they want to bear all the risks or do they want the insurer to accept some of the risks. A person might be prepared to accept a lower pension in order to have more peace of mind as they get older. In this case, they don't have to worry as to whether their assets will last until they die or what type of investments they should hold, because these are issues that can become more difficult to deal with as they get older. Instead these are issues that can be left to an insurer.

One other choice that can be considered is initially starting with a living annuity and then changing to a level or increasing annuity at a later stage. While this choice can be made, this does not apply to the other types of annuities where once an annuity is chosen a person is not able to change the choice. When a person is in their sixties and early 70s they might feel confident about making investment decisions, but not later and so might at that stage agree to allow the insurer to take on more of the risks associated with annuities. Some might be hesitant to take out an annuity at present because of the low interest rates and hence low annuity rates and so might hope rates will increase in the future and so might prefer to take out a living annuity now so that they can change their annuity to another type of annuity when rates increase. There is a risk however that this may not occur.

Assets needed for retirement

Coming back to the issue of what is regarded as sufficient assets upon retirement, this is an issue that others have considered. For a number of years it seems the prevailing view was that this should be a multiple of one's retirement salary, with a number of around 12 being a common number quoted. Based on this and table 14.3 it seems that this is unlikely to be achieved over a 30 year period, as the highest multiple is 10.8 when the average return over that period was at least inflation plus 6%. This also required a person to contribute throughout that period and not to take out amounts when changing jobs. It is likely that not many would have contributed for this period without taking withdrawals and so it is likely that not many would have sufficient funds at retirement purely from their retirement funds. This could be made worse by the contribution to a retirement fund not been based on a person's full salary. It could be based on say 80% of a salary or the salary excluding the bonus, overtime payments and travel allowance. This table also shows that even if a person contributes for 40 years that they may not have sufficient funds at retirement as only three out of the eight factors in the table are above 12, with another two just under 12. This is why people need to look to invest amounts in addition to payments to pension or provident funds to enable them to retire comfortably.

In recent years this approach seems to have lost favour to an income replacement approach, which says a person is likely to have sufficient funds upon retirement if their post retirement income is 70% or more of their pre-retirement income. For a person who is a member of a pension fund this means 35 years of service, if their fund pays a pension based on 2% of salary for each year of service. With people changing jobs more than previously the number of people with this period of service is going to be small.

Over the years I have also considered whether I was going to have sufficient assets at retirement and while I initially used the 'assets in relation to salary' approach I started to develop my own models. These started out being fairly simple, but have become more complex as retirement came closer. This has led me to believe that the above approaches are far too simplistic.

In relation to these approaches I have been asking myself the following questions, building on some issues discussed above:

  * If two people earn the same amount each month, with one spending all their salary but the other only spends 80% of their salary, do they need to have the same amount of assets for retirement? Surely the one who spends less needs less assets assuming their level of expenses is going to remain largely unchanged after retirement? 
  * If one person's pension is going to come from retirement funds which are fully taxed when received, while another has unit trusts which they will sell and hence pay much lower capital gains tax, doesn't it mean the amounts they are going to pay for tax each year is going to be quite different? This being the case I don't see this being taking into amount in either of the above approaches as they are only based on income.
  * If one person retires at 55 years of age while another retires at 70 do they need the same amount for retirement assuming they are both expected to die at the same age? Surely a person retiring younger needs more assets than a person retiring later in life? It is not clear whether or how the above approaches take this into account.
  * If we consider the 'income replacement approach' what assumptions are made? If it assumes a level annuity approach then what might be considered sufficient today is likely to be inadequate in a few years. If a living annuity approach is followed is the level of annuity sufficient for it to sustain itself until death? While this might be dealt with by those who support this approach I have not seen this issue being mentioned in the popular press.

Approach to determine assets needed for retirement

It is for this reason that I think the above approaches are far too simplistic and that a better approach would be to take the following into account:

  * Expenses likely to be incurred after retirement. I need income to pay for expenses, so if know my likely expenses I am likely to arrive at a better amount of what I need upon retirement.
  * Tax can be such a large expense and so should be considered separately as my likely tax profile can result in different amounts needed upon retirement.
  * Period from retirement to death. The longer I am likely to be retired the more assets I need and so this should be taken into account in the amount I need.
  * The return from the assets. The higher the expected return the lower the amount of assets that are needed for retirement.

Accordingly, I believe the approach noted below would be a better approach for most people in determining how much they need for retirement. The intention is get the right balance; if a person retires too early they could run out of assets before they die and if they retire late they might not have much time to enjoy the fruits of their labour. While ideally a person might want to live comfortably and die when the last of their money is spent, it is not practical to expect this to occur. Therefore getting the right balance is difficult as this can only be determined at the end of one's life. Nevertheless, this doesn't mean a person shouldn't be making any assessment as to whether they have sufficient funds upon retirement.

While I have noted some shortcomings in the approaches noted above, I do not believe the approach noted below doesn't have its own shortcomings; it is just that they are far less than those noted above. To overcome these shortcomings a person would need to prepare their own model to factor into additional assumptions.

For example, the approach below assumes information is going to be fairly consistent over time. This means it doesn't take into account the following possibilities:

  * It assumes that a person goes from working to retirement without going through a period of partial employment. If this were to occur the model below could use the retirement date as when partial employment ceases.
  * It assumes a relatively stable level of expenditure. For example expenses could change for a number of reasons, including the following:

  * The death of a spouse
  * Moving home
  * Significant change in standard of living

  * Economic conditions could change, for example, the markets could do better or worse than expected for a considerable period, inflation could be significantly different from expectations and tax legislation could be changed significantly.
  * The approach below doesn't take in account the type of annuity which might be received, but this will be dealt with later.

The model I am proposing requires a projection of expenses. Accordingly this can only be done with some degree of reliability if a person has a reasonable idea of what their expenses could be in the future. This might only be possible for those who face retirement in the next ten to fifteen years. Before then there may be too many unknowns, such as where one will be living, their job situation, likely promotions, expected retirement age, size of family, health challenges etc. This is not to say that these situations won't also arise later in life but the closer a person is to retirement the impact of these might be less than if they occur earlier in life. For example, the financial impact of a move from one home to another when a person is in a more mature stage of their working life might be less than in an earlier stage of their working life as they might be moving to a more expensive home during a period of regular promotions.

Approach to determine assets needed for retirement – not able to project future expenses

For those not able to predict their future expenses with any degree of reasonability, instead of projecting what assets they need at retirement in monetary terms, they should instead be determining what level of income should be set aside for retirement. They should carry out this exercise on a regular basis, such as annually, but when they are able to reliably estimate future expenses, they should change to the model described below for projecting assets needed at retirement.

If a person is not able to project future expenses reliably they should carry out the steps noted below:

**Step 1** – what will the relative amount of my retirement assets be at retirement? This is concerned with the amount of assets in relation to the person's salary at retirement. This comprises the following two components:

  * Using the factors given in table 14.3 above estimate retirement assets as a multiple of final salary from future contributions to funds to be used for retirement. For this purpose the number of years is the years a person still expects to work before retirement. If a person is currently 45 years old and hopes to retire at 65, then the person uses a factor from the 20 year column. The factor also takes into account what portion they are currently paying to a retirement fund and their expectations of future salary increases and returns expected on investment. If nothing is currently being paid to a retirement fund, start with portion the person would like to contribute. If this is different from the portions given in this table, it can be estimated. For example, if a person wants to contribute 20% of their assets to retirement funds, expects their salary to stay in line with inflation, expects to retire in 20 years and for returns on assets to average inflation plus 3%, then they can take the factor for 12% (i.e. 15% contribution less costs of 3%) of 3.4 and increase it to what it would be for 20%, namely 5.7 (3.4*20/12). This factor also needs to take into account costs that could be incurred in investing in retirement funds, particularly for insurance premiums for death and disability. As noted above these costs could eat up about 20% of amounts invested in retirement funds. These costs are likely to be negligible in a retirement annuity fund or an investment in a unit trust. In this example the contribution is to a retirement annuity fund and so the factor of 5.7 is unchanged.
  * Estimate retirement assets as a multiple of final salary from current retirement assets. For this initially calculate current retirement assets as a proportion of current income. For this purpose retirement assets are any assets set aside for retirement, such as retirement funds and investments. For example, if a person's annual income is R100 000 and they have retirement assets of R20 000 then the factor is 0.2 (20 000/100 000). This factor needs to be increased using the same criteria used in table 14.3, but using the factors given in table 14.9 below. Table 14.3 assumes a monthly contribution to a retirement fund, whereas table 14.9 assumes the current retirement assets are kept until retirement, with any additional investments taken into account in the previous bullet. Accordingly taking into account the same assumptions as used in the previous bullet a multiple of 1.8 is applied to the factor of 0.2 to arrive at a factor of 0.4 (0.2*1.8).
  * The factors in the previous two bullets need to be added together. In the above example this is 6.1 (5.7+0.4).

Table 14.9 – Existing retirement assets projected as a multiple of annual salary

**Step 2** – how long will the factor in step 1 last in retirement?

Table 14.10 can be used to determine how long a person can afford to life in retirement. For example, using the factor of 6.1 from step 1, this is about midway between factors 4 and 8. This means that if a person's expenses after retirement are much the same as their income before retirement, then their retirement funds would only last about 7 years (midway between 4 and 9 or 10) if the growth after retirement on their retirement funds is inflation plus 3% or 6%.

Table 14.10 – Number of years assets could last during retirement

It is however likely that expenses after retirement will be less than their pre-retirement income. For example, no contributions to retirement funds would normally be made and hopefully a mortgage bond would be paid off. In addition, less income probably also means less taxes need to be paid. Accordingly to continue the above example, if a person's expenses are likely to be about 60% of their pre-retirement income, their retirement assets could last about 12 years if growth on assets is inflation plus 3% (midway between 7 and 17 in above table) or about 16 years if growth on assets is inflation plus 6% (midway between 8 and 25 in above table).

**Step 3** – decide what further action is needed. This could one or more of the following:

  * The best possibility is that no further action is required. This could be when the above table shows that the assets could last throughout retirement; this is likely to be when the table shows assets will last 30 years or more after retirement.
  * The table might show that a person needs to work longer before retirement and that the period during retirement needs to be shorter. For example, it might show that a person can only afford to retire at 65 and not at 60, as had been hoped.
  * A person might have to accept a lower standard of living during retirement from what they had hoped. For example, they might have to move to a smaller house, change to a cheaper car, or give up expensive hobbies.
  * A dangerous option is to chase higher returns on assets, as the table might show that a higher growth rate is needed to fund retirement. The danger is that higher returns come with higher risks and so might not be achieved. This is one area where many retirees have suffered when promised returns from investments were not achieved. It is not realistic to expect returns to be significantly more than those achieved by shares and unit trusts for any length of time and so any decisions in this area should only be made after consulting a qualified financial advisor, especially those who will not benefit unduly from the advice given to the person.
  * Another possibility is that the table might show that a person needs to increase their contribution to a retirement fund.

**Step 4** – redo previous 3 steps using revised assumptions, until a combination is achieved that a person is comfortable with. For example, a person might decide to increase their future contributions to retirement funds, work longer and also target to be able to live on a lower portion of their pre-retirement income by paying off loans for their house and car before retirement.

Table 14.10 assumes a person is able to access all their retirement funds, but in the case of a person taking out an annuity, this might not be possible. In this situation a person could receive an annuity for a longer period than indicated above, with their income will be less than their expenses. This might mean they could be required to reduce their standard of living whether they like it or not. Alternatively, they might need to look for other sources of income, such as obtaining work again or obtaining financial assistance from their family.

A person could also use these steps to determine what portion of their income should be set aside for retirement. For example, a person might be starting work for the first time, have no assets for retirement, expect to work for 40 years before retiring, would like to live on 80% of their pre-retirement income and hopes returns will average inflation plus 3%. From table 14.10 they see a factor of 16 applies to assets lasting a 30 year retirement period, which they consider realistic. From table 14.3 they see that using the same assumptions plus an expectation that over a 40 year working life they could receive salary increases averaging inflation plus 2% that a factor of 6.9 applies if they contribute 17% to a provident fund. To achieve a factor of 16 this means they need to save additional amounts for retirement. This 17% translates to 13.6% after insurance premiums, so the percentage needed for retirement funding is 31.5% (16/6.9*13.6) of which the provident fund accounts for 13.6%. This means the person needs to contribute another 17.9% (31.5-13.6) of their monthly income if they are likely to retire comfortably using the above assumptions.

To show how sensitive the growth rate is in these calculations, if the person in this example instead assumes the growth rate is inflation plus 6%, then if the other assumptions used above are unchanged, a factor of 13.0 applies for a 40 year period in table 14.3. Table 14.10 shows that using a factor of 12 a person can expect to live in retirement for 34 years. Accordingly, using this set of assumptions the contributions to a provident fund should be sufficient for retirement as a factor of 13 could be achieved against a target of less than 12, but based on a lower growth rate a large additional monthly contribution is needed, as indicated in the previous paragraph.

It is for this reason that, as noted earlier, a regular reassessment is needed of progress towards retirement.

Approach to determine assets needed for retirement – able to project future expenses

The model I am proposing for those about 50 years or older and who are able to predict their future expenses with some degree of reasonability is the following:

A = E *(100/100-T) * F

Where:

  * A = assets needed for remainder of retirement period to provide pension
  * E = annual expenses to be incurred in the next year
  * T = effective tax rate
  * F = a factor taking into account how long a person is expected to live until retirement and investment returns.

These factors will be discussed before some worked examples are provided.

Approach to determine assets needed for retirement - assets

For the purpose of calculating assets it doesn't take into account all assets but only those that will be used to provide a pension. This means that assets such as a person's home, motor vehicle and furniture do not need to be included in the value of assets. Assets to be included would be those regarded as investments and various retirement funds.

Approach to determine assets needed for retirement - expenses

For expenses, the approach is to take the current expenses and then increase them by the expected inflation rate until retirement. However in doing this the current expenses and other payments should be adjusted for amounts not likely to be incurred after retirement. For the purpose of the formula expenses exclude income taxes. The adjustments can include the following:

  * Monthly contributions to retirement funds
  * Contributions to investments such as unit trusts and endowment funds
  * Bond payments if it will be paid off by retirement
  * Car repayments if they will be paid off by retirement
  * Other loan repayments that will be paid off by retirement
  * Expenses related to children if they are likely to be self-supporting by retirement. This includes not only direct costs relating to them (e.g. education, clothing, pocket money, sporting activities) but also an appropriate share of expenses such as food, medical (including medical aid contributions) and holidays
  * Unemployment insurance fund contributions
  * Costs of a maid if this is felt this is no longer needed.

There are also those expenses where the level of expenditure is likely to change upon retirement. For example:

  * Petrol costs might be less as a result of no longer going to work. This could also impact on insurance premiums
  * Clothing costs could also be less as a result of no longer going to work
  * Food costs could change as a result of less entertaining; also costs of having lunch at work could be replaced by having lunch at home
  * A person is still likely to have to replace their vehicle on occasion and so instead of borrowing to finance it, perhaps an amount should be put aside on a monthly basis so a savings account can be built up to fund the difference between a replacement vehicle and the selling price of the old vehicle. This monthly savings amount can be included in the projected expenses.
  * Holidays might become more modest or more or less frequent. If an overseas holiday is planned periodically, then perhaps, as in the case of a vehicle, a regular amount should be set aside monthly for this purpose. 
  * The same approach to vehicles and holidays could also be applied if costs are likely to be incurred for a child who could marry while their parents are retired.

Once an adjusted expense amount is calculated then the amount can be projected for the future as follows:

Future expenses = current expenses *(1+ inflation rate in percentage terms) to the power of the number of years until retirement. For example, if current expenses are R200 000 on an annual basis, the expected inflation until retirement is 5% and a person has 10 years until retirement then the expenses in the year of retirement would be R 325 779 (200 000+(1+.05)^10).

As noted above I have been modelling my retirement finances for a number of years, including projecting expenses. I thought it would be interesting to see how much those projections changed over time.

The table below shows the change in projections over a 7 year period, assuming that in the latest year the projection was expenses of R100 000.

Table 14.11 – Projection of post retirement expenses

This table shows that projections can be carried out with a fair degree of reliability, with for the three most recent projections before the current year, the estimate varied from the latest, and therefore presumably the most reliable estimate, by less than 7%.

Now that a year of retirement has passed it is appropriate to consider what the actual amount of expenses was. I was surprised to find that at R100 091 it was so close to my projection of R100 000.

Approach to determine assets needed for retirement - taxes

Tax is treated as a separate expense because firstly it can be such a large expense and secondly the tax before and after retirement can be quite different. Tax is based on the effective tax rate which is different from the average tax rate dealt with in the section on taxes. The effective tax rate is the tax payable on the receipts used to pay for the expenses. The table below gives example of how this may be done.

Table 14.12 – Calculating effective tax rate (assuming person is between 65 and 74 years of age)

Although interest free allowances, medical aid deductions and rebates can be different for those who are below 65 years of age, those between 65 and 74 years of age and those older than 75 years of age or older, I have suggested making an assumption that a person is between 65 and 74 years of age. This because some might only retire at 65, also after 74 the tax rate will drop, but not much, so it is building in a degree of conservatism. This conservatism probably balances with a higher effective tax rate for those under 65. For those who wish they could do three calculations for the different age groups and average it, but it is not likely to result in effective tax rates that are significantly different from it being calculated on the above basis. The formula also assumes that a person is only taxed on what they receive, either as investment income or as annuity. However, it is possible to be taxed on income not yet received; for example in the initial years of retirement a person could be taxed on amounts they reinvest, but in later years they might receive amounts that have already been taxed and so this is unlikely to have much effect on the effective tax rate.

The above table also shows that how one funds their retirement can have a big impact on tax. In example 3 and 4 the individuals have the same total income of R920 000, but one has an effective tax rate of 14.8% while the other has an effective tax rate of 27.6%. The respective after tax receipts are R783 579 and R665 864 respectively.

If two persons have the same level of expenses (excluding taxes) but different effective tax rates then they need different amounts to fund their retirement. In example 4 the person funds their retirement mostly from retirement funds, but in example 3 the individual uses both retirement funds but also other investments they built up during their working life. In this example the person sells units to the value of R300 000 each year.

Another ways of looking at this is as follows. Assume two individuals each have annual expenses excluding tax of R200 000 and have effective tax rates of 15% and 30%. This means that the first person needs to draw down R235 300 of their funds in a year to enable them to have R200 000 after tax, while the other person needs R285 700 to have the same after tax amount.

Approach to determine assets needed for retirement – application of formula

Table 14.13 – Factor to be used in formula

This table is based on assuming that the inflation rate is 5%, but has also been tested for inflation rates ranging from 2% to 9%. In all cases the factors at these other inflation rates are the same or similar to those given above. For example, at inflation 9% plus a further return of 6% the factor at 10 years of retirement in unchanged at 7.5 while for 35 years it increases marginally from 15.1 to 15.2. If inflation is 2% and the other factors remain the same the factors are 7.6 (vs 7.5) for 10 years and 15.0 (vs 15.1) for 35 years. In the return is just inflation then the factors are as follows: for 10 years instead of the factor being 9.8 it is 9.6 when inflation is 9% and 9.9 when inflation is 2%; for 35 years instead of the factor being 34.2 it is 33.6 when inflation is 9% and 34.7 when inflation is 2%. Thus at other inflation rates the factors don't vary by more than 2% from those above.

Now that the components of the formula have been covered let's look at a number of worked examples.

Table 14.14 – Example of calculation of assets required

This table shows the following:

  * Both person A and B are expected to live for 20 years in retirement (e.g. retire at 65 and die at 85) but while the person B's expenses are 3.5 times that of person A the assets they require for retirement are 5.6 times that of person A because of their higher tax rate and expecting a lower return on assets. If person A was also expecting a return of inflation plus 3% they would require assets that are 27 % higher at R3 158 000.
  * While persons A and D require fairly similar assets at retirement even though person A's expenses are double that of person D's, this is because person D is expected to live so much longer than person A. In addition, person D is expecting a lower return that person A. As implied from the amount noted in the previous bullet above, person A would require assets that are nearly 50% more than person D if they were expected the same return as person D, even though their expenses are double because of a lower life expectancy. This also means that a change of even 1% in the expected return can have quite a large impact on the amount of assets needed upon retirement.
  * Person C needs assets that are double those of person A, even though their expenditure is 50% higher than that of person A, as a result of having a longer expected life (30 vs 20 years).
  * If actual returns are less than expected, then the amount of assets needed can go up significantly. For example for person D the assets needed to go up 58% from R2 170 000 to R3 420 000 if the return on the assets just keeps pace with inflation and not the expected return of inflation plus 3%. Hopefully this might be an extreme example, but it shows the return on assets is important in determining the assets needed for retirement. This is why the calculation should be reviewed periodically to see to what extent previously determined amounts need to change.

The factors in table 14.13 can also be used in other ways.

  * They can also be used to calculate what the asset value should be in relation to a person's salary. For example, if a person is expected to be in retirement for 30 years and expecting a market return of inflation plus 3% then their assets should be 19.8 times the annual salary at retirement. This is only if their expenses, including tax, equal their salary. However expenses are expected to be less than their income; for one, their retirement funding would fall away (which could be about 15% of their expenses) and as noted above they might no longer have expenses such as loan repayments and costs of raising children. Thus the expenses before tax as calculated in the above table could also be calculated as a percentage of their annual income, including employer contribution to retirement and medical funds. If, for example, this ratio is 60% then that can be applied to the ratio in the table, so 60% of 19.8 is 11.9 meaning assets should be this multiple of the annual salary. Thus the assets needed for retirement can be calculated in monetary terms or in relation to the final year's salary.
  * While the factors above were developed to determine what assets are needed when a person retires, they can also be used after a person retires, although at that time there is less scope for a person to make significant changes. For example, Person D's expenses might be R160 000 ten years after retirement. If their life expectancy is now 25 years and they have an unchanged expectation of returns on investments, their asset value should be around R2 851 000 (162 000 *17.6). If their asset value is below that it might indicate they should look to reduce their standard of living; alternatively they might have to accept additional risk by targeting higher performing assets. However, if their asset value exceeds this amount they could look to spoil themselves.
  * The factors can also be used to show the value of assets needed if the expected number of years in retirement is changed. For example, if Person B changes their life expectancy from 20 to 25 years the value of assets needed at retirement increases by 17% (factor increases from 15.0 to 17.6).
  * The factors can also be used to determine how long a person can afford to live in retirement. For example, if a person has assets of R10 million and expenses before tax of R800 000, this translates to a factor of 12.5 (10m / 800 000). Based on the above factors, the person should be able to live comfortably if the their life expectancy is 10 years, for 15 years but only if they expect returns of at least inflation plus 3% and for 20 years only if they expect returns of at least inflation plus 6%.

I thought it would also be useful to see what would happen if the expectations in table 14.14 actually occurred, although the changes of that occurring must be low. For this purpose I assumed the assets required for retirement in table 14.14 were adjusted to 100 to show the value of assets during retirement.

Table 14.15 – Value of assets during retirement

The above table shows the following:

  * In all cases the assets grow before they decline. In the case of Person A they grow by 8% over the first 6 years, while for Person B they only grow by just over 2% over 4 years, before they start declining, even though they have the same life expectancy. This is due to Person B expecting a lower return on assets. For longer life expectancies the assets need to grow more before they start declining; for Persons C and D they both grow about 46% but for Person C this takes 16 years, while for Person D this takes 19 years as a result of a longer life expectancy.
  * In all cases the assets run out when expected and so if the life expectancy increases over time there is likely to a problem, unless some other factors also change, such as return being better than expected or expenses being less than anticipated.

Annuities (continued)

As noted when introducing the formula above, it does not take into account the fact that a person might receive an annuity. In some cases receiving an annuity might have little or no effect. This is likely to occur when a living annuity is received. It could also apply in the case of a 'with profits' annuity as long as the person's life expectancy is much the same as that assumed by the insurer paying the annuity. It could also apply in the case of the other types of annuities, but only if certain conditions are met; namely that the person's life expectancy is much the same as that assumed by the insurer paying the annuity and the person assumes a return similar to that assumed by the insurer. When these conditions are met a person receiving a level annuity needs to be aware that in the early years of their annuity that the amount they receive should be more than their expenses and so they should invest this difference until it is needed when their expenses have increased with inflation to such an extent that they are more than their annuity.

Accordingly if a person believes they have a reasonable possibility of living longer than the insurer assumes for a person their age will live, they should seriously consider allowing the insurer to carry this risk rather than themselves. This is because if they are correct, they are likely to have little chance of being able to remedy this situation by themselves, when they realise this at an advanced age. They should consider doing this even if the annuity has a cost associated with it (namely the insurer's charge which includes a profit element for them) and well as having less to leave in a will.

Accordingly, in some cases the type of annuity received might have an impact on using the formula noted above, but before an alternate approach is considered for these cases, some more information on annuities needs to dealt with.

Life expectancies and annuity rates

I thought it would also be worthwhile comparing the above results to other information. For this purpose I obtained two pieces of information. The first was obtaining information from an actuary as to the life expectancies of individuals and the second was annuity rates.

The table below shows the life expectancies at different ages and shows that insurers assume females will live longer than males.

Table 14.16 – Life expectancies in years at various ages

It should be appreciated that these are averages and so some will be expected to live longer or shorter than these averages. A person's actual life span can be impacted by the following:

  * Hereditary factors where parents or family members seem to live for a long period or are prone to certain types of diseases
  * Lifestyle factors such as whether a person has a healthy lifestyle or not (e.g. heavy smoker or abuses alcohol)
  * On average females live longer than males.

In addition, healthy people with good genes can die young due to disease or injuries, while those with unhealthy lifestyles can defy odds and live to an old age. Accordingly knowing one's likely date of death cannot be projected with any degree of certainty, which is why a conservative approach to this should be taken, namely assuming one might longer live than indicated by the above table.

Obtaining information on annuity rates hasn't been easy over the years. I would have thought that insurers would make this information readily available as they encourage the population to save and prepare for retirement, but no, this isn't the case. One newspaper regularly provides annuity rates but this is only for males and females who are sixty receiving a level annuity, when I was wanting annuity rates for different ages and different types of annuities. I was eventually able to obtain much of what I was wanting but it needs to be appreciated that different insurers will offer different rates and that these rates will change as interest rates and market expectations change.

Table 14.17 – Examples of monthly annuity rates based on investment of R100 000

The above table shows approximately what insurers will offer to pay by way of a monthly annuity, before deducting tax for an investment of R100 000 based on different ages, different types of annuities and separately for males and females.

This table shows the following:

  * Annuity rates increase as a person gets older. This is to be expected as a person's expected lifespan decreases, the insurer will be expecting to pay over a shorter period and so can pay more per month.
  * The highest annuities are paid when there are the least number of conditions, namely when an annuity stops when a person dies and no annuity is paid to any surviving spouse. This also shows that males will be paid a higher annuity at the same age, because they have a lower expected lifespan than females.
  * When an annuity includes a provision for the surviving spouse to be paid an annuity then the annuity offered to a male is less than that of a female. This is probably because when a female dies there is less likelihood of a surviving spouse than when a male dies and so on average the total period of paying an annuity is longer when the annuity is initially paid to the male.
  * The various guarantees reduce an annuity. For example, for a female aged 60 with no guarantees she would receive R728 per month for a level annuity. This reduces to R711 per month if she wants to ensure an annuity is paid for at least 10 years (i.e. for the period between her death and the end of 10 years the annuity would be paid to her estate). If she also wants an annuity to be paid to her surviving spouse but at 75% of her annuity it reduces to R690 per month, or R683 per month if the surviving spouse receives an unchanged annuity. This means the lowest annuity is about 6% less than the highest annuity.
  * The biggest differences arise between the different types of annuity. Initially the highest annuities are paid for level annuities, but as noted above it means that in real terms which take inflation into account, they decrease in value over time.
  * If a person instead wants an annuity which increases over time, then this means they will receive less initially but more later on. For a male aged 60 receiving an annuity with no guarantees his monthly annuity will be 34% less if he wants to receive an annuity which increases by 5% each year or 49% if he wants an inflation linked annuity. For a female at the same age the percentages are 37% and 52% respectively. For a female aged 70 these percentages reduce to 31% and 38% respectively due to a shorter expected lifespan at that age. Thus a person needs to realise that if they want an increasing pension that this is significantly less than if they want a level annuity. This can make a level annuity attractive until a person realises the long term impact of their decision.
  * The second highest annuity is if a person wants a 'with profits' annuity where a person is prepared to share more risks with the insurer. As a result a person can expect their annuity to increase, but the increases can be less predictable as they are not linked to inflation but to market returns and thus the state of the economy can affect whether a person receives an increase and the extent of any increase.
  * One may well ask why an annuity with no guarantees is more than an annuity that is guaranteed for 10 years, when people aged 70 or less are expected to live more than 10 years. For example, a female aged 60 would be offered a level annuity of R728 for an annuity with no guarantees, but this drops to R711 per month if she wanted the annuity to be paid for at least 10 years. The reason for this is as follows – while on average a 60 year old female would be expected to live say 24 years the insurance company would expect a certain number to die each year both before and after the expected age of death of 84. If they take out of the calculations the amounts that they expect to pay for those expected to live less than 10 years and replace them with 10 year payments, then on an overall basis they will be paying more and so this would mean they would be prepared to pay less to each person. Accordingly the extra amount that needs to be paid would be taken from those who want the 10 year guarantee.

It is also worth considering what the annuity would be in the future. The table below takes the annuity amounts in the above table for a person who retires at the age of 60 with no guarantee or payments to a surviving spouse and projects what their annuities would be at different times in the future, taking into account what type of annuity is selected.

Table 14.18 – Future annuities

The following comments are noted in regard with this table:

  * With an annuity that increases by 5% a year it takes 9 years for it to be higher than a level annuity; for a 'with profits' annuity it could take about 8 years, but for an inflation linked annuity it could take 12 years.
  * After 20 years the annuity with a 5% increase and 'with profits' could be much the same, but for an inflation linked policy it is still less than these other two types of annuity.
  * For a male it would take about 26 years for an inflation linked annuity to exceed an annuity with a 5% increase, while for a female this would take about 28 years.
  * An inflation linked annuity could exceed a 'with profits' annuity after 24 years in the case of a male and 25 years in the case of a female.
  * While the projections for inflation linked and 'with profits' annuities are those projected when an annuity starts, these would change if the assumptions underlying these projections were different from the actual outcomes.

To show that annuity rates can change over time, given below are annuity rates that I noted from a newspaper at various stages for a level annuity based on a male aged 60 investing R100 000, guaranteed for 10 years.

Table 14.19 – Annuity rates over time

For the purpose of the above table the same insurer was used, but the rates between the various insurers can vary as well. For example, for the six insurers for whom quotes were included in the newspaper in November 2013 the rates varied from R725 to R797 per month. This compares with R766 in table 14.17 which is an average of a number of rates. Accordingly when one retires and which insurer is selected can make a difference in the annuity that will be received.

Now let's apply these tables to information used previously to see whether they come up with similar results:

  * Table 14.14 has two person expecting to live for 20 years, needing assets of R2 484 000 and R13 950 000 respectively.
  * Table 14.16 shows a female aged 65 is expected to live 20 years.
  * Table 14.17 shows the annuity rate for an inflation linked annuity for a 65 year old female with no guarantees is R406 per month or R4 872 per annum.
  * Applying this last mentioned amount to the assets needed for retirement translates into annual annuity amounts of R121 000 (4 872/100 000 * 2 484 000) and R679 600 respectively (4 872/100 000 * 13 950 000).
  * If the person was a male instead the amounts would be R144 900 and R813 600 respectively, but as table 14.16 indicates the average male is expected to live less than 20 years.
  * If a 'with profits' annuity was taken by the female instead the annual annuity would be R169 600 and R954 200 respectively, based on a monthly annuity amount of R570. This amount of R954 200 exceeds the expected expenses of R930 000 mentioned in table 14.14, but the R169 600 is less than the R210 500 for the other person as a result of expecting a higher return on assets. This shows that the tables give approximate, not precise, amounts needed for retirement.

If however a more conservative approach is taken and a higher level of assets had been achieved as indicated in italics in table 14.14, then the annual annuity for a female aged 65 will be R205 100 (instead of R169 600 above) if an inflation linked pension was acquired for person A and R906 200 (vs R954 200) for person B, using the factor of R406 p.m. instead of R570 p.m. per table 14.17. These amounts would be R288 000 and R1 272 250 respectively if a 'with profits' annuity is acquired, which uses the higher assets and the factor of R570 p.m. again. This shows that if actual returns differ from expected returns that this can impact considerably on the assets available for retirement and the annuity payment is further impacted by the type of annuity selected.

Revised formula for certain types of annuities

Does this mean the formula used above to determine the assets required for retirement is not reliable because in some cases the annuity would be less than the projected expenses? I would say that the formula above is most appropriate when a person acquires a living annuity or has non retirement fund investments that are to be used for retirement. As mentioned above many are taking a living annuity today.

In the case of a person taking out a fixed, inflation linked or with profits annuity, then as noted in table 14.17 some of these come with guarantees from insurers. These guarantees come with an associated cost that is built into the annuity rates and this means that higher assets will be required. In this case the factor 'F' in the table should be changed to a factor based on table 14.17, instead of those given in table 14.13.

Table 14.20 – Assets needed for annuity with fixed increase, inflation linked increase and with profits annuity

For person A and C the assets needed are in between the two amounts shown in table 14.14 (namely R2.48m and R4.21m for person A and R5.05m and R10.59m for person B), but closer to the lower amounts, even though the amounts are not directly comparable. This is better illustrated for person D where the assets required are less than that given in table 14.14 of R2.17m. This is due to the person's age being 70, whereas in table 14.14 the person had 35 years of retirement. It is for this reason (i.e. age vs years in retirement) that the assets in this table are not directly comparable with those given in table 14.14. This is because it is not clear what life expectancy the insurers assume in their annuity calculations. Regarding person B the assets required are an indication that an inflation linked annuity can be costly in requiring substantial more assets than the higher assets of R18.6m in table 14.14.

The above table assumes that a person invests all their retirement assets into an annuity, when the reality is that a person may not wish to do this; instead they may have more than one type of annuity and may prefer to keep some of their own investments. In addition, in the case of a pension fund a person might not be told the value of their pension and furthermore may have less flexibility as to the type of pension they might receive. For example, they may receive a pension which doesn't increase in line with inflation, but, say, at 75% of the inflation rate subject to the pension being solvent.

As this complicates things the calculations themselves can become more complicated.

The first consideration is whether the annuity from a pension fund will be sufficient to cover future expenses. Following the formula above the projected expenses before tax at retirement can be calculated. Annuities from a pension fund, as noted above, are often based on years of service and final salary (say the average over the last three years before retirement). Accordingly the person should be able of determining the relevant factors from the pension fund rules which they should have been given a copy of. They then need to estimate the amount of the pension, taking into account their present salary and expected increases until retirement.

For example, the person might be earning R200 000 p.a. and is due to retire in five years' time by which time they will have 35 years of service with their employee. If they expect an increase of 5% p.a. until retirement and their pension will be 2% for every year of service based on their final salary , they can expect a pension of R178 675 p.a.(255 250 *2%*35). If this pension is expected to increase in line with inflation then if their expected expenses before tax are less than this amount, then their pension should be sufficient for retirement.

If the pension is not sufficient then the person needs other assets to fund retirement, but how much? Let's assume the same facts in the previous paragraph above but the person's expenses before tax is expected to the R250 000. In this case there is a shortfall of R71 325 p.a. (250 000 – 178 675). The factors in table 14.13 can then be applied to this shortfall, instead of the expenses before tax as used in table 14.14, to determine the amount needed outside the pension fund. If this was person A in table 14.14 a factor of 11.8 would be used to arrive at an amount of R842 000 (71 325 * 11.8).

If, however, the pension will not increase, then another approach is needed. One approach is to take the amount arrived at in table 14.14 and then deduct an amount based on table 14.17. For example, if a person expects a pension of R750 000 p.a. which is not expected to increase thereafter and which will to be paid to her husband if she was to die before him, but at 75% of her pension, then if the person is a female aged 65 the factor for a level pension would be about 729 (although this factor is not given in table 14.17). Based on this the value of the pension is about R8 573 000 (750 000/(729*12)*100000) . If this is person B in table 14.14 who needs assets of R13 950 000, then they need assets of R5 377 000 (13 950 000 – 8 573 000) for retirement in addition to their pension fund. In comparison, if person B's pension was to increase instead by inflation then the amount need would be R2 700 000 (13 950 000 * (930 000 – 750 000)/930 000), a lower amount as would be expected.

If the pension was instead to increase by, say, 75% of the inflation rate, then a similar approach to that outlined in the previous paragraph could be carried out, but the factor to be used will have to be estimated as table 14.17 does not include such possibilities. For example, for a male aged 60 with no guarantee or spouse the factor is 809 for a level pension and 416 for an increase in line inflation. Accordingly for an increase of 75% of inflation the rate might be around 514 (809 – 75% of (809 -416)).

As can now be appreciated calculating assets needed for retirement is not easy and even after retirement the assumptions made about retirement are likely to be different from projections. Nevertheless this doesn't mean efforts should not be made, even if the end result is not as precise as some might like.

Progress with obtaining required assets

The next issue for consideration is progress on obtaining the required assets during one's working life.

One way to do this is to project the assets using the formula below. A financial calculator or spreadsheet can also be used if a person wants to use additional assumptions not catered for below.

Projected expected assets = projected existing assets + projected assets from future contributions

Projected existing assets = a*((i+e)/100+1)^y

Where

  * a = current existing assets
  * i = expected inflation rate
  * e = the expected rate of return in excess of the inflation rate
  * y = number of years to retirement

Projected assets from future contributions = (c*y)*((i+e)/100+1)^(y/2)*f

Where

  * c = existing annual contribution
  * f= factor per table 14.20 (this accounts for the compounding effect of contributions increasing as salaries increase)

Table 14.21 – Adjustment factor for increasing contributions

Table 14.22 – Projected assets at retirement

This table shows that if a person who has 40 years to retire and is currently starting to contribute to a retirement fund amounting to R50 000 per annum (R4 167 per month, suggesting a monthly income of about R28 000) and they expect inflation to increase by about 5% p.a. while their contributions will increase at a higher rate of 7% due to expected promotions and returns to grow at the inflation rate plus 3%, that their projected assets at retirement will be about R35 million. While this sounds a large amount, if this person was a male who retired at 65 and purchased a 'with profits' annuity with no guarantees they would receive a monthly annuity of R235 100; at a 5% inflation rate this translates to R 33 250 per month in current terms which is a more reasonable amount when compared with the current salary – but with promotions the final salary amount is likely to be close to R60 000 in current terms.

Shortfall in assets

If the above calculations show that it is likely that insufficient assets will be held at retirement then this indicates that extra contributions will be necessary until retirement; alternatively the likely date of retirement can be changed to see if this 'solves' the problem. These extra investments might be contributions to a retirement annuity fund or other types of investments, such as unit trusts. The amount of the expected shortfall can be taken as a percentage of the revised projected assets from annual contributions to determine the amount of contribution required. For example, using information in table 14.22, if the person in the second column projected that they needed assets of R8 million, they have a shortfall of about R0.95 million. This amount is about 25% of their projected assets from annual contributions of R3.7 million. Applying this % to the annual contribution of R40 000 means they need to contribute about another R10 000 p.a. for retirement, with this increasing to the same extent each year as they expect their salary to increase.

Use of models over time

As noted earlier I developed a number of models over the years to assess how long I can afford to live after retirement:

  * The first one was similar to the model explained above; it took my then value of retirement investments, my then current contributions, the growth in contributions which was also the investment return and increase in expenses after retirement, my current age and date of intended retirement and the tax rate on income after retirement. The last piece of information was when I could expect to die and it then showed what income I had available for expenses each year after retirement. Unfortunately it didn't tell me what that income was in terms of the value at the time I did the calculation, so the amount was interesting and not particularly valuable. Looking back on this model about 15 years later it was indicating that my income would in real terms be about 20% of my projected income at retirement, which was woefully inadequate although I didn't realise it at the time. This model, which was included in a financial package I had wasn't able to have an investment return that differed from the rate at which my contributions grew.
  * A number of years later I developed my own model. It compared my current level of expenses with a level annuity using my retirement assets at that time less tax. This showed a surplus which I knew was necessary because of the impact of inflation over time on a level annuity. At the same time I did the same exercise projecting expenses and retirement assets to my expected date of retirement. This showed I couldn't afford to live beyond 80, which was a concern as both my parents and all my grandmothers reached 80 years of age. This took into account that in the early years of retirement the level annuity would be more than I needed for my expenses and so I could invest this surplus until I needed it.
  * I then revisited this model each year. I then realised I had incorrectly calculated tax and after adjusting for this it appeared I could live into my 80s.
  * The next major change was to change the calculations from using a level annuity to a living annuity, so that income would be expected to increase each year instead of staying at the same level.
  * My last major adjustment to my model was when I realised that not all my retirement assets would be needed at retirement and that some could be used at a later date. For example, an annuity from a retirement annuity fund doesn't need to be taken at retirement, but can be delayed to a later date, but no longer than 70. It was at that point that I stumbled across what seems to me to be a smart tax strategy that I don't recall hearing about previously. We will come back to this below.

The approaches outlined above can be used by many people, but for those with more complicated finances they will need to develop their own spreadsheet model. A self-developed model can make allowances for the following:

  * Some income may start or end at different dates. For example, a person may work part time until becoming fully retired or may take a retirement annuity starting after retirement
  * Expenses may have different patterns. For example some costs such as medical aid costs are likely to increase at a rate that exceeds CPI, while other costs might diminish over time (e.g. a car might be dispensed with at some future date). In addition, costs might change as a result of moving from one's own home to an old age home. The amount needed by each spouse can also change over time as well. If a person has dependents such as children, siblings or even parents the costs associated with them could reduce over time (or even increase if, for example, a child or sibling has disabilities). As mentioned above with medical costs increasing at a rate that exceeds CPI, a separate investment might be kept for these costs and so medical costs may be dealt with separately in a financial model.
  * As noted in the section on taxes as people age they have additional abatements or allowances for medical expenses and so these can be used to project future taxes more accurately.
  * Some assets held to fund retirement might be held offshore and so these might have to be considered separately from other assets. In addition assets might change, for example, a person might have a house which is rented which could be sold at a later date. This also means that different types of investments might be expected to achieve different returns.
  * In addition projected income might change if a person expects to start retirement with a living annuity and change to another type of annuity at a later stage.

Such a model might be done for each year or for a group of years. A model can also possibly be used to do other calculations, such as the following:

  * Based on my assumptions when is it projected that I will run out of assets?
  * If this date is before when I expect to die to what extent do I need to reconsider my expected expenses and standard of living?
  * Can I afford to live to a specified date?
  * Based on when I can be expected to die, what amount can I afford to spend each year?

It should be appreciated that having sufficient funds in retirement is based on a number of variables, such as length of retirement (which itself is based on when a person is expected to retire and when to die), expected expenses, the inflation rate, expected assets at retirement and the return on investments. While date of retirement and assets at retirement is known at that date, the other variables remain throughout retirement and so as indicated above a conservative approach should be taken in estimating these to reduce the risk of assets being extinguished before one dies, particularly as one has little ability to affect these variables.

Using tax to enhance pensions

Let's look at the tax strategy I referred to above. The question is this – if I have both retirement funds and investments which I can use to fund my retirement, should I have a preference as to which funds I use? If I use retirement funds for an annuity then that annuity is taxed as normal income. However if I realise some of my investments, I have already paid the tax (e.g. interest bearing investment) or I pay tax at a CGT rate, which is not only 1/3 of the normal tax rate, but is only paid on the gain on disposal and not the whole proceeds. For example, if my expenses are R200 000 per year and I took R235 000 out of a living annuity this would translate to about R200 000 after tax. If however I sold some unit trust for R200 000 I might not have to pay any tax at all. If those units cost R100 000 I would have made a profit of R100 000 and the first R30 000 is not taxable and so I would only be taxed on 1/3 of R70 000, namely R23 300 and this is below the level at which I pay tax. Even if the gain was R200 000 this would still be below the level at which I would be required to pay tax.

So if I can use less of my assets (namely selling investments for R200 000 instead of taking an annuity of R230 000) and end up in the same position after tax (namely R200 000), shouldn't I follow that approach? Accordingly my tax strategy is to initially use as little of my retirement funds as possible and to use investments to fund the rest of my retirement expenses. This means that I intend to take the minimum possible as a living annuity from my provident fund, and then to delay using my retirement annuity funds until I am 70. This also means that hopefully my provident fund should show healthy growth when I have a greater need for it.

This comes to the last topic to be dwelt with under retirement funding, namely the impact of tax on funds when a person has the ability to influence the timing of tax. For example, upon retirement from a provident fund a person could take an annuity and pay tax on that annuity on a monthly basis or could take the whole lump sum, pay tax, and then purchase an annuity from an insurer, which would be partly taxed.

Table 14.23 – Alternate uses of funds

This table shows in this example that if the person pays tax up front by taking the whole amount as a lump sum, which is then used to purchase an annuity, then the resulting annuity after tax is less than if the whole amount was used to acquire an annuity. In this case no tax is payable on the purchased annuity as it is assumed that about 75% of the annuity is a refund of capital and so the portion taxable is about 25%, namely R60 500, which is just below the level at which tax becomes payable.

As noted above the first R500 000 of a lump sum is tax free and so it might be thought that by forgoing this amount by not taking a lump sum it would be disadvantageous from a tax perspective, but it also needs to be appreciated that presently the first R70 700 of income in any year is not taxable.

A better approach would be to take some of the amount in the provident fund as a lump sum and acquire an annuity as shown in the examples below, which uses the same information as used in table 14.23 except for the amount of the lump sum. Tax is based on rates applicable to the year to 28 February 2015.

Table 14.24 – Example of different combinations of annuities

This table shows that initially as lump sums are taken that income after tax grows, but after a lump sum of R1 050 000 it starts to reduce. The exact maximum optimal lump sum from a tax perspective will depend on a person's tax position, as the amount will change depending on the amount of the funds in the retirement funds and other investments.

Conclusion

This chapter shows that the issue of having adequate retirement funds can be fairly complex and that a person could benefit from making efforts to understand some of the financial principles relating to retirement and the earlier this is done in a person's working life the better.

### Chapter 15 **– Giving**

I am probably in the minority on this, but I don't think our constitution in South Africa is as great as politicians and lawyers in particular make it out to be me (and they do so because it suits their causes). The constitution, with its focus on rights, can make people focus on their rights. This can lead them to have an entitlement mentality and because self-absorbed. A constitution which promotes selfishness is not one I admire.

Rights vs. obligations

While there is a place for considering rights, our country can only become better if each of us considers what responsibilities we have. If we all expect others to do what we want, who is going to do the actual work? Is it right to expect the state to look after our health and to provide a pension, when we could do something about that ourselves?

A focus on our needs can blind us to the needs of others. If we have some knowledge of the needs of others then we might realise that even if we have to face difficulties, there are others who face worse issues than we do. While for some people problems could be because of their own decisions, for others life has been cruel to them. This could be because they have disabilities or abnormalities they were born with, injuries obtained from accidents or lack of opportunities from parents who were unable to provide them or because of their unwise decisions.

The case for giving

Are we just thankful that we don't have these circumstances to deal with and then crowd out those thoughts with our own concerns, or do we wash our hands of this saying that is what the government should be dealing with? It is a reality of life that the government is not able to deal with all these issues and allows charities and non-governmental organisations to deal with some of these issues, even if they don't provide much financial support.

Some problems faced occur throughout the different strata of society. You can suffer from cancer or be blind whether you are rich or poor; the same applies to those injured in accidents. For families of those affected this can be a large burden, not just financially, but also in other ways. Some help can be obtained from those able to fund research to find cures or remedies, but for others it could be giving of their time to care for those in need.

Accordingly, I believe we should all be grateful for what we have and look to assist with the needs of others on the basis that we are likely to be far better off than many others. I don't know how true it is, but one website I visited recently said if I was earning R14 000 a month that I would be in the top 1% worldwide, based on earnings, and that was what about 200 doctors collectively earn in Malawi.

The art of giving

This gratefulness should translate to giving of time and/or money. For some they only give monetarily if they have amounts over at the end of the month and then this might only be small change.

If a person wants to give of their time, it is unlikely that opportunities will come to them; they need to look for them. While some might say they don't see opportunities for service, how hard are they looking? The same applies to those who say they don't have the time; is this because they only have time for friends and parties?

If people don't want to give they will find an excuse that their conscience can live with.

I think giving needs to be a conscious decision. It is easy to find reasons to spend money on oneself instead of others; it is similar to the saying that work expands to the time allotted to it; spending expands to the money allotted to it.

Like successful savings giving needs to be a specified amount or proportion that is not easily avoided. If I find a reason not to contribute an amount this month, it is easier to find a reason not to contribute an amount the following month. I did this by including giving in my budgets and ensuring my standard of living took into account the amount I thought appropriate to give. If I received an increase or bonus part of this was given away as well.

As indicated in section 7 dealing with expenditure, table 7.2 doesn't show giving, but it is included in the total expenditure in included in table 7.1. Giving was an expense even in those years when expenses exceeded income. To give a reasonable amount consistently requires a conscious decision and discipline.

The amount to be given and who to is for each person to decide. The same applies to whether the amounts are given to one or more organisations. Obviously it can make sense to contribute to those organisations a person has some connection with. This can for example be a church you attend, a cancer association if a family member has suffered from cancer or an organisation you pass by regularly. For some donations to public benefit organisations a tax deduction can be claimed of up to 10% of taxable income before medical aid deductions as noted in section 13 above.

Lotteries

Some might argue that they donate by way of buying lottery tickets. If this is the case this is a very inefficient way of donating. Which is better – giving R100 to my chosen charity now, or pay R100 now for about R30 to be given to some charities I have never hear of about a year later? Why effectively pay someone R70 to donate R30 so much later?

Some would argue that they buy lottery tickets with a dual purpose, namely to donate money and have the chance of winning amounts. While the reality of this first purpose can be challenged, the reality of the second purpose is that as the bumper sticker says – The lottery is a tax on people who are bad at math. There is a higher chance of a person being struck by lightning than winning the jackpot prize in a lottery.

It seems that many of the poor, who can least afford it, are the biggest buyers of lottery tickets. The problem is that even if they did win the lottery they are highly unlikely to be able to properly manage their sudden wealth and the 'friends' such a win seems to attract. While the lottery operator is aware of this, the real question is does the win make them happy other than in the short term? I read a quote recently from a study which stated that six months after winning the lottery that the winner is likely to be no happier than if they had been paralyzed in a car crash. Perhaps it is a case of beware of what you wish for.

I also believe we should be working to accumulate assets rather than relying on chance. As we slowly accumulate assets from working, we are able to learn to make changes over time and so are more likely to be able to handle large amounts than if it was suddenly thrust upon us. In addition, why pay out amounts when the likely returns are so low and when for the vast majority of those who buy lottery tickets they would be better off investing the same amount each month into a savings account or investment? In a lottery a lucky few are being subsidised by the majority who spend money without receiving a return, hence the comment that a lottery is a form of tax which can be avoided, but many choose not to avoid to their own detriment.

Giving after death

Some might prefer to donate amounts after they die. While this is acceptable, I would question this if the person wasn't giving during their life – isn't it just another form of giving but only after one's needs are satisfied? If we are seeing needs now, why not contribute to them now rather than many years in the future when needs might have changed?

Why not give when you can, instead of when you must? Isn't it better to be known as generous in life rather than generous in death?

As noted in the previous section on retirement funding some annuities stop when people die and no amount is included in their estate. This does not relate to living annuities, annuities with a guaranteed minimum payment period (e.g. 10 years) and that minimum period has not been completed; in addition if an annuity continues to be paid to a remaining spouse then that will continue to be paid until the remaining spouse dies.

Leaving assets to family members

Some will want to leave amounts for family members and again while there is a place for that I question whether it is always necessary. If a person works in a family business or on a family farm it makes sense for the business or farm to be left to them as they might not be able to afford to them if the owner died. In addition, if a person has a child or grandchild with costly special needs then it is appropriate to consider leaving funds to finance this. However, if I am approaching retirement and I expect to have sufficient funds for retirement and my parents are still alive do I need their assets when they die? Probably not. In that case shouldn't the parents be looking to bequeath their assets to those who are in need?

Leaving assets to family members can sometimes be a curse. It can lead to disputes and squabbles resulting in family members not talking to each other. Some might want to rule from the grave, when this is not appropriate – is it a case of not being willing to give in both life and death? Some family members can't manage their finances responsibly and so giving them amounts is like casting pearls before swine.

Even some of the richest people in the world have warned about giving wealth to family members:

  * The almighty dollar bequeathed to a child is an almighty curse. No man has the right to handicap his son with such a burden as great wealth. He must face this question squarely: Will my fortune be safe with my boy and will my boy be safe with my fortune? – Andrew Carnegie
  * Inherited wealth is as certain death to ambition as cocaine to morality – Cornelius Vanderbilt
  * Fortunes tend to self-destruct by destroying those who inherit them – Henry Ford

Having a will

If a person looks like they might die with substantial assets they could give some of it away to worthy causes before they die or nominate worthy causes in their will. Having a will is important to ensure assets go to whom it is intended. The less the assets there are in an estate I suspect the less the surviving family members are likely to bicker about whom gets what assets. If no will is left then the assets will be split between the surviving spouse and children, in terms of the laws of intestate succession.

If a person dies without a will and leaves a child then the assets to be given to that child are given to the state run Guardian's Fund until the child reaches maturity. The return on such funds might be less than if they were looked after by a trustee and so is again a reason why a person should have their own will.

Conclusion

There is also the option of going on ski-ing (spending kids inheritance) holidays in order reduce assets.

As noted in the section on taxes above, taxes are payable when a person dies, but some of this can be avoided by donations to certain bodies or a spouse. In addition, trusts can be used to manage taxes, but this is beyond the scope of this book because as noted at the beginning of this book few are likely to have sufficient funds to retire comfortably, meaning even less are likely to have significant assets when they die; and if they do they can afford to obtain the necessary advice.

While some might accept much of what I have said in this book, the subject of giving is one where they might be less inclined to follow my suggestions. While I would like them to do so, the best I can ask it that they seriously consider their role in society – will society have benefited from what they have contributed while they are living, even if the giving is done anonymously, or was it all about how they benefited? 

### Chapter 16 **– Other issues**

This section covers a few remaining areas that can be considered when looking at finances.

Holidays

It is acknowledged that breaks from work can be helpful, whether for a few minutes or a few weeks.

Even taking a lunch break can be useful. On a number of occasions while my mind was thinking of other things during lunch time, a solution popped into my head relating to a problem I had been dealing with before lunch, even though I wasn't consciously thinking about it.

Sleep is about rejuvenating our body and holidays do the same. A few might think they are dispensable, when this illusion is only in their own minds. Some might work seven days a week without a break to their own detriment – it might affect their health or the relationships with their families. What is the point of spending so much time at work, if later in life they don't have family members who want to spend time with them?

Accordingly, holidays are something that all should be planning to take. For some their holiday dates may be specified, such as when their factory or office closes over the holiday period. Others might in theory be more flexible, but the reality is that there is little flexibility due to children being at school. This can impact on the cost of a holiday as they are more expensive during school holidays.

The type and length of a holiday should take one's financial situation into account:

  * A person could have a holiday at home, where different activities from the normal activities are done. This should involve other family members, including activities and outings that other family members would enjoy; ideally these should be discussed as a family and not just the decision of one person
  * Other cheaper holidays can include camping or caravanning holidays, which could mean longer holidays are taken
  * Staying at a bed-and-breakfast or a self-catering place is also something that can be considered. Sharing costs by going to a place with another family is also something that could be done.
  * Staying with family in another town or city is also a possibility, but is probably best avoided if family relationships could suffer as a consequence 
  * Having a holiday in a hotel should only be considered by those who are able to afford it
  * An overseas holiday can also be considered. The costs of some overseas locations are quite reasonable when considering the flight and hotel costs
  * Boat cruises have become popular in recent years. They are often reasonably priced and have the benefit of offering not just travelling from one port to another, but also accommodation and meals, making it an easier way to travel to the various destinations than if flights and hotels were used instead.

Some will take only one holiday a year, while others might take more including some weekend or long weekend breaks. Some want to go to one place on holiday and stay there for the duration of a holiday, while others want to travel to a number of places, which can include game reserves. There is a place for all of these as people have different views on how to best enjoy a holiday. Tensions can arise if family members have different preferences and so some compromises may be necessary when planning a holiday.

Timeshare

Being a member of a timeshare is also a possibility for holidays, which has it pros and cons. It can have the benefit of ensuring you have a place to stay while being on holiday, also that a holiday is taken to ensure the levy is not a wasted cost. Being a member of a timeshare organisation can also be helpful in finding accommodation when wanting to visit another part of the country or when going overseas on holiday.

It seems that timeshares are being less aggressively sold than previously. They were often sold on the basis that they were an investment and helped to fix the cost of a holiday. The reality seems to be different. It seems it is not easy to sell timeshare weeks and that prices offered are generally less than the cost of the original investment. We bought a timeshare week from a widow whose family didn't want to continue having the timeshare at a significant discount to the price that unsold weeks were being marketed for at the time.

The levy for this timeshare has increased on average by 10% p.a. over the 17 years we have had the timeshare, while over that period CPI has increased on average by 6% p.a.

Some change their timeshare from a week in a specific resort to a membership of a timeshare association so that they can have holidays in different resorts. This has the benefit of allowing them to see different parts of the country instead of just one part of the country, However, it seems that this can be a disappointment in that it can be difficult to find an available week when wanted in some possible resorts. These people can be resentful if they have paid a levy but are not able to take a suitable holiday.

I remember being invited to attend a timeshare presentation while being on holiday once only to be surprised at the low price, but then realised that the timeshare was on leasehold land and the timeshare would stop when the lease of the land came to an end, which wasn't mentioned by the marketing people.

I suspect that some just abandon their timeshare to avoid paying levies when they are not able to sell their timeshare. Accordingly a person needs to be aware of this if considering buying a timeshare.

Loyalty cards and coupons

If your spouse was to say to you after returning from the shops – I just saved a massive R300 by buying an item, how would you respond? Do you say show me the money you saved? If the item was going to be bought in any event then you might have spent R300 less than expected, but if the item was only bought because of the discount then money has been spent not saved.

Loyalty cards are best used when you were going to spend the amount anyway and not just to get the benefits from using a loyalty card.

Loyalty cards can work in a number of ways. They can give you air miles which can be used to obtain air tickets, be used to upgrade the class of air tickets, they can be used to get discounts for future purchases of items or be deducted from the cost of future purchases. There are also cards that allow the benefit of using the card to go to a charity or school. The points gained from using the card can also possibly be exchanged to acquire a range of available items.

Some of these cards have the benefit of being issued for free, so you lose out if you don't obtain a card.

With the number of possible loyalty schemes it can become confusing to know what card to use when, as well as trying to keep track of what cards you have, where they are if you have a number of such cards and what benefits are available.

The schemes don't always work out as expected. When I obtained a loyalty card recently I soon found out that the benefits were not as great as I expected as a result of not appreciating some of the conditions attached to the scheme. A number of people have tried to use air miles only to find that no flights were available when they wanted to use them, or that they needed to use more air miles than expected. I have encountered times when no flights were available, but this seems to be at times that are popular for flying. Another time, the only way I could use air miles was to fly via another city instead of a direct flight resulting in the time from departure from where I stay to my ultimate destination more than doubling. Air miles can also expire if not used. Some have used unwanted miles positively by allowing others to use these miles.

Although there can be these type of issues, there can still be merit in having these cards and being members of such schemes and so they shouldn't be ignored as a way of saving money.

Coupons can also be used to save money. These might be offered in newspapers, magazines or on the internet. Again they can come with conditions as to when they can be used, the number of items that can be purchased and might be limited to what they have available. They can also be used to save money if the items were going to be bought in any event, but not if they are only used to obtain a discount, because in this case it isn't a saving at all.

For those who have reached retirement there can be additional discounts available. Some stores give pensioners discounts if they buy items on certain days of the week. This is an area where I have still to find out what else might be available. I recently went up a cable car only to be asked for my identity number; I thought it might have to do with security for using the cable car only to find that the attendant returned some money I had given him as I qualified for a lower fee because of my age. In addition some banks offer higher interest rates for senior citizens.

Thus loyalty cards and coupons have a legitimate place in managing one's finances.

Sureties

When banks and other providers of credit give credit to customers they might want some form of security to ensure they get their money back. If you buy a house the security is in the form of a mortgage bond, but even then the bank might require the person to also take out life insurance. If you buy a car it would normally be offered as security for the loan, as well as the bank requiring insurance should the car be damaged or stolen.

For other loans people might offer other assets as security, such as investments. If a person has a limited amount of assets to offer as security, then the only way they might be able to obtain a loan is if another person stands surety. For example, a person might need a loan to start a business and get a friend to say they will repay the amount owing if the person starting the business is unable to do so.

Providing surety is something that should be avoided as far as possible. History shows that most businesses fail within a few years of commencement and so providing surety to a start-up business means there could be a high likelihood of being asked to pay amounts owing. Beware of being persuaded that the business can't fail, or thinking that this is necessary to retain friends and is low risk.

When providing surety you should know how you would be able to pay the amount owing if called upon to do so. Don't think the credit provider will only approach you when all other avenues to recover the amount have failed; you could be the first port of call when scheduled payments are missed.

If a person is going to provide surety it should only be to assist a close family member such as a parent or child to buy an asset such as a home or motor vehicle. This might be necessary to help parents move into an old age home while they sell their existing home, or helping a child become financially independent. Even then it should only be provided if the risk of being called upon to pay amounts in terms of the surety is low. If a child is financially irresponsible and could skip payments without appearing guilty, because they know mom and dad will pick up behind them, then that is not a situation when a surety should be provided.

Managing finances as a couple

Ironically this last section has the potential to be one of the most difficult to deal with. Finances could be a major cause of friction between a couple and so if they are wise they should discuss this before marriage.

When a couple get married they might just assume that things are going to work in the same way as they saw it occur between their parents, particularly in areas where there wasn't friction. For areas where there was friction between parents they might consciously decide to adopt a different approach or might even just think that is how it is.

Accordingly spouses might come into a marriage just assuming things are going to happen in a certain way only to find that their spouse has a similar view, but where the approaches are different. For example, some couples might have separate finances, while other couples might operate on the basis that the husband gives the wife an allowance each month.

It is for this reason that a couple should agree upon an approach they are comfortable with. There are different possible approaches but that doesn't make them right or wrong. Some couples have a joint bank account into which their income is deposited and expenses are paid. This can work and can save bank charges. Where this can become problematic is where the joint bank account is in the name of one spouse and the other spouse feels disenfranchised financially. In addition, there can be problems if the other spouse is due to receive an amount and the person who is to deposit the amount will only deposit it into a bank account with the other spouse's name on it. To overcome these concerns, a savings account could be opened in the name of the other spouse to give that spouse some financial independence where this is necessary.

Other couples might have separate bank accounts. They could agree that one spouse would pay certain expenses while the other spouse pays other expenses. There are other alternatives that could be agreed upon. If one spouse pays all the accounts then the other spouse could transfer an amount from their bank account to the other spouse's bank account to help fund the payments. Alternatively one spouse could pay the accounts other than monthly debit orders one month and the other spouse the next month.

If only one spouse is working, then having separate bank accounts can still work, but the couple might decide this is not necessary. For example, the working spouse could transfer an amount to the other spouse's bank account so that they have funds necessary to run the home while the other spouse is out working. Alternatively, the working spouse can give the other spouse an allowance for the costs of running the home. It might be better if the working spouse gave the other spouse a debit and credit card so that the other spouse has access to funds when needed.

While banking arrangements can be important to a couple, their attitude towards finances can be a bigger issue. One spouse could be a spendthrift while the other is miserly; in this case this is likely to cause friction. One spouse might expect their spouse to be miserly, but feel no guilt spending large amounts on themselves. A spouse might not fully trust their spouse on financial issues and so hide some of their finances. These are the types of issues which could lead to divorce if not dealt with.

Accordingly a couple should be discussing their approach to finances and how they will manage finances before they are married. 

### Chapter 17 **– Reflections**

Before I reflect on the overall contents of this book I stated in section 1 of this book that one of the objectives in writing this book was to learn some things. The following is among the areas where I have learnt while writing this book:

  * In section 5 on the consumer price index I eventually carried out an exercise I have wanted to do for some time, namely comparing the weighting of my expenses with the CPI weightings. This showed that while some variances could be explained, the fact that the highest quintile starts at about R142 000 a year means that for those whose expenses are substantially more than this their average weightings are likely to differ from those published for this quintile as a result of it covering such a wide range of expenditure. A person spending R1 million a year is likely to have a different pattern for expenses from a person spending R150 000 a year. I also now have a better understanding of how the cost of housing is included in the CPI which unfortunately is based on a theoretical amount (namely what the accommodation could be rented to a third party for) and not on actual costs.
  * In looking at my expenses in section 7 supplemented by further analysis in chapters 10 on children and 12 on insurance I have looked at the 'shape' of my expenses. While I previously had the amounts available, including the amounts in graphs has led me to have a better understanding of how expenses change over time. I hadn't fully appreciated that expenses on children had increased so much from high school years onwards (and that the cost of post school education was a lesser cause than expected) and that the cost of the various types of insurance was as high as it was. In addition, in some years interest was a larger portion of expenses than I had realised.
  * In section 11 on investing while I had known how prices had changed over time, looking at whether the increases in prices had exceeded inflation and working out the actual returns was interesting new information for me. Having information on actual returns helps to determine whether returns projected for retirement are realistic or not. I also learnt what impact the costs of investing in unit trusts had on the value of investments over a long term when looking at the impact of costs on the reduction in yield on investments.
  * In section 14 on retirement funding I had an idea of how to determine the level of assets needed for retirement. While my idea seemed to work I realised it needed to be adjusted for those who intend to fund their retirement through fixed increase, inflation linked or 'with profits' annuities. In addition, while I previously had a limited knowledge of annuity rates, obtaining annuity rates for different types of annuities, with different types of guarantees for different ages and sexes has been illuminating. I now have a better idea of the cost of the guarantees, but this wasn't without some surprises. With females normally living longer than males I expected their annuity rates to always be lower than that of males, but this is not always the case. I now understand why there is a difference between annuity rates with a guaranteed minimum period of 10 years from an annuity rate for a person who is expected to live longer than 10 years. In addition, it seems it takes longer than I expected for an inflation linked annuity to exceed an annuity that has a fixed increase or is a 'with profits' annuity.

Initially I thought each section could be a stand-alone section but I soon realised that they were interlinked:

  * The section on the use of graphs and data (section 2) was important in that the book contains a number of graphs to help explain its message.
  * Chapter 3 on compound interest was important in understanding how it can be both a benefit and a curse. Its application when credit is obtained (section 8) helps explain why some battle for long periods to overcome problems with credit, while in sections 11 and 14 it is the magic ingredient to help people retire comfortably financially.
  * Chapter 6 promotes the use of budgets in managing one's expenses, but this can only be done effectively if a person knows what they spend money on, which is covered in section 7. In addition knowing the weighting of expenses included in the CPI as outlined in section 5 is useful in this regard.
  * In section 7 which looks at actual expenses, some of this is considered in more detail in sections 10 and 12 which considers finances relating to children and insurance respectively. Chapter 13 also discusses one of the biggest categories of expenses, namely taxes, while section 14 discusses whether giving should be part of our expenses.

Chapter 2 on graphs and the use of data shows that while they can be used to present pictures that help to understand information, how they are presented can potentially produce misleading understandings. They can be helpful in understanding changes over time and can also be used to compare items, but sometimes the starting point, the scales used and physical size of the graphs could present different pictures if any of these elements were changed. Accordingly, when reading graphs and tables these elements should not be ignored as being irrelevant.

Compound interest is a very powerful force and can be used to either increase debts or increase our assets. Chapter 3 shows the longer compound interest is left to have an impact, the greater the impact it has. It is for this reason why it needs to be exploited in building assets for retirement.

Having the right attitude towards finances is critical to financial success. It is for this reason why section 4 is probably the most important section of the book. Without realising it many probably spend, not according to the level of their current income, but according to the level of income they expect in the following year. Many also suffer the financial result of wanting instant gratification as opposed to the financial benefits of delayed gratification. This section acknowledges that some through circumstances will battle to be healthy financially, but comments that in some cases the circumstances might be as a result of a person's own decisions. These decisions might have long term financial consequences which only become evident much later in life.

If a person wants to be in control of their expenses, there are a number of areas they could look at:

  * Chapter 5 which explains the CPI can be used to assess whether a person's expenses in various categories are excessive or not. This section shows that what people spend money on changes depending on what they have available to spend. This section also shows that the CPI is a rough guide as it represents the 'average' person which doesn't exist in real life, as it combines people with different spending profiles. For example, it combines smokers and non-smokers; those who rent and those who own their own homes and those who commute to work in their own vehicles, as well as those who use public transport instead.
  * If expense patterns need to be set to manage finances then the use of budgets is important. Chapter 6 provides guidance on how a budget can be set. This section includes some ideas on how costs can be cut and questions whether amounts are spent because a person wants to portray a certain image as opposed to expenditure that is actually needed. This section also highlights how advertising can impact expenditure and cause financial problems. While a budget is important it is also important to know whether budgeted amounts are being achieved or not if a person wants financial health. Accordingly this section also provides some suggestions on how the amount of actual expenditure can be tracked or determined.

The absolute and relative amounts of expenses change over time. Chapter 7 shows which expenses are likely to vary more than others time as well as those expenses which are likely to be major at the beginning and end of one's working life.

Chapter 8 recognises that we don't always have the cash necessary to acquire items and deals with the use of credit. It is in this area where many start a downhill slide from which they have difficulty recovering. Credit should only be obtained by those who are able to manage it. While credit can be easy to use and obtain, it can nevertheless be an important part of managing one's finances. Accordingly, this section shows that while credit is not for all, but for those who use credit appropriately where it is most appropriate for it to be used and how it should be used. This section also shows the benefit of paying off interest bearing loans early.

One area where it is normally appropriate to use credit is where the amounts needed to acquire assets are substantial and where without the use of credit it could take many years to acquire assets. This means credit is likely to be used to acquire homes and motor vehicles as outlined in section 9. This section also discusses the advantages and disadvantages of owning a home and mentions how some might go overboard financially in always wanting the latest gadgets and appliances.

In the early years of marriage acquiring a home and vehicle can be important considerations, but when children arrive they can add to the financial challenges. Chapter 10 makes a case for parents who want and are able to stay at home for a period to raise their children, as opposed to the politically promoted view that women should occur 50% of all top positions, on the basis that developing the future generation is an important function that parents should aspire to if possible. This section also shows that the costs of raising children increase over time until they start to work themselves and that the costs to be concerned about might be more vehicle, accommodation and wedding costs than educational costs.

Once a person has their finances under control they might then be able to save and invest. Some savings might be for short term goals, such as a holiday, while others might be for longer term goals such as a deposit for a house or even retirement. While saving for retirement might be a compulsory saving as part of the conditions of employment, for those where this is not a requirement they need to start saving for retirement at some stage. Chapter 11 outlines the different types of investments that are normally considered and mentions that the returns earned over time are likely to differ in accordance with the risk associated with the different types of investments. This section also shows the types of returns that can be achieved over time and that returns can be volatile.

While there are risks we face when we make investments, there are other risks we face on a daily basis. Chapter 12 discusses the need for the various types of insurance. The section also discusses the risks to our financial health if we don't take out insurance. We can't control all events that can lead to loss or damage of assets, our health or claims against us and as the amounts involved have the potential to be large, most will struggle to cope without some insurance.

One of our largest expenses can be taxes. Chapter 13 discusses the various taxes we can incur and not just income taxes, but also other types of tax such as VAT and estate duty. This section outlines the main features of our tax system. If we are employed we don't always feel the pain of paying tax in that it is deducted in determining our take home pay, but if we are self-employed and have to pay the same amount of tax, but as a provisional tax payer, the amounts are felt more.

While having financial health during one's working life is important, it can be a bigger challenge to have sufficient funds to retire comfortably. Some might manage their finances successfully during their working live only to stumble at the hurdle named retirement. Chapter 14 ended up being longer than expected because of the challenges in estimating the extent of assets needed for retirement. It gives ideas on preparing for retirement and provides suggestions on how to estimate what funds are necessary for retirement, which can change as retirement approaches. Some have unrealistic expectations of how their retirement is going to be funded. This section also helps a person assess whether contributions to a pension or provident fund are likely to be sufficient for retirement. In addition it explains the variables that influence whether a person can retire comfortably and as they can change over time a person should periodically review the progress towards retirement. The fact that many people might use some or all of their retirement funds upon resignation from a job before retirement is noted as something they might regret later in life. The different types of annuities and the typical guarantees that are available with annuities are also covered in this section. While level annuities might initially appear to be attractive, this section mentions that they can be a form of slow torture as they progressively decline in real terms.

The one area of expenses least likely to be considered by most people is in the area of giving. Chapter 15 makes a case for people to realise that for all their problems they are probably better off than many others and that if they are grateful for this, they should be considering giving as part of their monthly budget, and not just if they have funds over at the end of the month. For some, the only giving they might do is when they die and their assets go to their family and other parties. This is possibly one section where readers might not follow the suggestions made, but nevertheless is offered for consideration. It also raises the controversial suggestion that if one's family doesn't need a person's assets that they should be given to worthy recipients after death as well as during one's life if one has sufficient assets to live on.

Chapter 16 mentions a few remaining financial issues that came to mind. These include holidays and the benefits of using loyalty cards and discounts. Holidays also covers ownership of timeshare weeks and mentions the advantages and disadvantages of owning a timeshare. This section also warns about the danger of standing surety for others and recommends they be avoided as far as possible. In addition, this section mentions that finances in a marriage have the potential to be a major cause of tension between spouses if not dealt with.

As a reminder Chapter 1 mentions that a reader should be aware that I am not suggesting that how I have dealt with finances is necessarily the only way a person can be healthy financially. In addition, this book is aimed at the average man-in-the-street and deliberately doesn't cover areas that might be interest to the more wealthy, such as the use of trusts and offshore investments, where the person can afford to obtain the required professional advice. Also as section 1 indicates while I can provide comments, suggestions and ideas on issues in relation to personal finances, I am not a qualified financial adviser and so a person should be aware of this when making financial decisions in relation to investments.

Finally, while this book is dealing with financial issues, it needs to be realised that financial issues are not the only issues one needs to deal with. For a person to be content and satisfied a holistic approach to life is needed; with finances being only one factor. Now, dear reader, it is for you to decide whether or what actions you need to take in order to ensure your long term financial health.
ABOUT THE AUTHOR

Garth Coppin is a chartered accountant who retired in 2013 from Ernst & Young, a Big 4 accounting firm, after being a partner for 25 years. He continues to serve on various professional committees and is involved in his church. In addition he is now also an author with his book 'Financial Reporting for Directors in South Africa' having been published shortly before this book. He is married with three daughters and in 2015 completed the Cape Town Cycle Tour for the 22nd time.

The author can be contacted at garthcoppin@gmail.com.
