The problem of scarcity
The challenge with discussing investments and investment strategy where we have to tackle multiple savings goals is that investing can only take you so far and only achieve so much without introducing imprudent risks. In a world of infinite savings goals, investment problems, like any other economic problems, require that we recognise our scarce resources and prioritise our choices.
In its simplest form, each individual has a finite amount of money to allocate across their various needs:
- Immediate consumption needs (spending today at today’s living standard)
- Deferred consumption needs (spending tomorrow to maintain your standard of living)
- Future risks (making provision should something happen to impact on your earnings ability or potential)
- Aspirational needs (wanting to improve your standard of living)
An individual’s resources are a combination of human capital (your skills that allow you to earn a salary) and financial capital (savings or assets). The challenge is that we never seem to have enough financial capital, while we heavily undervalue human capital or don't use it effectively. This is the classic financial adviser’s dilemma – how to allocate an individual’s limited resources to their financial goals.
Financial inequality
In the past few years, the World Economic Forum’s global outlook report1 has seen the ‘deepening income inequality’ rising to become the most important and key challenge of our time – the poorest half of the population often controls less than 10% of its wealth. This was further highlighted in the recent Oxfam report, Economy for the 1%, with the stark statistic that 62 of the world’s richest people have the same wealth as half the world’s population.
This is a global economic crisis which Oxfam declares as ‘morally questionable’2. If history repeats itself, as it does, then this could result in significant social disruption on a scale far greater than the French Revolution. It’s a universal challenge for the whole world to address.
One way is to emphasise initiatives that either enhance human capital, particularly of low-income earners, or translate human capital into financial capital and create the opportunity to grow wealth across generations. Research has shown that housing and children’s education are pivotal factors in providing financial security – and these in themselves are catalysts towards creating intergenerational capital, which in turn has the ability to reduce financial inequality.
Our next question is: Can savings and investments contribute to a solution? Our key focus is to review the viability of a savings programme which allows an employed individual to meet basic financial goals that can provide financial independence up to retirement, while enhancing financial and human capital.
And if we find a strategic solution, should not become an obligation for government, corporates, employers or other institutions to provide the means and resources to help develop effective sustainable frameworks to achieve this end?
The power of compounding
If you go to a financial advice seminar, it’s likely that one of the sections would describe the power of compounding. This concept demonstrates that the earlier you begin to save – and therefore the longer the savings period – the greater the ultimate benefits of your savings. Assume three friends (Vusi, Nazia and Joe) want to save R1 000 every month for 10 years to buy a special gift in 30 years’ time. Vusi is disciplined and starts today. Nazia, less diligent, starts 10 years later. And Joe, a serial procrastinator, starts 20 years later.
Each puts away the same amount for 10 years, yet time is the greatest differentiator to their largely diverse outcomes. Nazia would have to put away R2 010 per month for 10 years to get to the same value as Vusi in 30 years, but Joe would need to save R4 040 per month!
To solve the savings problem, we need to harness the greatest asset available to investments – time. The challenge of meeting multiple goals simultaneously, including retirement, emergency savings, housing, education and medical savings, requires as many levers in your investment toolbox as possible: time, investment strategy, portfolio design, cost management, risk controls and liability modelling.
In modelling this problem it becomes evident that the earlier you start the process, the more likely you are to meet these objectives, specifically when the available resources are scarce. This also suggests that sequencing investment decisions for multiple goals matters. The amount available for saving and the time you have need to work in tandem to maximise the probability of meeting your financial objectives.