Is your money growth strategy working?

[Sassy_Social_Share] Is your long-term savings plan for your child really going to work? Many of us know we have to save for our kids. For some of us it is something at the back of our minds and for others, there is already some sort of specific savings going on. Many banks are indeed offering children or junior accounts to help us as we get started. Although efforts to save for our kids are commendable, I think sometimes we do need to take a step back and evaluate where we are saving and whether it really is the best option given the objective. While writing this article I spoke to a few parents who have started saving for their children and for most of them college fees was at the forefront as one of their objectives. Please note that this is not about immediate school fees for your child. In this article we are talking about saving on behalf of your children so that later on in life they do have funds or investments they can actually access or those funds can be used for college education.

Therefore, this generally speaking is quite a long-term investment and what these funds will be able to do in the long term should always be evaluated. Let’s look at two generic examples. George and Tom are friends and both fathers to 7 years old daughters. They both want to start saving for their children’s college education. Tuition at the college, they would like their children to go to costs Kes 300,000 per annum today. George opens a junior account with his bank and starts putting in Kes 10,000 a month. At a saving of Kes 120,000 year, he figures that should be enough. Besides he does not want to risk his daughter’s college funds by placing the money in something risky. The bank is giving about 4% p.a. interest on this account and George will reinvest any interest he earns back into the account. Tom on the other hand decides to do things a bit differently. He decides to open a stock brokerage account instead and invest Kes 10,000 a month buying different shares. His friend George advised him against it but he figures since he does not intend to withdraw money in the short term, he should be OK. He is also focused on investing in the shares that have long-term growth potential.

Before we get to the numbers, lets understand the reasoning behind their actions. George does not want to take risk given that the funds are for college whilst Tom who has the same objective has put his money in a risky environment. Despite that, I would say that Tom has the right strategy. This is a very long term investment therefore he can possibly ride out any volatility that may be in the stock market. If anything he can take advantage of it to accumulate good shares. For any investment you are doing over the long term, the intention should not be to keep your money safe but to grow your money. You cannot grow money by leaving it in a bank account. To save adequately for college over this period, funds need to grow. Your shilling next year cannot buy what it is buying this year because of inflation. The same way, college in 10 years will not cost what it costs this year. Let’s assume college fees are going to rise by 10% p.a. That means next year it will cost Kes 330,000, the year after 363,000 and so on. In 10 years the college fees will be approximately Kes 750,000 a year. For a four year course that translates to about Kes 3 mn. George’s savings including the interest he will have earned will be worth Kes 1.5 mn. He will only be able to afford two years of college. Tom on the other hand is much better off. Shares over long term are expected to beat inflation. Lets say on average his shares appreciate by 15% p.a. (Note: This is not a guaranteed return and he may have some years when the returns exceed this and others when they are less hence this is just an average estimation. It also depends greatly on the nature of the specific company he invests in). His stock portfolio will be worth Kes 2.5 mn (Kes 1 mn more than George) and he would just be Kes 500,000 short of the entire amount needed. For both what would greatly enhance their end values is if they continued adding extra amounts each year onto what they are saving/investing. However even with that George, would still need to invest more money than Tom.

Always look at what you need at the end or at the point of consumption and this can then guide you as to how you need to invest it. You will be clear on whether you just need to keep money safe or grow it. As much as George did not want to risk his funds he has still taken a risk by investing in way that may compromise his ability to see his daughter through college. Sometimes taking no risk is the biggest financial risk. If you have long-term plans the value of your money is going to be affected by inflation. For those plans, ensure you are investing in vehicles that will give you a return over and above inflation otherwise you have to save a lot more money.

Waceke runs a program on personal financial management. Find her at waceke@centonomy.com|

Questions
I have been following your articles and have really made progress on setting up an emergency fund. However I keep going backwards because of my cousin. He is always in some sort of problem and emergency and keeps coming to me. This has made me dip into these savings. How do I handle this situation?
Your cousin is taking advantage of you. Your emergency fund is typically not supposed to be for your cousin’s emergencies but your own. It is there to cater for your specific situations including loss of income. It should provide you with a buffer incase you lost your income or ability to work today. Will your cousin give you money if you lost your job? You need to set boundaries with your cousin. He comes to you all the time because he knows you will give him money. The more you keep giving the more he comes back. You need to stop giving him money or come up with a set maximum every month if need be.

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