Making a habit of it

The forming of habits is a neglected but vital element of managing personal finance. And small changes can make for a big impact over the long run

In my first personal finance column for the FM I want to focus on one of the most important, but mostly overlooked, aspects of personal finance and, truthfully, life: habits. We’re human, and habits are hard, as proved every January. We promise ourselves we’ll save more, drink less and exercise, but these lofty goals seldom make it into February.

But a good habit over a lifetime can make a real difference. One of the oftrepeated personal finance ideas is to buy one fewer cappuccino a day or a week, and rather save the money. But is anybody really getting rich by saving R30 a day or a week, especially if you keep the habit for only a few months — or worse, spend the money saved?

Well, we know a lifetime habit of exercise will benefit us greatly. So will a lifetime of managing our finances well. If we do this right, even the small habits will make a difference if we use the power of time.

So let’s throw out that overused cappuccino example and look at the real strength of time.

Imagine a child born today and some generous person deposits R36,000 into a tax-free account for them (R36,000 is the annual limit). Assume this amount grows at an annual 7% real return (that’s growth less inflation. I use the real return so the future spending power is the same as today’s spending power).

At age 65 that single investment of R36,000 is worth more than R2.7m in today’s money, and is totally tax free. Assuming the 7% real return remains in place, you can now draw 7% every year while the pile of money will continue to grow tax free and at the rate of inflation. This equals almost R200,000, tax free, per year — for the rest of your life growing at the rate of inflation.

The secret here is twofold. First, a kind soul who deposited the initial R36,000 into a tax-free account for you. But the real secret is time itself, all 65 years of it.

And while saving tips are great and fewer coffees are likely better for your wallet and your health, what matters most is that you’re able to stick to the new habit.

How do we do that? Make it accountable. Get friends and family involved by telling them about the new habit you’re trying to master and why it’s important to you. Explain how they can help and support you. But don’t ask them to join you in the new habit. Habits, and personal finance, are just that personal.

Equally important is keeping it small. Yes, the cappuccino idea seems silly, but it’s also achievable. Starting giant new habits is near impossible. They sound great, but they scare us by their size. Over time, as we succeed at small new habits, the larger ones become easier.

At age 65 that single investment of R36,000 is worth more than R2.7m in today’s money, and is totally tax free