In Part 1 of the 50,000 dollar problem, we looked at my techie friend’s dilemma. He’d come across Kshs 50,000, and was looking to make “good” and certain returns in a year, and since I wasn’t offering him any viable solutions, he was going to buy the iPad2 instead. My advice to him was to take a SACCO loan to pay for his gadget. Why would I give such atrocious advice?
Financial success is often a battle between our short term desires, and longer term benefits, and in most cases our short term desires win (you live once right?). Most personal finance gurus teach you to curb your desires, to learn the art of delayed gratification, to plan for your desires etc, but we all know this doesn’t work in real life. If I’m desiring an iPad 3,saving for it over 3 years may not be very realistic because in 3 years time, the tablet will be obsolete, and my desires will have changed. That’s not to say there’s no value in delayed gratification, it is actually the essence of personal finance success.
While a select few can delay gratification for years (or decades maybe), most of us cannot. Does that mean our finances are doomed?
Not at all.
In my opinion, financial success isn’t all about curbing your desires and living a dull life, but about pricing your desires right. You can have anything you want (within your reach of course), but you have to price it right, and be ready to pay the price in full.
My friend could have his iPad 2 using his windfall earnings at zero cost to him theoretically, while in actual fact he would be doing it at a loss since he’d have to forgo the Kshs 6,000 return he could make if he invested the money, on top of losing potential investment capital.
I advised him to save the money in a SACCO and take out a loan of the same amount to buy the gadget for several reasons:
1. Preservation of capital
The money was a windfall income, meaning it was a one off benefit and not part of his regular income. He probably wasn’t going to earn a similar bonus the following year because 2012 so far is a tough year for businesses. By saving it in a SACCO, he was ensuring that he at least preserved the money, as opposed to spending it all at once and having to build up equivalent capital over a 1 year period or longer. In addition to this, most SACCOs have a mandatory minimum savings amount, and he would get an opportunity to build up his savings this way.
2. Opportunity to make returns
Most SACCOs pay a decent annual dividend on savings. My SACCO pays between 6% and 9% every year. While this may not seem to be significant, it’s better than nothing. When you consider the fact that the same SACCO then avails you 3 times your savings as loans at 12% interest, then it means you get an opportunity to make money from your borrowing. As I wrote in my post about SACCOs, when you borrow from a SACCO, the interest paid is reduced significantly by the dividend the SACCO pays to you at the end of the year. On a more longer term, this money remains in his wealth statement (see below) for as long as he wishes.
3. Pricing a desire right
As mentioned earlier, instant gratification has a cost, and most times it’s loss in future earnings and savings. My friend was going to pay Kshs 3,309 in interest on the iPad 2. It doesn’t seem much right? Yes, it’s not much, but it’s a price to pay, for choosing to have his pleasure now, as opposed to fully investing his capital and possibly earning better returns from it in the future.
There is a second cost to it. I told him not to alter his savings budget to cater for the loan repayments. He was going to pay back the loan by cutting down on a luxury he was regularly spending on. In this case, I zeroed in on his love for entertainment and socialisation.
He liked to go out on Fridays and Saturdays, and his spend each day was an average of Kshs 1,500, coming to a total of Kshs 12,000 per month. Again, my desire wasn’t to make him a dull person, so I wasn’t going to suggest he curbs his need to socialise. He needed about Kshs 4,500 per month to make his loan repayments, and an additional Kshs 1,000 which is the monthly minimum SACCO saving , so I suggested that he gives up 4 nights out of his 8 nights of socialization every month, and instead spend that time with his gadget, and socializing online 😀
End of Year Results
Assuming he did as suggested, what will my friend’s financial statements look like at the end of the year? See below, and look out for my next posts that will decode personal financial statements and demystify terms like “wealth statement” and “income statement”.
|a. iPad 2||Kshs 20,000|
|b. SACCO Deposit||Kshs 50,000|
|c. SACCO Savings||Kshs 12,000|
|TOTAL ASSETS (a+b+c)||Kshs 82,000|
|SACCO Loan||Kshs 0|
|a.SACCO Dividend (Income)||Kshs 3,720)|
|b. Interest on Loan (Expense)||(Kshs 3,309)|
|Profit / (Loss) (a-b)||Kshs 411|
Looks like he wins both ways!
Is this the recommended model for all our whimsical purchases? Not at all! In the next post, we look at why you shouldn’t use this method for all your luxury purchases.
Photo courtesy of Clutch Mag