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Spend, save or invest - Turning $7 beer into frothy savings

This is the second of a four part Coffee Conversation series brought to you by CIMB where its private banking economist - and foodie - Song Seng Wun makes simple even the most complex of economic brews.

Interviewer: I will soon be receiving my year-end bonus. Should I spend it on a downpayment for a new car or a family holiday to Japan?

Mr Song: Getting an extra sum of money is always exciting. But rather than spending it all, think of the bonus as an extension of your regular income. Just as you should save part of your income, invest another portion of it and spend the rest, so you should apply similar principles to any windfall you receive.

As a general rule, many people spend about 60 per cent of their income, save about 20 per cent, and invest the rest. For the portion allocated towards spending, consider more urgent big-ticket needs first - for instance, you may need to replace your ageing car when the COE expires a few months down the road - before splashing out on a discretionary item such as an expensive vacation. In other words, settle your compulsory needs first before your non-essential wants.

Interviewer: Why should I save or invest - or even reduce my debt - now when interest rates are so low? Doesn't it make more sense to just spend the money?

Mr Song: Saving and investing are long-term journeys. When interest rates and inflation are low, and you need to spend less on consumer goods or on servicing your debt, you may be tempted to spend the difference. But when rates rise again, your debt repayments will rise in tandem, and probably so will consumer prices. So it may be a good idea to shore up your savings now to help offset the higher costs in future.

 

If you view saving over a longer-term horizon, as long as interest rates are not actually negative, the power of compounding interest can turn a modest amount of savings into a tidy nest-egg for retirement. Saving $7 a week by forgoing one weekly beer gives you $700 in less than two years - the price of a premium whisky! After 20 years, at an annual interest rate of just 2%, it will snowball into $9,400 - the equivalent of 1,340 bottles of beer or 13 bottles of premium whisky.

Interviewer: How does saving compare to investing?

Mr Song: Depositing your money into a savings account is likely to earn you an interest rate less than the rate of inflation every year. Technically, this means that you're losing buying power.

Compared to saving, however, investing offers more options - from bonds and stocks to property or even whisky - and carries potentially higher returns, but at commensurately higher risks. Often your principal sum, or the money you initially put into an investment, is not guaranteed. But if managed wisely, investments may help to grow your money faster than pure savings.