The Investor: Turning Interest Into Your Friend

In a UMR survey, at least half the respondents said they were “very satisfied” in all the following aspects of their lives: current housing, safety, education, health, job, opportunities to succeed, community and environment. And a full 70 per cent were very satisfied with their family life. It’s enough to make you feel all warm and fuzzy.

However, only a quarter said the same of their finances.

This was down 5 per cent from the previous year, “the only aspect where New Zealanders reported a significant drop in satisfaction,” says UMR.

It’s pretty obvious what has caused the change. The global financial crisis, slower economic growth, increased unemployment and finance company collapses have affected some families directly and eroded the confidence of others.

The same can be said for the 10 per cent drop in house prices from the peak to the trough – as reported by the Reserve Bank. People who were forced to sell property at a bad time – perhaps because of a job loss – have been hit hard. Others are simply less inclined to borrow or to spend when they see the value of their biggest asset declining.

Clearly it’s not good to see savings slashed. But, beyond that, the toning down of the gung-ho borrowing and spending of a few years ago is probably good for both the nation and individuals.

True, the change in attitude has held back economic growth. If people borrow less and buy less, that affects not only retailers but everyone providing the goods and services not being bought. We don’t want to go too far down that road. But it’s clear that before the recession we were erring in the opposite direction.

The question now is whether the increase in household saving and reduction in household debt is permanent or, as some experts suspect, just a common reaction to a recession that will change when things look rosier.

Here’s hoping it’s the former. Too much borrowing and too little saving has increased New Zealand’s vulnerability to a worse economic downturn. Even if that doesn’t happen, a little belt tightening at the household level would be excellent.

Consider this: If you are in the habit of buying things on a credit card or hire purchase, you will pay many thousands of dollars in interest over your lifetime. That’s real money that you won’t have to spend on travel or luxuries in retirement.

But if you save up before buying, you make interest your friend rather than your enemy. Compounding interest on your savings helps you to reach your goal.

To make the switch from interest as enemy to interest as friend, simply manage without buying your “wants” as opposed to your “needs” for a period. How long? If you’re talking about buying cars, it might be several years. But if you start with lower-priced items, it might be a just a year or two.

Meantime, set up regular savings of about the amount you would otherwise have put into credit card and similar payments.

At the end of the period, you can go back to buying less-than-essential items – using your savings. As long as you continue regular savings, raising the amount whenever your income grows, you should be able to keep purchasing from the savings account for the rest of your life – and no longer waste money on interest.

Need a bit more convincing? Try this quote from Australian law professor Mirko Bagaric: “Retail therapy is a con. Debt stress is a reality.”