Consumers who decide to reduce their savings by even R100 or R200 per month to buffer against the impact of the 1 percentage point VAT increase, are effectively robbing themselves of the benefit of compounded growth.
Compound interest is essentially the addition of interest to a principal sum – basically getting “interest on interest”.
Estimates of the effect of the VAT increase on household budgets vary from a couple of hundred rand a month to many thousands depending on lifestyles, but it seems certain, according to Heap, that all South African households will have at least a couple of hundred rand less to spend since the VAT increase kicked in on April 1.
She says the power of compounding can be a great force for good or bad.
“Which way it goes depends on whether you progressively add a little more to your savings and leave it to grow over the years and decades, or if you allow small cost of living increases, such as the extra 1% of VAT, to lower your savings rate, thereby chipping away at your nest egg,” she says.
“A lack of care might result in a little pain growing into a much bigger one over the long term. It is better to feel a slight pinch as you readjust your budget than merely kicking the can down the road and effectively magnifying the effect significantly.”
Inflation impact
Heap explains that there are many reasons even people with the best financial intentions come up short. Allowing the amount you save to fall behind inflation or your earnings growth, is one example.
“Not adjusting your savings in line with inflation has much the same effect as reducing the amount you save,” she says.
Also, in order to maintain a certain standard of living in retirement you need to keep your savings in line with your earnings.
“You are storing up trouble for yourself in later years if you let your retirement savings become a smaller and smaller percentage of your earnings. As your salary grows with inflation, or hopefully even ahead of it, so should your savings,” says Heap.
“It might be easy to justify not keeping your savings in line with your earnings when the cost of living goes up particularly in a sudden spurt with something unusual like a VAT increase. In the end, only you will suffer.”
Author: Emma Heap
Source: Fin24 via News24Wire