How a coffee fix can turn into R175,000

Small sacrifices can turn into big savings if invested wisely. By Nic Oldert.
Publication date 3 April 2019

The idea of denying yourself the daily cappuccino and investing the money is not new. If you don’t drink cappuccinos, any other indulgence will do — chocolate, wine, cigarettes, massages, fast food — nearly all of us indulge in things that have less expensive substitutes.

Whatever your particular little extravagance, you need to know exactly what giving it up can do for you. Denying ourselves some of life’s little pleasures is only sustainable if the rewards are worth it.

The interesting thing about the “invest that cappuccino” idea is that it highlights the core reason that so many people don’t save. Delaying gratification is hard. And saving is so… abstract. Drinking a cappuccino now is so good. You can taste it in your mouth, right now. Whereas getting a bit of extra money at some indeterminate future time is… well, meh. Hey, maybe you won’t even live that long, right? Or maybe you’ll win the lotto and you’ll have suffered all that self-denial for nothing.

But let’s get real. You’re not going to win the lottery. You’ve literally got more chance of being struck by lightning. And the odds are that you’ll live longer than your parents.

Still, you need an incentive to embark on a programme of self-denial. So our purpose here is reduce the cappuccino plan to actual rands and cents.

Turning Coffee Into Cash

At R25 a cup, skipping one cappuccino every working day works out to around R500 a month. (Actually, the average month has 22 working days, so you can cheat twice and still put aside R500. Plus you’re not giving up the weekend cappuccinos — bonus!)

If you’d invested R500 a month for the last ten years in a money market fund (we’ll come to this in a moment) you’d have R85,000 today. That’s right — a decade of daily cappuccinos is worth eight-five grand.

This is not a theoretical number. This is the actual amount you would have today if ten years ago you’d started putting R500 a month into a money market unit trust run by Absa or Allan Gray or Coronation or Kagiso or Investec or Nedgroup or Stanlib, the worst performer of which turned that R500 a month into R85,000.

But wait, there’s more. To be precise, you could have made much more. Stay with me.

To inspire you further in this project of delayed gratification, let’s look at the results of different investment options. Eighty-five grand is just the beginning.

To understand what comes next you have to get your head around two simple concepts: the power of compounding, and rates of return.

A Better Return on Investment

You’ve no doubt heard the expression “compounding the problem.” It’s what happens when someone does something that turns a small issue into a bigger issue.

In the world of investment, “compounding” has the same meaning — making something bigger — but when we’re talking about money, or course, this is a good thing.

Compounding is often described as “interest on interest” — the interest earned in the first month or year earns interest in the next month or year. It’s a sort of multiplier effect that gains momentum and gives increasingly better results the longer you let it run. The power of the compounding effect increases the higher your rate of return.

A “rate of return” (or “return on investment”) refers to the amount of money an investment returns to you over a year. So if a savings account advertises a rate of 5%, the basic return on investment over one year is 5%, or R50 on a R1,000.

When you combine the effects of compounding and higher rates of return the results can be spectacular. For example, if you had put your R500 a month into a fund tracking an index of top American shares over the last ten years you’d have R175,000 in your account now (“now” being the time of writing, which is end of March 2019).

Again, this is not some hypothetical calculation. This is the actual return of R500 a month invested into the Sygnia Itrix MSCI US Index Fund over the last ten years.

Why, I hear you ask, would anybody not choose the Sygnia fund, or similar? The answer, of course, is that it’s a riskier option. It paid off, but the road was bumpier. And there are scenarios where it wasn’t the best choice.

Have a look at the graph below. It shows the first three years of our ten year programme (remember, we gave up a cappuccino a day in April 2009 and started investing R500 a month).

The line that looks like a series of small steps that march inexorably upward — that’s the money market fund. Your investment earns interest, which is added to your balance every month. The total value of your account can only go up, it never goes down.

The line that looks like a profile view of the Drakensberg mountains, that’s the Sygnia US tracker fund.

Now here’s the important part. Four months after you started — if you’d chosen the Sygnia fund — your investment had lost value. You’d have had more money in July 2009 if you’d put the R500 a month under your mattress (R2,000 versus R1,864, to be precise).

Of course, by April 2010 you were patting yourself on the back –the Sygnia fund was up 20%, the money market had only returned about 7%.

Four months later — at the end of August 2010 — you would have been kicking yourself again. The money market fund was still inching upwards but the value of the Sygnia fund had plummeted back to where you started (you had R9,000 in savings but zero return on investment, whereas your balance on the money market fund would have been around R10,000).

This three year period shows exactly why we recommend a money market fund for periods less than three years. Equity funds increase in value in the long run but in between they yo-yo up and down. Over the long term they almost always give the best returns (compared to other asset classes), but in the shorter term they can leave you in the lurch.

Look at the graph again. Let’s say, for example, that you’d had an emergency in August 2010 and you needed to raid your savings. At that point in time you would have been better off in the money market fund. In August 2010 the fact that the Sygnia fund was high in April 2010 and high again in February 2011 was irrelevant because you needed the money just when the Sygnia fund went into a dip.

This is the reason we recommend money market funds for periods of less than three years. If you’re just starting out as an investor your first savings account is often also an emergency fund — in this case you want stability, not returns that fluctuate.

Once you have something to fall back on — enough savings to cover a few months’ expenses, for example — you can start a long-term equity-based investment plan.

In future articles we’ll provide more tips on how to decide on the split between money-market (safe, interest-earning) investments and equity investments.

To end off, have a look at this second graph. This is the ten year view. After 2012, as you can see, the US equity fund rose so much that the dips and value fluctuations were no longer cause for concern.

We can’t promise that future returns will match those shown above. But based on past experience, there’s a good chance that investing a cappuccino a day could see you sitting on somewhere between R100,000 and R200,000. If that doesn’t motivate you, nothing will!

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