Saving is when money is kept for the future, often in a bank account, or for a time when you need or want it for a specific reason.
Another way to think about saving is money you have but do not spend today. You can also save by spending less money on buying new things.
People use their savings in many different ways. For example, to buy a house, a car, to go on holiday, to buy a special item they want, to use for investing, or to give to someone else (like a child or a parent).
How do people save?
A deposit account which pays interest is typically used to hold money for future needs. This is generally the safest way to save money.
There are also other ways to save, but these refer to some form of “investing”.
But there is a difference between saving money and investing it (we will explain this later).
Why is saving important?
Saving money, and doing it regularly, is the foundation of all financial success you will enjoy in your life.
If you have money saved, then you are ready to buy things when you want or need to (such as your headphones).
Even if you are only saving a small amount of money, it is important to save something.
We will discuss later that if you save money every week or month, then over a longer period of time this will add up to a large sum that you can enjoy in the future.
The best way to understand ‘interest rates’ is as a pre-agreed amount (rate, typically as a percentage of the total amount you have) of money (interest) which gets paid by the bank or other party (known as ‘borrower’) that you give the money to.
It might be paid every month, or every 3 months, or every year – whatever is agreed in advance.
And it is paid until the money is taken out of the bank account, or until the end of the investment period.
Dad wants to borrow USD1,000. The local bank says ‘10% Interest’. So to borrow the USD1,000 for 1 year will cost Dad the following:
USD1,000 × 10% = USD100
In this case the ‘Interest’ is USD100, and the ‘Interest Rate’ is 10% (people often say ‘10% Interest’ without saying ‘Rate’).
Of course, Dad will still have to pay back the original USD1,000 after one year, so this is what happens:
- Dad borrows USD1,000, but has to pay back USD1,100
- This is the idea of Interest... paying for the use of the money
To understand the special words used in this situation:
- Dad is the ‘Borrower’
- The bank is the ‘Lender’
- The ‘Principal’ of the loan is USD1,000
- The ‘Interest’ is $100
It is also important to understand that, for various reasons, interest rates might be higher or lower.
This is to do with whether there is a higher risk for you by choosing this investment. Or it might be based on the policy chosen by the government of that country.
‘Inflation’ is best understood as a regular increase in the general level of prices for goods and services. It tends to be measured as the percentage of the increase on a yearly basis.
In terms of what this means to you, is that as inflation goes up, every dollar you have to spend can buy less of a particular good or service. Or, in other words, you need a little bit more money to buy the same thing a year earlier.
EXAMPLE: If the inflation rate is 2% annually, then, in theory, a USD1 pack of chewing gum will cost USD1.02 in a years’ time.
This is a technical word that you need to understand and be aware of because it affects whether you have money available to use when you want to.
- If something is ‘liquid’ – you can basically have the money for spending on anything else. It means you can quickly sell something you own to get the cash. This will help you to do important things like buy food.
- If something is ‘illiquid’ – you cannot get your money quickly because it takes a lot more time to sell the investment you own. For example, your house will likely take several months to sell, so you cannot get your money quickly, making it relatively ‘illiquid’.
Liquidity is also something which is important to understand when you come to investing.
This is something which refers to the benefits of saving at a young age so that the money can start to grow as soon as possible.
This works in the following way – after 1 year of keeping your money in a bank, it earns interest. This interest gets added to the amount you started with. At the end of year 2, you get interest on this new, larger amount – not just the money you started with. This continues each year, so that you get interest on an amount of money which gets bigger every year.
To see the real benefit of “compounding”, you will need to wait for probably more than 10 years. But it has a very big impact that will significantly boost your wealth.
Jenny and Charles both start to save money when they are 11 years old.
Jenny saves the HKD10,000 that Uncle Henry gave her as a generous birthday present at an annual compound interest rate of 5.5%. When she turns 50, her investment will have grown to HKD38,134.
Charles waits until he is 35 to invest the HKD10,000 that Uncle Henry gave him for his 11th birthday. He gets the same interest rate. By the time he reaches age 50, his investment will be worth HKD22,325.
Even though they both invested the same amount, Jenny gave her money more time to grow. She earned a total of HKD28,134 in interest, while Charles earned only HKD12,325.
This shows why it is so important for you to start saving your money now!
You have probably heard your mum and dad talking about their bank account, or the fact they need to go onto a bank website or into a bank branch to pay a bill.
But if you ever go into a bank branch they look like very uninteresting places, where people queue up a lot and fill out forms or take money out of ATMs. Why are they so important?
Banks are responsible for taking care of most of the money in the country. People who earn money tend to put most of it into their bank accounts, while other people who need to borrow money mostly do this from banks.
The main purposes of a bank
Banks do a few important things.
1. they keep your money safe.
Your mum and dad usually earn money from the jobs they do, plus any investments they have. But it’s risky to keep all this money at home. Imagine if your house was burgled, or got damaged in a fire. All the money would then be gone!
Instead, most people choose to put their money into an account at the bank. These are called deposit accounts. There the money is safe, as the bank takes care of it and promises to always give it to you whenever you need it.
The bank pays you to keep your money with it.
The bank also pays you an interest rate for keeping your money there. While this is usually not very much, it means you make more money simply for keeping your money at the bank!
2. They lend you money if you need it.
The reasons banks pay you to keep your money is because they use your money and lend it to other people or companies, and then charge extra money for doing so.
Most people borrow from banks at some point. Your mum and dad might have borrowed money to buy your house. This is called a mortgage, and involves borrowing a lot of money over many years.
Companies borrow money too. They might want to build a new factory, or hire lots of new workers to grow their business, but don’t have the money right now. So they go to the bank and borrow the money, and pay a rate of interest for doing so.
3. They can help you pay your bills more easily.
Families tend to have many payments they need to make every month. For example, they need to pay for electricity, water and gas.
Remembering to pay these can be annoying. So the bank offers auto-payment facilities. This means the bank will automatically move money from your parents’ account to pay all the bills they have set up for auto-payment. It saves a lot of time and hassle!
How does a bank operate?
1. Getting your money out of a bank
There are several ways to get the money you keep at a bank.
Usually you can access the money through a debit card, which you use at an ATM to get money out. There are lots of ATMs in towns and cities. Try looking out for ones with the symbol of your bank next time you are walking on the street!
You can also write a cheque to someone else, to pay them without using cash. The person then takes the cheque and gives it to their bank. That bank talks to your bank, which agrees to move the money to their account.
You can also transfer money to online bank accounts, using the internet. But don’t forget your bank details and password!
2. Charging interest
While banks lend money to lots of different people, they typically only agree to lend the money for a certain period, and they charge interest rates on the money during this time.
The interest rates they charge can change a lot, from only 1% or 2% of the original amount a year to up to 15% to 18% a year for the use of something called a ‘credit card’. This is a small plastic card, generally issued by a bank, which allows the holder to buy goods or services on ‘credit’ – meaning they do not need cash and instead pay it back later.
The main reason the rate of interest varies so much is because some people or companies are riskier, so the bank charges you more.
Let’s use Mum and Mary as an example.
Mary earns a lot of money, has always paid her loans promptly and on time. She also has a lot of money in bank accounts at the bank.
Mum is a new bank customer, and has never borrowed before. She also makes a lot less money than Mary.
Always understand how much interest you will have to pay before you agree to any type of loan, and work out if you can afford to pay it.
Sometimes banks quote the interest they charge on a monthly basis because it sounds low, but the yearly rate is actually quite high.
For example, a bank might offer a personal loan for 1% a month, which sounds good. But the yearly interest rate on this loan is actually 12%!
Borrowing comes in many forms
There are many types of borrowing, and some of the most common include:
- Mortgages. These are very large loans that last for a long time, often 20 years. The banks lend the money to people to buy a house. The reason the banks do so is because the interest rates are quite good, and also if the people cannot pay the mortgage the bank will take over ownership of the house and sell it, to get its money back. The house is called ‘collateral’ for the loan.
“Collateral’ means that if you cannot pay back the loan, the bank is allowed to take whatever has been pledged as the collateral and sell it to make sure that they get the money back.”
- Credit Cards. A credit card is basically a plastic loan. If you use it, you are borrowing money from the bank and spending it on something. However, you have to pay it back in a month if you want to avoid being charged interest. And the bank charges high interest rates on credit cards, because
they can be used to pay for anything. So it’s best to pay it back quickly!
- Car loans. This is like a mortgage, except the money is put towards a car rather than a house. The car will be collateral for this loan.
Why people borrow money
There might be various reasons why you would want to borrow money, and the different types of ‘debt’ you take on when someone lends you money can be considered as ‘good’ debt and ‘bad’ debt – depending on the purpose you are using the money for.
1. Borrowing to help make a plan come true.
Many people don’t have enough money to pay for something they want to do, such as create a new business or buy a house. However, they think that over a longer period of time they will make money, so they are prepared to borrow money to get what they want.
By lending them the money, banks help these people or companies make their plans work. This can be very good news for the borrowers, and for the bank too – as it gets paid interest for lending the money.
2. However, borrowing can be risky
Borrowing money from the bank can be risky too. If the borrower doesn’t spend the money carefully, or something goes wrong, they can end up struggling to repay the money. If they cannot keep up with their payments they can get into a lot of trouble with the bank.
Therefore, it’s a wise idea to think carefully about how you will repay any money you borrow, and whether you can afford to repay it.
Also, some of the money you can get access to by borrowing is lent over a short-term period. This leads to higher interest rates, so if you borrow this type of money and do not pay it back quickly, then you will pay back a lot more over time.
- Insurance. Many banks provide types of insurance (this will be explained in more detail later). Insurance is like a type of protection. You pay the bank some money to protect you against something happening. If that thing happens, then they will pay you some money in return. Banks often offer life insurance, in which a person pays them some money every month, and when the person passes away the bank will pay an agreed amount of money to the person’s family.
- Investment products. Banks often help people to invest in investment products too (this will be explained in more detail later). These are financial instruments you can put your money into, with the hope that you will get more money back. Common products are shares, which are essentially the ownership of a tiny amount of a company, or bonds, which are ownership of a tiny amount of the debt of a company.
Mum and Dad have decided to buy their first house and have gone in to the bank to apply for a USD2,000,000 mortgage.
After discussing what they need and their financial situation, the bank asks them to choose how they want to repay the loan, and over what time period.
Many banks offer long repayment periods (up to 40 years). Although the monthly payments are smaller, you will end up paying significantly more in interest payments compared to a shorter repayment term.
The Mum and Dad looked at 3 different options for how long they would take to repay the mortgage loan – 10 years, 25 years and 40 years – each at an interest rate of 5%. The shorter the repayment period, the less overall interest Mum and Dad have to make, although they will have to pay back more each month.