It would be ideal to live in the moment, spending money without a care for tomorrow, but while that might seem tempting; the reality is that saving for the future opens doors to endless possibilities.
It's not just about retirement; it's about breaking free from the paycheck-to-paycheck cycle and preparing for significant purchases like a car, a dream vacation, or even your own home.
Living hand-to-mouth isn't exclusive to lower-income brackets; it's a plight that befalls those who overlook the importance of financial planning. As the adage goes, "Fail to Plan = Plan to Fail." The more you invest in your future, the more avenues you will have to live on your terms.
First Master the Principle of Saving
Saving is the area you can impose the most control over. Even those who are Financially Independent and enjoying their money need to exercise control over their spending. For those who are building wealth, it really is the most powerful lever you can pull.
Start as soon as you can and commit to increasing your savings rate regularly. Thanks to the power of compound interest, increasing your savings rate by just £5 per week and investing in stocks and shares (equity) will increase your retirement pot by £55,000.
a. Spend less than you earn.
c. Don’t save what’s left over after spending; spend what’s left over after saving.
d. Pay yourself first and automate by direct debit as much as possible so that it happens.
e. Spend intentionally and avoid lifestyle creep.
f. Start early and benefit from the Magic of Compound Interest.
Once you have mastered the art of saving, the next step is strategically allocating your funds for maximum returns; tailored to your short, medium, and long-term goals.
When it comes to investing or saving your cash there are numerous places where you can put your money. Here is a step-by-step guide to making your money work harder for you.
1. Pension Match
If your employer has a Company Pension Scheme they will usually make a contribution matching what you pay. So, if you pay £100 a month, your employer gives you £100 as well.
This free money is in addition to your agreed salary!
Also, all payments into pensions are tax-free when paying in. So, if you pay £100 into your pension, the government returns £25 tax to your pension. More free money!
The sooner you start saving in your pension the better. If two people saved £1 a month for retirement but one starts at 25 and the other starts at 35, the earlier saver will have nearly twice as much by the age of 65.
You can find a real-life example pension plan for John, at ‘How to choose a workplace pension fund’.
2. Pay off Bad Debt
Bad debt refers to things like credit cards or other consumer debt that do little to improve your financial outcome. They often come with very high interest rates which, if not paid off IN FULL each month, will compound negatively. This leads many people into a debt spiral.
By paying back debt on a 30% APR credit card, you are effectively earning a 30% return!
If you are struggling with debt and feel that you can't manage, there are debt charities like 'Step Change' who will advise you on all of your options for free. Speak to them before you speak to anyone else - don't pay for debt advice.
3. Set up an Emergency Fund
This fund will stop you from going into debt if something unplanned happens, like a lost mobile phone or a car breakdown. Keep this in a savings account or premium bonds for quick and easy access.
Most people say we need an Emergency Fund with enough cash to cover at least 3 to 6 months of living expenses, as you never know what’s around the corner (eg COVID epidemic). This may be overkill to start with.
Aim to have, say £1000 put to one side for real emergencies and then move on to other things on this list. While doing these other things, you can continue to add to your emergency fund month by month to build it to the 3 to 6 months (Some of these other things can also be used as second-stage funds in crisis times).
4. Have a Lifestyle or Fun Fund
Life is for living, now and in the future. If you are budgeting effectively and spending intentionally, then you can reward your present self by putting aside a fund to pay for near-term, planned lifestyle choices and experiences.
It feels great when you know that you already have money set aside for a planned holiday or product purchase. You won’t have any financial worries post-event because you have been intentional in your spending.
5. Take out some Protection Insurance
Protection insurance is an umbrella term to describe insurances that provide cover for you and your loved ones in the event of accident, illness, or death.
There are many stories of individuals or families having their lives turned upside down by one small slip that they could not recover from; an illness or an accident that destroys assets, or disables the ability to earn an income.
Your employer may provide some cover, so work out what additional cover you need depending on your personal circumstances.
If you do buy insurance, you then pay hoping you never need it. But when you do need to claim, you are very glad you have it. It’s finding the balance between what you can afford and what you need. If life insurance was free we would all have a billion pound cover!
Don’t forget Car Insurance which is a legal obligation, and Home Insurance which isn’t - but, if your home burns down…you are screwed!
6. Open a LISA
A LISA or ‘Lifetime ISA’ is a special ISA not to be missed. You can pay up to £4,000 into a LISA each year towards a first home or your retirement, and the government will give you a 25% bonus. That means you could get a chunky £1,000 of free cash annually.
You can withdraw money at any time to buy a house without any penalties. You can withdraw money at any time after the age of 60 without any penalties, and free of income tax, unlike a pension. But, if you withdraw before the age of 60, not for a house purchase, there is a 25% charge.
If you are buying a first house in the future, this is a must-have.
Most people will live at least a decade in retirement and do not save enough money to enjoy this time. By using a balance of pensions and ISA / LISA, the requirement to pay tax can be minimised. Retirement may seem a long way off, but your future self will thank you!
7. Set up an ISA
An ISA or ‘Individual Savings Account’ is simply a type of savings plan with tax benefits to help you save money for the short, medium, and long term. All payments made into an ISA can be withdrawn at any time without any tax liability.
Normal savings accounts and general investment accounts both attract tax.
ISAs can be wrapped around a bank savings account as a cash ISA for short to medium term needs, or an investment account as a Stocks and Shares ISA for long term needs due to the short term volatility experienced when investing in equity.
You can hold both an ISA and a LISA at the same time and the maximum that you can pay into both is £20,000 per year.
(Note: Short term is defined as less than 5 years. Long Term is defined as over 10 years)
Where Should I Invest My Money?
You can find out more about investing in your stocks and share (or Equity) ISA using Low-Cost Global Index Funds in earlier blogs. It is less complicated than ‘the experts’ make out!
Write down your Personal Financial Plan
Every journey requires a plan, without it you don’t know where you are going or how you are going to get there – or why? This is true if you are planning to sail around the world or save for a home.
Sitting down and writing a financial plan will help to identify what you want to achieve and then detail how to get there. Making a plan is a way of increasing your chance of adherence and reducing your chance of self-sabotage.