Money — some say is the root to all evils. Yet, we can’t live without it, it is arguably the one thing that keeps society together, and make everything working around us. From paying for baby food to buying school uniforms, buying your first house to paying for care at an old age. Without money, we would have to rely on bartering for our food, our clothes, and everything else. Whilst that can work on a small scale, it is very slow, hard work, and cannot be scaled. How many yards of cloth do you have to swap for your broadband connection anyway?
So, we are stuck with money, and the joys of having it, and the stress of not having enough.
It is said that a good portion of working people are two pay cheques away from being homeless, that is, if they don’t get paid for two months straight, they would have fallen behind in all their bills and repayments that they risk being evicted or lose their home. That’s a scary thought. Even if it is say four months instead of two, it is still very scary. From that, you can see why losing a job is such a big deal for many.
The trick, which many books and websites tell us is to have at least 6 months’ worth of wages in savings, which sounds like an impossible idea for someone living from pay cheque to pay cheque.
Why 6 months?
Because it may take you 6 months to find a new job, all the while, you still have a mortgage or rent to pay, utility bills, food, loans to pay.
When my kids were little, I used to have maybe one month’s worth of savings, I kept a very close eyes on my spending to make sure I can clear my credit card bill each month. Then, I was made redundant, the company I worked for decided to close down the regional office, and my finances completely stressed me out. It took me several months to find a new job, it was a stressful. I was lucky that my wife works as well, so we could still afford to pay the bills, but it was not a good time. All because I didn’t have enough of a money buffer. The credit card balance took me many months to clear. At something like 20% interest, it was costing me dearly.
Have you noticed that each time you get a pay rise, or get a bonus payment, your expenses magically goes up to eat up the extra cash? When you are told you will be paid a bonus, it is easy to tell yourself you deserve a treat, maybe buy that new mobile phone you’ve been eyeing, or the holiday you deserved. When you get a pay rise, you tell yourself you can afford a bigger phone contract, or you now qualify for a bigger mortgage. So bit by bit, our outgoings creep up to match our income.
The magic happens however the other way round too, when you get a pay cut for whatever reasons, or if you didn’t get that end of year bonus. Your expenditure magically shrinks with it, you learn to spend less!
Pay Yourself First
It’s common for people trying to save by putting away whatever that’s left at the end of the month, £10 here, £20 there, £100 if you’ve been really careful that month. The problem is the magic of money, we tend to spend most of the money we have lying around. So the amounts left at the end of the month will usually be less than you hoped.
One trick to take advantage of the magic is to pay yourself first. Put away the money for savings as soon as you got paid. A good level to aim for is 10% of your take home pay. That may sound like a lot, and not everyone can afford that, especially those on low pay. The important thing is to get into the habit, you can start with 1%, then slowly once you got used to living off 99% of your pay, to increase it to 2% then 3% etc. Slowly over time, you learn to live off 90% of your pay, and you won’t even notice it, such is the magic of money. You will adapt your lifestyle and learn to live on 90% instead of 100%.
If you put away 10% a month, within a year, you will have a full month’s salary saved up, from less effort than if you paid yourself at the end of the month.
Invest that pot of money
Once you have a pot of money stashed away, you must put it to work for you, to earn for you. The easy, but bad option, is to put it into a Cash ISA account which may earn you 1.5% of interest a year if you’re lucky. £1000 would get you £15 of interest.
On the face of it, because bank savings are guaranteed by the government, you will always get back at least what you put in, even if the bank goes belly up. Except you don’t. Inflation works tirelessly to make sure you will get back just that little bit less than you started with. You may have got back £1015, but that £1015 is worth a bit less than you think. UK inflation was at 1.8% last year, so you have lost 0.3% in spending power from your £1000. That £1015 is actually worth around £997 after inflation, because everything got that bit more expensive since you put the money in. Worse still, you’re more likely to get less than 1% interest from your bank in the first place, making your £1000 worth less than £995 in real terms.
A better option to the Cash ISA is the Stocks and Shares ISA, that is, investing your money in the stock market. This is where a lot of people starts feeling uncomfortable or draw a blank.
Investing in the stock market needn’t be hard work. If you have a private pension, either via work, or started one yourself, then chances are, you are already invested in the stock market in the form of Funds.
What is a Fund
In simple terms, a Fund is like an investment club. You pay your money into the club, the club buy some shares using everyone’s money, then give you entitlement to a percentage of the whole pot in the form of units. As time goes on, more and more unit is added as more money is added by everyone and more shares are bought.
It is the fund manager’s job to look after the pot of money in the fund. They do the hard work of picking what shares to buy or sell, so you don’t have to. All you have to do, is decide which fund you want to put your money into and how much.
There are two broad types of funds, actively managed funds and index tracked funds. One is managed by a human team, the other is managed by computer algorithms. The former is slightly more expensive than the latter. A well managed fund should out perform an index fund, but that’s not guaranteed. Some years, an index fund will do better than the best managed funds.
A word of caution though, there are many rogue fund managers out there, who are more than happy to take your money, and proceed to make loses year after year, then have the nerve to charge you management fees on top of the loses. So choose wisely. Although once you’ve found a well managed fund, you should be able to leave them at it, and only check in every few months or even once a year.
How to buy Funds
You can buy funds from many online share dealing sites these days. The one I use, who is one of the biggest in the UK, with arguably the widest range of funds on offer is Hargreaves Lansdown, they are not the cheapest but they are one of the most trusted, so they are unlikely to run away with your money or go bump, taking your money with them.
You can open a Stocks and Shares ISA with HL and start investing in all sorts of funds as well as buying shares directly.
If you are under 40 years old, you also have the option of opening a Lifetime ISA, which I’ll write about another time, but is a good way to save up for your first house.
Compound Interests / Growth
If you don’t know the power of compound interest, then you really should spend some time to understand it, because it will help you achieve financial wellbeing more than anything else, more than your religiously putting away 10% of your earnings each month!
This is another reason why investing your money properly is important, rather than leaving it in a savings account.
Basically compound interest is interest on top of interest, or growth on top of previous growth.
The compound interest on a 1% interest from a bank for 5 years is 5.12%, but the total growth from a 5% growth of a well managed fund is 28.34%, that’s 23% more in just 5 years!
The difference between a few percent of interest or growth each year will make a huge difference over a long time.
Why have I put in 10% in the illustration above? Surely you can’t guarantee that kind of return year on year? No, I can’t. However, there are funds out there that have averaged 7%, 10% and even 20% of growth over many years. So it is plausible to get 10% average for 10 years.
Where to now?
The first step is definitely to just start getting used to paying yourself first. That in my experience is the best way to save, and gives you the best chance of achieving your savings goal.
When you pay yourself, make sure to put the money into a separate account, ideally with a different bank, so you don’t see how much you have every time you log into your current account. While some of us have more will power than others, we all have a limited reserve of will power. Help yourself by not letting yourself see just how much “spare cash” you have. That pot of money is for your long term financial wellbeing, for genuine emergencies only, not for splashing out on a new car or kitchen or house extension. If you want a new car or what not, you will have to save for it separately from the 90% after you’ve paid yourself.
This may sound like impossible to you if you’re not in the habit of putting away money each month, but believe me, you will feel much better about yourself when you can finally stop worrying about losing your job, or the boiler breaking down, or where to find money for the next emergency.
A word on risk
There are of course risks associated with the stock market. Values of shares, funds, stocks, will go up and down all the time. Do not put everything in one basket, do keep some money in a cash account and take the hit of the low interest, in return for quick access to money for emergencies.
This piece of writing should not be taken as advice of any kind, I don’t have any kind of financial qualifications at all. I wrote this based on my experience only and mistakes are expected. Please seek professional advice before investing.