The advice I wish I’d been given
As part of our GetAdvised campaign, we’re looking at ways professional advice can help you evaluate, develop and implement a solid plan to support your future. Jason Butler gives us the crucial financial advice that he wished that someone had given him in his salad days.
Making good financial decisions can make a big difference to your quality of life. While not all life goals have a financial implication, many do, and the choices you make in the early part of your adult life will probably have the biggest impact. Over my 25 years in the financial advice profession, I’ve learned some valuable principles and practices for managing personal finances, which I wish someone had shared with me when I was a young adult. Here is a summary of what I think all younger people should consider when thinking about their personal finances.
“Debt can be used responsibly to enable you to buy things today that you really need, like a home to live in, but for which you don’t have enough money to afford to buy outright.”
Here are your basic principles:
Watch your spending
It doesn’t matter how much you earn. If you spend all, or more than, you earn, you’ll always be poor. While it is easy to be seduced into buying what you want, rather than what you need, deferring gratification and living within your means is the cornerstone of financial success. It’s a good idea to track your spending for a week or a month to get an idea where your money goes. Small but regular changes in expenditure can free up cash that you can use to build financial security. As the old saying goes: ‘Fools work for money and money works for the rich.’
Pay yourself first
Your financial security is the most important priority when it comes to devising a personal expenditure budget, before rent, travel, socialising etc. I don’t mean that you should live like a pauper in pursuit of saving for the dim and distant future, but rather change your mindset so you prioritise regular saving as the first expense that you need to meet. A bit like fitness training. Start small to begin with and then gradually increase the amount you save.
The devil of debt
Debt can be used responsibly to enable you to buy things today that you really need, like a home to live in, but for which you don’t have enough money to afford to buy outright. Whatever the reasons for which you borrow money, remember two things: interest is a definite regular cost that will reduce your ability to save and the capital must eventually be repaid.
While current interest rates are low, they won’t stay like that forever and you need to think very carefully about the impact on your expenditure if interest rates were, say, three times higher than at present (as they have been in the past). For this reason, even though buying a home with a mortgage can be a good long-term use of funds, make sure that you don’t overstretch yourself. There’s more to life than paying a mortgage! Also avoid at all costs any form of borrowing on credit/store card or payday loans.
Keep it simple stupid (Kiss)
The technology company Apple has made a virtue out of simplicity and it drives everything it does. You should adopt the same mindset to your personal financial planning and keep things as simple as possible.
If it looks too good….
If anyone tells you that they have a sure bet investment that is virtually risk-free and will generate a 10 per cent return in a short time period, and it looks as though they actually mean or believe what they are saying, you need to give them a wide berth. If it looks too good to be true then it probably is.
You need to avoid becoming obsessed about avoiding tax. There is a whole industry dedicated to feeding off the greed and stupidity of people who hate paying tax and the authorities are increasingly attacking contrived and aggressive planning. A certain amount of tax is necessary for any decent society to operate in a fair and equitable manner. Minimise your tax bill by using all the legitimate and tried and tested products and solutions available, but not to such an extent that you don’t have enough money to live on today.
The media is not your friend
The media, in the form of newspapers, 24-hour news, websites or magazines, is not designed to help you to make good decisions. It focuses on what personal finance professionals call ‘noise’ or ‘financial pornography’ in the form of negative stories or sensationalist ‘get rich quick’ ideas because they are newsworthy. In general the news is not the truth but a form of entertainment, so remember that when forming your opinions about money.
Keep costs low and diversify
As a general rule with long-term investing you get everything that you don’t pay for. There is no evidence to support the commonly voiced (usually by those with an interest in the outcome) assertion that it is better to buy an expensive investment fund than a similar lower cost one. Costs are certain whereas investment returns aren’t.
Here are your basic practices:
Build a cash reserve
Having a cash reserve available is essential to enable you to cope with the inevitable ups and downs that arise in life. Your cash reserve should represent at least three months’ expenditure, plus any funds that you will need to spend within the next few years, such as a house deposit or education/training costs. A cash ISA will usually offer better interest than standard savings accounts and is free of income tax but avoid accounts that lock you in to a fixed term or charge a high transfer fee. You need to be able to access your cash should the need arise.
Protect your income
At the beginning of your working life your greatest asset is your ability to earn an income. If you were unable to work due to disability or illness for the medium to long term, it could consign you to poverty for life. Income protection insurance will keep paying you a proportion of your income until you can return to work or reach a certain age. Healthy young people can usually get this type of cover easily and at relatively low cost, so if your employer doesn’t offer cover buy your own personal policy. Do not confuse this with the (justifiably) much-maligned ‘payment protection insurance’, which pays out (if it does at all) for a short period only and does not provide any long-term protection.
Invest in yourself
In addition to a positive mental attitude, increasing your relevant skills and knowledge is the best way to increase your earning power. Therefore, looking for ways to invest in your capability, whether that’s night school, distance learning or day release by your employer, makes a lot of sense.
Join a pension plan
If you are offered the chance to join an employer-sponsored pension plan, then do so. Over the next few years (the exact dates depend on the size of the employer) all employees will be automatically enrolled in a pension plan through their employer unless they actively opt out. Whatever you do, DO NOT opt out because the employer has to make contributions in addition to your own and the government also contributes. If you are self-employed then contribute to a low cost pension with a choice of index funds and limit your risk by spreading your contributions across global markets, whether via one fund or several.
The earliest contributions make the most growth and can make the difference between a decent retirement income or not. Although these funds can’t be accessed until age 55, that might actually be a good thing!
Don’t rush to buy property
Although buying your own home generally makes more sense than renting over the long term, avoid rushing in to buy a house until you have established your earning power, know where you want to live (which may be dictated by your work) and have a clearer idea of who will be your life partner. Buying and selling properties is an expensive business and if you have to sell at a time when the value of the property has fallen and your equity is reduced, it can set you back years.
An interest-free loan from your family is the cheapest form of borrowing and payday loans are the most expensive. As a general rule you should avoid, or repay, debt as fast as possible, starting with the most expensive debt first.
Below is a simplified list of borrowing types in broad order of interest costs, with most expensive first. Typical annual interest rates* are shown in brackets:
- Pay day loans/doorstep lending (400 – 2,000 per cent)
- Pawnbrokers (130 – 500 per cent)
- Storecard (20- 35 per cent)
- Credit card (8-55 per cent)
- Secured personal loan (6-23 per cent)
- Unsecured personal loan (5-15 per cent)
- Residential mortgage – 95 per cent of property value (6 per cent)
- Residential mortgage – 85 per cent of property value (5 per cent)
- Residential mortgage 70 per cent of property value (3 per cent)
- Student loan – pre 2012 graduates (1.5 per cent)
- Borrowing from family (nil to 4 per cent)
Invest most of your long-term money in equities
Assuming you have followed all the previous suggested actions above, you should invest the bulk of any surplus income, plus your pension fund, into worldwide equities. A very rough rule of thumb is to take your age from 100 and the answer is the amount to invest in equities. Don’t worry about volatility (the value moving up and down) because, with an asset class which is expected to rise over the long term (20 years+) regular savings benefit from something called pound cost averaging. This means that the average price you pay for the investments should be less than the average price value of the investment.
As you get older you may need to reduce your exposure to equities but by then the compounding of returns (earning returns on previous returns) over time will have worked its magic and reduced the relative risk of price fluctuations because your capital should be worth many times what you invested.
*Sources: moneyfacts.co.uk, slc.co.uk, Bloomsbury internal research (19.09.13)