At last week’s Work Your Money, Honey event, Jeanette Makings from Close Brothers and Rebecca Tunstall from Rathbones helped us understand the importance of saving and investing as a means of controlling our financial futures. But for those who did not make the event all is not lost; this recap will give you a solid foundation for starting out in saving and investing:
Saving – the gloom
The latest research on women and their long-term savings is not pretty reading. A person on the average UK salary with no career breaks is estimated to earn a pension pot of £327,791 by the age of 65. For a woman who has taken two 6 month maternity leaves, the first at 30 and the second at 33, and then returns to work 3 days per week after the second leave, the pension pot drops to less than half, £160,177.
The big picture – looks rosy
On the flip side, women are set to own 60% of the UK’s wealth by 2025, making investing an important step in ensuring we’re maximising the money we do have.
So how do we start with saving effectively? Here are the 7 steps to financial wellbeing:
- Planning and budgeting
- Managing debt
- Protection – death in service, income, health, unforeseen costs
Next priorities are:
- Retirement planning
- Savings and investments
- Property and mortgages
And the final priority is:
- tax efficiency.
And when it comes to savings there’s also a hierarchy. Top priorities are to manage your debt – that does not mean have no debt, but manage it so that you are able to make regular and achievable payments on the debt you have. The second priority is to have a rainy day fund. The rule of thumb for rainy day funds is to keep 3-6 months of your total expenses. Then after that, you can look at pensions, ISAs, share plans and other investments.
Other things to consider in saving strategy is what the objective is, what are you saving for. If it is a short term investment goal, ie. up to 5 years, then savings should be in a very liquid asset. That means it can be converted into cash very easily eg. cash-based savings (bank accounts) or Cash ISAs. If the goal is over 5 years away, such as for retirement or school fees then we can start looking at other places to put our hard-earned £££ so that it can take advantage of different instruments to grow over and above savings rates (which is not hard in this era of low interest rates). These would be stocks and shares ISAs, company share plans and other investments.
If we want to delve more into the hows and whys of investing we need to look at the different drivers that impact your money.
If you want to save there are three things you can do: put the money under the mattress (cash); put it in the bank account (cash); invest it.
The problem with putting cash under a mattress or in a bank account is that over time, inflation means that the value of that money actually falls. What that means is that if, for example, inflation is 2% then what we can buy with our money is 2% more expensive each year. And so the value of the money we have drops over time.
Furthermore, interest rates these days are so low that even if we put the money in a bank account, the interest we receive on it is not enough to cover the value lost through inflation. eg. if we happen to have £1m in our back pockets we could put it in the bank and receive 1% interest (£10,000). This is then taxed at 40% (£3,800). If inflation is 2% (current estimated rate of inflation) then our money is only worth £986,200. Tough problem to have if you have £1m. But you get the gist…
Investing meanwhile has been shown to give an average annual return of 5%. What’s more, with compounding, over time this adds increasing amounts to your initial investment on an annual basis. For example, if you invest £100 in the first year with a 5% return, you have £105 at the end of that year. In year two you start with £105 and so at the end of year two, you have 5% of £105 which = £110.25. And so on. Over time this can compound to a large amount. eg. that same £100 would be £265 after 20 years ie. two and a half times the original amount.
So what are the main types of investments you can make to start attracting compound interest?
- Equities – stocks, or shares. Owning an equity means you own a little piece of the company. You may receive dividends which could be an important part of income in later life.
- Bonds – you loan a sum of money to a company or a government. They pay you annual or semi-annual interest payments and pay you the whole amount at the end of the life of the loan (called redemption).
- Unit Trusts – the fund makes investments in a number of equities. You buy the fund.
- Tracker Funds – passive investing. invests in all the companies in an index. eg. FTSE 100 tracker will invest in all the companies in the FTSE 100.
When considering the type and amount to invest there are a few decisions to make first.
- Risk vs return.
How much risk are you willing to take? The higher the risk, the higher the potential return. But also the higher the risk the higher the likelihood of losing a lot. eg. government bonds are relatively safe. You will not get as high a return as with equities, nor will you lose much. For equities however the returns are higher than government bonds but you may lose big as well if the markets go against you.
- Correlations and diversification
The key to successful investing is to invest in assets which have no correlation or are negatively correlated. What that means is that if one of the assets will go down the other will not go down similarly. For example when equities are losing consistently and the economy is looking weak, gold is often an asset which will rise in value. Having both means you can mitigate some of the risks for an overall portfolio.
OK, so we’ve tried to bust the jargon. Hope we succeeded and you are starting to understand the nuances of saving and investing. Any questions just let us know!
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Vivien de Tusch-Lec