A beginner’s guide to saving money

by Stefani Williams, Financial Planner

According to the Office for National Statistics, almost half of individuals aged between 18 and 29 have no accessible savings1. With today’s young adults less likely to have money set aside, the lack of readily available savings could mean that they are increasingly dependent on debt or the bank of mum and dad.

Much to our dismay, Personal Finance is still not a compulsory subject in schools, making it easy to understand why young adults simply don’t know or understand how to invest. With this in mind, we write with our saving tips for those starting out on their savings journey. In the event you already have well established savings provisions in place, please feel free to forward on to the younger generation, if you think it would come in useful.

1. Think about your savings across 3 time-frames:

  • Short-term (5 years and under): Keep these savings in cash and make sure you have enough kept aside for emergencies (eventually, you want to aim to build up around 3-6 months’ salary), i.e. your “sleep at night money”. Although the interest associated with cash is currently relatively low, you can be guaranteed to preserve the capital value of these savings during this time-frame. Comparison websites are a good way to establish which cash accounts have the best associated rates of interest.
  • Medium-term (5-10 years): Consider investing these monies. Although the monies will be subject to some investment risk, the longer you invest, the more likely you are able to weather low market periods. Over a medium-long term period, higher risk investments (such as stocks) tend to have higher returns, compared with lower-risk investments. A stocks and shares ISA (detailed in section 4) can be a great way to save in a tax-efficient manner over the medium term.
  • Long-term (10 years+): Again, with more time to weather low market periods, you should you consider investing these monies. By adopting greater investment risk with the monies, you have the potential to benefit from greater rewards. Pensions (detailed in section 4) are a tax-efficient way to save over the long-term, towards your retirement provision.

Depending on what stage you are in your life, you’re likely to want to focus on one of these time-frames; however, it is important that you save towards each.

2. What to invest in and what is diversification?

  • We strongly believe in investing across a diversified range of investments, i.e., investing across a wide variety of asset classes, e.g. higher-risk investments such as equities (shares in companies) and lower-risk investments such as bonds (a loan which you receive a fixed-interest from). The aim of this is to smooth out the risk associated with your monies (as one asset class is falling, hopefully the other is doing the opposite and increasing).
  • When you begin your savings journey, a ‘balanced’ fund is a good start. A balanced fund will be managed by an investment manager, tends to be inherently diversified and will be available in both ISA and pension wrappers. Make sure you do your research on the available balanced funds, as different funds will have different track-records, as well ethical mandates and risk profiles.
  • If investing for “good” interests you, there are now plenty of ethical funds available and you don’t necessarily have to sacrifice returns to invest in this way.
  • It’s important to note that enhanced returns from investing isn’t guaranteed. In addition, past performance of an investment, is no guide to future returns.

3. Although it may feel like a long way away, don’t forget about retirement and start saving for it now

  • It’s easy to neglect your retirement savings, when you’re thinking about getting on to the property ladder (or your next holiday!); but, thanks to compounding, the earlier you start saving into your pension on a regular basis the better, even if just a small amount each month.
  • Currently, the maximum one can receive from the Government in the form of a state pension is around £8,500 per annum. With £8,500 falling well below the average family spending needs2, it’s not hard to see that you will need an additional pot of money to contribute to your income needs.
  • By way of an example, if you retired today with the need for an additional £20,000 gross a year (bringing your total income to £28,500 per annum), you would require circa £400,000 in additional retirement savings!
  • With minimum contributions in auto-enrolment employer pension schemes increasing to 8% per annum, saving for your retirement has become easier. Aegon estimates that the average 22 year old starting an auto-enrolment scheme could have pension pot of £450,000 by the time they reach age 68.
  • In addition to the above need, pensions have good tax savings, which we refer to in greater detail below.

4. Make use of the tax-advantageous investment wrappers

The two key methods of saving in a tax-efficient manner (for UK residents) are investing into an ISA and pension. We discuss the benefits associated with both, below:

ISA (Individual savings accounts):

  • There are two main types of ISAs – Stocks and Shares ISA (for when you are prepared to take some risk with your medium and long-term savings) and Cash ISA (for when you want to take a more cautious approach with your short-term savings).
  • You can save up to £20,000 individually in any one tax year; and have the flexibility of contributing on a monthly or ad-hoc basis.
  • Benefitting from tax free growth, this is a great way of building your savings in a tax-efficient manner.
  • In addition, you can withdraw monies from your ISA whenever you choose, with no tax liability.

Pensions (defined contribution):

  • Like your ISA, any monies held within your pension benefit from tax-free growth; which is really beneficial when you’re saving over the course of several decades.
  • In addition to this, you can benefit from immediate tax-relief of 25% of the amount you contribute. For example, in the event you make a £1,000 contribution into a pension, you will immediately receive £250 from the Government in the form of tax-relief. To help with some of the jargon, your £1,000 contribution is referred to as a ‘net pension contribution’, and the total £1,250 is referred to as the ‘gross pension contribution’.
  • For those with earnings over £46,350 gross this tax year (2018/19), you might also be able to benefit from additional tax-relief through a reduction in your tax-bill (this additional relief is not automatic, and you will need to inform HMRC of your contribution to benefit from this).
  • The amount you can contribute in any one tax year is limited to your earnings or £40,000 gross, which ever is lower.
  • In the event you earn over £110,000 per annum your annual allowance might be tapered below these levels (your annual pension allowance could fall to £10,000 per annum). As it’s quite a complicated calculation, it’s important to get advice in this area.
  • In the event you are a non-earner, you can still contribute into a pension and will be limited to £3,600 gross per tax year.
  • Under current legislation, you can’t access your pension until you reach age 55. Although this might seem like a negative, it does mean that the money is locked away so you can’t be tempted to take some funds out during your working-life and subsequently be at a disadvantage when you eventually come to retire.

Other hints and tips:

  • You might not think you have cash available to save, but just remember every little counts, no matter how small. If you set your direct debit for regular savings the day after pay-day, you’re less likely to feel the pain of money leaving your bank account!
  • Keep your cash savings separate from your main current account. This way, you’re less likely to dip in.
  • Do your research. By having a better understanding of personal finance, you will have greater confidence in savings and investments, which will inevitably work in your favour.
  • When investing your money in the stock market, you will typically be more cautious at the beginning of your journey as you simply don’t have the experience in investing. Remember – adopting some investment risk with your monies can work in your advantage over the long-term.

Money management doesn’t need to be as difficult or complicated as some people make it seem. If you’re unsure about something, ask someone who might know – taking small steps and learning the fundamentals of financial planning can lead to big results. It’s also important to make sure you have the right level of protection in place, to make sure that you and your family is protected in the event you die or are unable to work. Previously written articles regarding different types pf protection can be found here: income protection article and life assurance article.


The content of this article is for your general information and use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be, or constitute, advice.


Footnotes:

  1. https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/articles/howwellareyoudoingcomparedwithotheryoungpeople/2018-10-04
  2. https://www.ons.gov.uk/visualisations/nesscontent/dvc203/index.html
  3. https://www.thisismoney.co.uk/money/pensions/article-5490761/Employees-opting-workplace-pensions-throwing-450-000-away.html

Stefani Williams
Financial Planner