Habits that build financial well-being
A few years back I heard a speaker talk about the 10,000 hour rule. In his best-selling book “Outliers”, Malcolm Gladwell suggests that you can become successful in any field simply by putting in the hours. If you google “10,000 hours of practice” you will see articles both for and against this. There certainly is an element of truth here – practice builds habits.
However, one of the surest ways not to become successful is not to start. This applies to areas as diverse as business, relationships and sport. Building a good habit starts with a start.
We need good habits with our money
There are two key parts to financial planning and for many people they overlap. Firstly, we have a goal that we want to achieve and for many of these we need money to pay for it. Some goals are relatively mundane (a roof over our heads and food on the table), but others tap into our deeper desires to have experiences. A common goal is to have a comfortable retirement, but before we get to that there will be others. Secondly, we need to build up the money to do this.
Not many people suddenly find themselves surrounded with the money to achieve fund their future. More often than not they have developed a habit of saving and investing.
Before we start
We need to ensure that we can afford to pay our bills and meet our commitments. If we are living beyond our means we need to radically revise our spending or seek to increase our income. Failure to do so will ultimately lead to bankruptcy potentially with pain and difficulty in other areas of our life along the way.
We then need to be certain that we can continue to do this even if our income was interrupted. It is also important that this emergency fund covers unexpected expenses – they will arise at the least convenient times. For most people 3-6 months’ worth of core spending is about the right amount of money to hold as an emergency fund. If your income tends to be quite variable this probably needs to be a bit more.
Building the habit
We need to be intentional and take action. Money is very easily spent. If we plan to save what is left over each month we might save some money. However, when the temptation arises to spend some of this part of your budget, you might seek short-term gratification at the expense of your longer-term financial health.
A more successful habit is to take saving out of your control. Automate it and do it before you ‘see’ the money in your account. This requires an act of planning and reduces the reliance on your self-will to follow through.
Start by working out roughly what comes in each month. Set aside bonuses for a moment as you may want to consider a separate ‘rule’ for them (e.g. half spent, half saved). Write down your key financial commitments (mortgage, bills, food, transport) and how much money you want to allocate to leisure. The difference between the two is how much you could put to work for the future.
At the very least immediately set up a direct debit to move this money out of your current account into your savings account. This small barrier will help reduce the temptation to save this money which should be being built up to fund our financial future.
Putting our savings to work
Having taken the first steps we need to make sure that our money is not idle. Some of our money should be held in cash – particularly if we need access to it in the next couple of years. However, over the longer term, interest rates for cash are lower than the prevailing rate of inflation – this means that your money has less buying power over time.
For these longer-term purposes, we tend to invest. Unlike cash, the value will go up and down, but over the longer term the trend tends to be up. If we knew whether markets were going to be up or down, we could pick the right time to invest to maximise profits and minimise losses. This isn’t the case. Investing is full of clichés and one which is true is ‘time in the markets, not timing the market’.
One way we can reduce the impact of the ups and downs is to invest on a monthly basis. Given that we don’t know what markets will do from day to day or month to month, this stops us from investing all of our money at a peak and maximising losses. Some of our money will be invested when markets are down, so when they recover we are rewarded. Over the longer term investing monthly averages out the highs and lows.
The rewards of a good investment habit
Starting your investment habit now means that your money has more time to grow. Albert Einstein said that “compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it”. Investing now on a monthly basis should result in a greater return than waiting until you have built up a larger amount of cash.
The chart opposite shows the power of investing £250 per month for 10 years, and then letting it accumulate for another 10 years. For the purposes of this chart we have assumed an investment return of 5% p.a. after charges.
So how can I get started investing
Investing for the first time can seem daunting. Markets go up and down, and there are literally hundreds of opportunities out there to choose from. Making the right decisions for the long term can be tricky. So where to start?
One of the first decisions you’ll need to make is whether you want to manage your own investment portfolio – and there are a number of online platforms where you can do this – or whether you’d rather let a professional do it for you. At EQ, we specialise in making investing easy by offering the latter kind of service… so we’re clearly a little biased!
If you are thinking about managing your own portfolio online, it might be worth checking out our online calculator to see whether you really will end up saving you money by ‘doing it yourself’, once you’ve accounted for the time it takes to do this properly.
If you’re looking for a straightforward and cost-effective way to have a team of investment professionals do the heavy lifting for you, why not check our online and telephone investment service.