If I asked you to write a list of your priorities for the rest of the year what would be on it? If you’re like me you’d probably include things like spending time with friends and family, and becoming more healthy.
During our working life we tend to make sure that we earn at least enough money to achieve these in the here and now. However, we also need to think about what happens when we stop work (or if we are forced to stop working). We will need money saved now to live the life we want in the future.
Money behaves a little bit like water in a bucket with a hole in it. If we don’t actively do something with it the tendency is for it to leak out and away. Some people have excellent self-control, but for most of us it leaks out in the form of impulse purchases or other non-essential spending. Creating a financial plan will help you focus the way you manage your money, so that you can do the things you want to in your life.
Step 1: your income
Most of us have a fairly good idea of how much money we have coming in each month. As we roll into the new tax year our Personal Allowances will be increasing slightly and the basic rate part of our income will be increasing too. This will generally provide a small, but welcome increase in the money we have available.
If you are an employee, you will by now have been automatically enrolled into a pension by your employer. This means that you are already automatically saving towards retirement. The minimum contributions started low at 2% p.a. (at least 1% p.a. from the company) and are increasing. 6 April 2018 saw this increase to 5% p.a. with at least 2% being paid by the employer.
Whilst most allowances have increased, there are a few groups that will see their taxes increase. For example, the Dividend Allowance has now reduced from £5,000 to £2,000, which could mean paying tax at 7.5%, 32.5% or 38.1% on more of your income as a result. If you live in Scotland the tax you pay on most income (except Interest and Dividends) will become more complicated. Tax rates for income over £24,000 will increase by 1%, but a small part of the basic rate band will now suffer 1% less tax.
This all means that the amount of money you have available to spend this year is likely to be different. Knowing your income after tax is vital to working out how much you can afford to spend and save for the future.
Step 2: your spending
It’s not uncommon to not really know how you spend your money. We probably have a fair idea about the regular amounts which tend to be related to our homes – rent or mortgage, council tax etc. However, when it comes to the smaller items like phones, coffee, lunches, and entertainment. I’d expect you to be a little less certain.
We need to have a good understanding of where we are spending our money. I remember my dad telling me that when he started University he wrote down everything that he spent to help him manage his money. Some online banking systems let you categorise your spending and set a budget. There are also apps that you can give permission to ‘read in’ your transactions and help you understand where you are spending your money.
Research consistently shows that people gain more long lasting satisfaction from spending on experiences rather than things. Why not review your spending and see whether it is aligned to your values and whether it improves your wellbeing?
Whilst there are areas of ‘essential’ spending (travel expenses, utilities etc.) this exercise will probably reveal a few areas that don’t really match your priorities. These will be different for everyone, but these are areas that you could choose to redirect to savings.
Step 3: acting on it and saving
It’s one thing to know how much we have going in and going out. It’s quite another to act on this. Simply saving money by not spending it (and leaving it in your current account) is unlikely to have a real impact on your financial future.
A wise principle is to ‘pay yourself first’. This means physically moving money out of your current account into savings or investments. Essentially you are paying your future self. Doing this before your other spending prevents it leaking out. You might want to use a direct debit or standing order to do this automatically so that your saving is almost unnoticeable.
Once you’ve worked out how much you are going to pay yourself first you need to decide where to put it. There are some current accounts that pay interest, but they are in the minority. Having some money in cash to cover emergencies is sensible, but it’s not a strategy for the long term. Inflation means that prices tend to go up which means our money buys less things.
For money that is going to be sitting around for a long time it may be prudent to invest it. Whilst the value can go down as well as up, over the long term we would expect returns to be greater than cash. Investing money on a monthly basis can help smooth out the highs and lows.