My son has his first proper full time job, so he has disposable income to save and is savvy enough to see that he needs to set some goals in place. He asked for some guidance, so I thought about what he needed to explore. This is not a simple “do this” or “do that” as there are quite a few variables to take into account.
First variables; are you saving or investing? Saving suggests a relatively short period accumulating assets, say less than 5 years and small amounts put away regularly, probably under £1000 per month. Saving also suggests a guaranteed return at the end of the period, although that return may be modest to the point of invisibility after the effects of inflation. Investing implies a longer period of accumulation, 5 years and more, either regular amounts being put aside or larger lump sums and an unpredictable return, anticipated to be more than cash, but could even be less than the amount you have contributed. Some element of risk in investment is inevitable.
The next variables are your attitude to investment risk and your capacity for loss. These phrases are a bit of industry jargon, but they are fundamental to understanding the risks and rewards of investment. Your attitude to investment risk is asking you how willing are you to take a calculated gamble over an extended time period. As an adviser we usually measure this on a scale of 0 to 5, where 0 is “no investment risk at all”, close to “cash under the mattress”, with no desire to accept any investment risk and reluctant to pass control to anyone else; and 5 is closer to betting on the 2:30 at Newmarket, willing to accept significant risk of a big return or a total loss and willing to pass control to another party. Betting is not an investment, there is not a significant time element; a better analogy would be buying single company shares in China or Brazil, which are exposed to significant risks, but the anticipated returns are high.
Capacity for loss asks if the total loss of the sum invested will impact adversely on the lifestyle you hold now. For a young adult, as they might reasonably expect to be earning for 40+ years the loss of three months’ income, although a setback would not be a disaster. For a retiree, the loss of accumulated capital would be a significant blow, as the opportunities to earn it again are very limited. Acceptance of investment risk and capacity for loss should be considered together when offering advice as accepting high risk when there was no capacity for loss would be foolhardy!
The next variables are how much can you afford and what are your ambitions? It is very easy to be a hedonist and spend all you have, (and more), on pleasure of one form or another, but to steal a truism, wealth is a measure of what you haven’t spent! To get what you want in later years, you will need to accumulate wealth to do what you want to do without being a slave to the bank or credit cards. Borrowed money is never without strings and it can cost you more than money alone.
The order of business should be;
Sort a budget. Set aside a sum of money to save regularly and stick to it, say 20% of your net income. Transfer it out of your current account to an instant access deposit account and leave it there until disaster strikes; the first priority is an emergency fund to meet short to medium term disasters, like sickness, loss of a laptop or a car breakdown. This is to keep you out of expensive debt and should be about 3-6 months of net income.
Once you have an emergency fund in place, set up a Cash ISA to hold the sum, tax free, on the expectation of not spending it. If you have a “flexible ISA”, you can take out and put back savings up to the annual limit of £20,000 in the same tax year.
Once you have an instant access emergency fund in place, consider what you want to save for and how long it will take. If the time scale is less than 5 years, then stick to cash assets and stay within the Cash ISA environment, (but shop around annually to get the best rate).
As soon as you have a financial goal of more than 5 years, look seriously at investment rather than saving. Currently savings rates are at or below the rate of inflation, so the value of your money is being undermined as you are accumulating it. Use an ISA wrapper to keep the administration and tax simple; get professional advice to find the right combination of investment assets.
If your employer offers an occupational pension scheme, put in at least as much as will get you the maximum employer contribution. It is as near as you will get to free money, although you won’t be able to access any of it before your 55th birthday!
If your employer offers a Sharesave scheme or some form of profit sharing, look at it seriously and get advice if you don’t understand it. Most people will benefit from them, so don’t let apathy rule.
The fastest and most certain way to increase your net investment returns is to keep the costs down, so concentrate on keeping the annual charges down and look for high value products; perhaps passive funds in developed markets and active funds where an active manager’s knowledge and insight delivers additional value.
Almost all investment products are a combination of cash, corporate bonds, government debt, (“gilts”) and equities, (shares), so direct exposure to these assets will be cheaper, but more volatile, than packaged retail products. Look to buy shares for the long term; utility and multinational companies tend to be a good store of value over decades, but remember that diversity will reduce your risk overall.
Most successful investment is about being in the right place at the right time; keep some cash for flexibility and try to avoid a forced sale of assets because you have run out of options.
Try not to follow the crowd. All markets go from boom to bust in regular cycles, so blindly following the crowd will make and lose your money. Another truism is buy low and sell high – the theoretical ideal!
If you would like to know more about how we can help you plan and realise your financial goals then contact us at firstname.lastname@example.org or call us on 01223 792 196.
The information contained is for guidance only and does not constitute financial advice. It is based on our understanding of UK legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. Accordingly no responsibility can be assumed by Martin-Redman Partners its officers or employees, for any loss in connection with the content hereof and any such action or inaction.