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Taking stock of your finances: step four

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AR011063 01/2018

Repaying debt and saving

If you’ve followed the advice in steps one to three of this guide, you should have a goal – or goals – and feel confident that you can cut your spending by at least a few hundred pounds a year. Time to put these two things together.

Having reduced your monthly expenditure, the best way to cement those savings is to set up a regular direct debit into a bank account or savings plan, such as a stocks and shares ISA. 

But before you do so, make sure you clear any high interest debts first. 

For example, daily fees for unarranged overdrafts can easily cost you £100 a month, so make sure you get your balance back within the agreed limit. Even then, you could still be paying high interest (typically 15-20%) within an agreed overdraft limit, so make sure you try to run your account in credit at all times. 

Credit cards can also be costly. If you don’t think you will repay your balance quickly, try switching to card that offers 0% interest for an initial period, and aim to clear your debt before that period expires. 

Short-term to medium-term saving goals

Match short-term goals (from a few months up to four/five years) with short-term savings plans. For short-term goals, cash is king. You can’t afford to take too much risk over short periods as you don’t have the time to recover from a fall in the value of your investments. 

Consider an instant access cash ISA or an instant access savings account. Basic rate taxpayers who save in cash deposits can earn £1,000 a year in interest without paying tax and higher rate taxpayers can earn £500 a year. This means you are free to choose a non-ISA savings account if you can get a better interest rate (and you usually can).

If you have a lump sum to set aside, you could also consider a fixed-term deposit for any period from six months to five years. This might earn you a better rate of interest, although you would be penalised if you then wanted to access any fixed-term savings early. 

With interest rates so low, it won’t make a huge difference whether you go for instant access/term deposit rates or ISA/non-ISA rates. However, those savings have been hard won, so make the most of them even if you are only a few pounds better off.

Remember also that inflation may reduce the spending power of cash savings.


Medium-term goals

You might want to consider medium-term investments if you’re saving to pay for something 5 to 10 years into the future. 

Over this term, investors who are prepared to take more risk should go for a wider spread of investments, also known as ‘assets’. This could range from cash (instant access and fixed term deposits) to bond funds, through to share-based or ‘equity’ funds.

For people who find it difficult to choose what investments to buy, providers who sell ISAs and pensions usually provide a range of ‘ready-made’ funds or a portfolio of funds that match the amount of risk you are prepared to accept.


Longer-term goals

For goals that are 10 or more years away, shares (equities) have historically produced the best return over most, but not all, long periods. The return from shares is not guaranteed and the value can be volatile. Even over longer periods, most investors diversify their investments and keep some savings in bond funds, and some in cash. 


Regular savings

Regular saving reduces the risk of investing all of your savings when the market is at its peak value. That is because you are buying investments at the prevailing price each month, or each year, over a longer period. This means you will buy investments at closer to the average price rather than at the highest price.  

Remember that no investment is guaranteed and its value can go up and down. And you could end up getting back less than you invested.

Your attitude to risk and capacity for loss

You should also consider your own personal tolerance to investment risk.

If the thought of your savings falling by a large amount over a short period would make you lose sleep, then perhaps investments that are more volatile are not for you.

You might also be prepared to take more risk for some goals than others.

For example, it may be fine to accept the risk that your planned round-the-world trip could turn into a less extravagant trip if your investments don’t perform so well (or a more extravagant trip if your investments do perform well). But it may not be acceptable that you won’t be able to pay for the cost of your child’s university accommodation, if your investments perform badly.

If you’re unsure as to what investment approach would suit you best it’s recommended that you seek professional advice. Whatever investment approach you take, make sure that you review your investments regularly to ensure that they still meet your needs. 

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