Originally Posted on Reaching Aspiration – updated 15/01/19
People stress the importance of saving money, but there is less guidance on how to actually make it work for you. How to grow your wealth. Unfortunately putting your cash in a savings account and contributing to your workplace pension is unlikely to cut it.
Step 1 – Know why
The why will differ from person to person, but I expect will be some combination of the following:
- Logic – Compound effect – Knowing that assuming a reasonable return (7%), every 10 years you wait, you literally halve your retirement pot.
- The Stick – Misery – Being poor can suck.
- The Carrot – Financial Freedom – Once you are financially secure (or at least stable), your mind can explore so many more possibilities for your life.
How much will you need? – This will be very country and lifestyle specific. I could give you some calculations, but that will probably put you off. What is important is to balance between living now and saving for later. There are loads of calculators available with a quick Google search such as here.
Step 2 – Find the money
A lot of people say they can’t afford to save. Somehow (Parkinson’s Law?), expenses always seem to catch and overtake income – I certainly have experienced it.
We may need to live like there is no tomorrow, but we should definitely save like there is one. A good rule of thumb is that 20% of your income should be spent on your future self:
- Paying off debt (steals from your future),
- Educating yourself; &
- Crucially accumulating wealth.
Even when paying off debt, try at least contribute to your pension and slowly increase your cash safety net (not having one, means you are more likely to go into debt again).
Is 20% enough for you? – I have no idea, it depends on your aspirations, how old you are, your lifestyle, how much debt you are in, how much savings you already have. Could be more, could be less.
What are some ways you can find 20%?
- Cut down fixed expenses – Often the easiest and quickest way. Scroll through your bank account and identify places you could save. Perhaps downgrade that mobile phone package, cancel that subscription, find a cheaper gym, eat or drink out each week on fewer occasions.
- Spend what is left tactic – make sure your investments (and fixed expenses) are paid straight straight after pay day. Then spend the rest as disposable income.
- Save more tomorrow – Whenever you get an increase or bonus, commit more than 20% to Wealth Accumulation. Do it straight away, before those expenses catch up again. I wouldn’t suggest the whole increase, but more than 20%.
- Earn more – Find a second job, get a raise. Not usually easy or a short term fix, but something that could be looked at longer term. The second job may also mean you have less time available to spend money.
Step 3 – Have a simple strategy
I would love to give you an optimum strategy, but your circumstances are unique and optimum could mean complex, which could mean you don’t end up doing it. As mentioned, unfortunately, having a cash savings account (even tax efficient) and workplace pension is unlikely to be enough, so you should should complementing your strategy with other investments.
There are four key principles to consider when investing:
- Start early – The earlier you start, the more the compound effect kicks in and chances you can “ride out” unfavourable market conditions.
- Diversify – Don’t have all your eggs in one basket. Diversify across asset types, geographies and industries. There are some great index funds that will do this for you.
- Reduce commissions and taxes – Probably the most strategic thing you can do. Fees and taxes can significantly affect your return. By reducing your commissions you can add 50% to your Wealth (A mere 1% reduction, over 40 years and 7% return.)
- Re-balance – Selling some of what has done well, buying a little more of what has not done as well. Sell high, buy low.
That is it, although some concepts may be new to you, it is worth taking time out now to get your head around them.
Typical Pillars and thoughts for a strategy:
Depending on your experience and personal situation, these are some of the things you could be considering.
- Pension – Is generally tax efficient (pre-tax) and typically a core pillar. 10%-20% (Including employers contribution) is often considered enough, but some additional questions to guide you:
- Is it tax efficient? – Most are.
- Is it diversified? – Across geography and industries.
- Am I maximising my employers contribution? – Particularly first time employees often miss out (big).
- There are loads of providers to chose from, I use Pension Bee (Referral Link) and Scalable Capital (Referral Link).
- Property – People like property, it can be seen, it can be touched. On the flip side it is highly leveraged and typically not tax efficient (other than personal property), returns are often over estimated, as people forget about the expenses along the way. Consider 0%-10% directed towards property if it is appealing to you, more if it is your personal property.
- Typically people focus on one area that they know well
- It is hard work and admin intensive – So return is sometimes proportional to the effort put it.
- It is Leveraged – meaning that the investor is basically investing the banks money and some of their own. Which is great in good times, but remember it can drop 50%-70%. Have you watched the “Big Short”?
- Cash – Having a cash pool, allows you take take calculated risks. Typically a good “emergency fund” should cover 3-6 months of expenses. Of course it may be useful to have more, perhaps to pursue business and investment opportunities when they arise. If you can’t find any worthwhile investments, consider holding cash for a while, perhaps even a few years. The danger is that it gets spent on expenses rather than investments and that you never get a worthwhile return.
- Tax Friendly Investments E.g. ISA in the UK, you don’t pay tax on gains) – 5%-15% could be about right. Focus on diversifying your risk.
- Other – There are multitude of other opportunities, such as setting up an online business. They are a lot of hard work to set up, but if done right, can provide a decent passive income, with moderate on-going effort. I would caution any “fool-proof system”, there is likely to be at least one fool involved. Some more resources to investigate:
To wrap up, consider if you need to get a financial planner, particularly when things like Inheritance Tax come in to play, but delegate, don’t abdicate your responsibility. Know enough to know when they are not giving you appropriate advice. Being Financially Literate is your responsibility, but we are here to help, so why not start with our free course?