The UKPersonalFinance flowchart represents a great starting point when thinking about saving and investing for the long-term.
You can always find the latest version on this page, or a direct link at https://flowchart.ukpersonal.finance/
Step 0: Budget and reduce expenses, set realistic goals
Read more about this section: Budgeting
Fundamental to a sound financial footing is knowing where your money is going. Budgeting helps you see your sources of income less your expenses. There are many ways to budget successfully, and there is a whole FAQ page dedicated to it on the Wiki. Start there first.
It makes financial sense to minimise your outgoings – housing costs, utilities, and basic sustenance are harder to eliminate than “entertainment,” eating out, or clothing expenses.
Once your budget is figured out, you need to figure out what your goals are. Secure retirement? Buying a house? Saving for a car? We’ll get to specifics on how to save for these below.
Also consider the mnemonic PIPSI when considering what priority budgetary needs should have. This stands for:
- Protection: Life insurance is important if you have a young family or are the main breadwinner. It may seem like money for nothing but it can be invaluable.
- Income Protection: Some employers have income protection as a staff benefit. If not there are private policies available. Same reason as above.
- Savings: This relates to regular savings such as pensions and regular ISA contributions
- Investments: Lump-sum investments come last on the list of priorities.
STOP: Are you reliant on debt to make ends meet?
Step 1: Build a small emergency fund
Even if you have expensive short-term debts, we recommend that you build up a fund of at least 1 month of expenses to fall back on. This is a “small win” and will help build resiliance and reduce the chance of relapsing into increasing debt to deal with emergencies.
Step 1a: Invest in some reading material
It cannot be stressed enough how much benefit you could reap from reading/watching/listening to the recommended resources.
Pound for pound this is probably the best investment you could make, at outset. The page also includes online resources, podcasts and video series, if that is more your style.
Step 2: Minimum contributions to your automatic enrolment pension scheme
Once you have a small emergency fund you should make sure you are enrolled in your employer’s automatic enrolment pension scheme. This is a minimum of 3% extra pay in exchange for you contributing 4% of your take-home pay.
It is slightly controversial to recommend this ahead of repaying credit cards and personal loans, but as long as you are not reliant on debt to make ends meet (if you are, see section above) it is the best return on capital you’re likely to get anywhere.
What if I’m self-employed or not eligible to join the pension scheme?
If you’re employed but haven’t been automatically enrolled, it means you’re either too young or don’t earn enough. You’re almost certainly still eligible to join, but will have to opt-in. Speak to your employer.
If you’re self-employed you will need to arrange your own pension scheme. This is a higher priority than it would be otherwise.
Step 3: Pay off expensive short-term debts
Full article: Debt repayment
Before focusing on long-term savings and investments, fix any short-term finance leaks. Use the avalanche or snowball method (discussed in the debt repayment article) and get those debts paid off!
Step 4: Build an emergency fund
An emergency fund should be a relatively liquid sum of money that you don’t touch unless something unexpected comes up. The idea is not to dip in every time you forgot to budget for a night out, but for genuine emergencies. Redundancy, emergency home maintenance, and so on. If you need to draw from your emergency fund at any time, your first priority as soon as you get back on your feet should be to replenish it. Treat your emergency fund right and it will return the favour.
How should I size my emergency fund?
For most people, 3 to 6 months of expenses is good. A larger emergency fund (e.g., 9 to 12 months) may be warranted if your job is uncertain or you are self-employed. It is worth spending some time thinking about this, and ultimately it is a personal choice. Some opinions from regulars in this thread.
What kind of account should I hold my emergency fund in?
Generally emergency funds should be held in safe investments you can access quickly. Traditionally this might include high-interest easy access savings accounts, easy access Cash ISAs, or NS&I savings products (which are 100% guaranteed by the government). Other less obvious options are floating-rate note funds and similar, which are available on investment platforms. BE WARNED, however, that these are not completely risk-free. Many “cash” investment funds lost value in the credit crunch, for various reasons.
Latterly, current accounts have been offering far higher interest rates than savings accounts. This is generally used a loss-leader to get customers in front of the bank’s salesforce, but can be taken advantage of. Examples change all the time but can be found with some searching online. Aim for 3% or higher in-credit interest (late 2014).
Examples of bad choices for emergency funds: equity-based investments, P2P lending schemes, fixed-rate savings accounts with withdrawal penalties or no withdrawals allowed.
Step 5: Short-term (<5 year) goals
These goals might include saving for a house deposit, or school or university costs for you or your children.
Buying a house is often top of the list of priorities people have. Generally speaking, if you plan to buy a house in the next five years, any funds you intend to put towards this should probably sit in a savings account. Whilst the stock market may look attractive, this is too short-term a goal for the risks to generally be worthwhile.
One important point to note is that the deposit is not the only cost of buying a house. Budget for conveyancing fees, mortgage fees and other less obvious costs like valuations, damp inspections and so on.
We are lucky in the UK that most higher education costs are provided by way of subsidised loans. It may seem like common sense to want to repay these loans as quickly as possible (see Step 0a), but in reality the cost is usually much lower. Money Saving Expert has an in-depth guide about this which is essential reading for anybody looking at the costs of undergraduate study.
Step 4: Longer term (>5 year goals)
Next you should look at other long-term savings plans. In the UK you can basically choose between a (Stocks & Shares) ISA or a pension (SIPP, personal pension and stakeholder are all fundamentally similar).
ISAs and pensions have their own advantages/drawbacks. More detailed analysis can be found on this Monevator article, but in summary:
Please Note: The limit is £20,000 (18/19) per year in either Cash, Stocks & Shares, or a combination of both. You can only subscribe to one cash ISA and one Stocks & Shares ISA per tax year, but you can transfer previous years’ ISAs to anywhere. In ISA terminology new money paid in is a “subscription”.
Example: Mr I N Vestor pays £100 into a Cash ISA and £100 into a Stocks & Shares ISA on 6th April (start of the new tax year). He cannot open any other ISAs this year, and has made a total subscription of £200. He could pay the remaining £19,800 into either plan or a combination of both. He could transfer last year’s ISA into either one of his current plans, or any other different plan, without penalty, as long as no further subscription is made to the other plan.
Cash ISAs can be useful, but in the current low-interest environment the overall tax benefits of Stocks & Shares ISAs are better for most people most of the time. Especially considering that some current accounts pay double the best current Cash ISA rates
|Treatment||Stocks & Shares ISA||Pension|
|Annual limit||£20,000||Lower of £40,000 or annual salary, unless net adjusted earnings exceed £150,000, when it tapers down to £10,000 *|
|Lifetime limit||None||£1.03 million (planned to rise with inflation) *|
|Tax relief on contributions||none||highest marginal rate (20%, 40%, 45%) up to annual limit *|
|Tax treatment of funds within||Tax-free growth (no CGT) and tax-free income (through dividends)||Same as ISA|
|Tax treatment on funds taken out||tax-free||25% tax free, remainder subject to income tax as earned income|
|When the funds can be taken out||Any time||After age 55 (due to rise to be 10 years before state pension age)|
|Death treatment||Can’t be inherited in-situ, forms part of deceased estate||Payable 100% tax free outside of estate if death before 75, liable to income tax on recipient if death after 75 *|
|*The treatment is actually far more complicated, but for most people this is correct.|
As you can see, there are pros and cons to both. From a purely financial point of view, for most people pensions will be better, but ISAs have some key advantages:
- No lifetime limit
- Funds can be accessed at any time
- Less risk of regular goalpost moving (pension reforms are often a key promise made by political parties to win elections).
It is generally agreed that whilst pensions should be prioritised, it doesn’t hurt to have some savings in ISAs too.
Side-note: How to achieve Step 4
There are lots of options when it comes to investing. Here are a few:
- DIY investments. The recommended resources section on investments is a good start, as well as our Investing secion
- “Robo investing” apps or websites (notable examples are Nutmeg, Moneybox, Wealthsimple). These are often quite a bit more expensive than doing it yourself, but offer slick apps and automated investment profiles for their additional cost.
- Dealing with a professional financial planner/adviser. A good adviser will provide a positive return on their fees by helping you clarify your goals at outset, develop a plan in line with those goals, and keep you on the straight and narrow when you’re tempted to stray from your plan.
Step 5: Frivolity!
Leave a little aside from all of the above serious life-planning exercise and consider treating yourself. Life is too short to funnel all of your money away immediately.
Generally speaking consider allowing 1%-5% of the lump sum to go out for a nice meal, a holiday, a bungee-jumping experience, or whatever else takes your fancy. You won’t find this suggestion in a financial textbook, and you may want to ignore it completely.