My name’s Linda. I would like to have a comfortable retirement but I am not sure how much money I need to have saved up in order to achieve this goal. I am not particularly extravagant but I do want to be able to afford at least two holidays a year. I additionally don’t have access to a fixed workplace pension so I need to live within the means of my own investments and the state pension. How should I go about working this out?
Thanks for this question Linda.
There are a few ways to think about this.
Firstly, when do you want to retire? The reason that this matters is that your state pension will only kick in at the state retirement age so if you retire earlier than this you will need to make up the difference from your own investments.
You also need to consider your living situation during retirement. If you are likely to be married or in a relationship then you would have two state pensions coming into the household but not double the costs – for instance, utility bills don’t double with double the number of occupants in a home.
You would also need to factor in that, even if you are in a relationship, one person will probably outlive the other and at that point one source of pension income may be lost.
TWO WAYS TO GET AN INCOME IN RETIREMENT FROM A SAVED LUMP SUM
There are two ways that your savings and investments can be used to secure your income in retirement:
The first way is to buy what is called an annuity. The second way is to just draw down your income slowly over time.
An annuity is a financial product that provides a guaranteed income for life. Essentially, you take a lump sum of money, give it to a financial provider and they tell you how much they can pay you for life depending on the features you want. For example they can give you a fixed amount every month for life, or they can increase that amount every year by inflation, if you want an annuity that grows with inflation the starting amount will be smaller than if you go for the fixed amount. You can also buy an annuity that covers one person’s life or two people’s lives, that is, once the first person dies the annuity continues to pay out until the second person named on the annuity also dies.
Annuities used to be popular in the past but because interest rates have fallen drastically since the 2008 financial crisis they have not been so attractive.
How much would you need if you were planning on retiring today, were getting a state pension and were planning on buying an annuity?
According to this is money who in turn source a report by Royal London, you would need £260,000.
“Royal London’s sums were based on the amount needed to bridge the gap between an £8,500 state pension and two-thirds of the £26,700 average salary.”
Two-thirds of £26,700 is £17,800. This means Royal London are assuming that you would live on £17,800 every year: £8,500 of this would be coming from the state pension and £9,300 would be coming from the purchase of the annuity. These figures suggest the annuity is giving a return of just 3.6%.
In my opinion, that’s a very poor return and not even worth getting the annuity.
This is money also confirm in their article that if you plan to retire in 30 years’ time rather than today, this £260,000 becomes £400,000 and this further assumes that annuity rates improve by then.
If interest rates are just as low in 30 years’ time as they are now and if we assume average inflation of 3% per year (which is what it has been historically), then instead of £260,000 you would need £630,000.
Personally, I do not recommend the annuity route AT ALL. If you are happy to take a little risk then you would be FAR better off just drawing on the invested money.
The most popularized rule for drawing down on your invested pot is the 4% rule. The 4% rule essentially says that if you drawdown 4% of an invested pot every year, you are unlikely to run out of money over a 30 year period. While the study that came up with the 4% rule used 30 years as the period during which a person would be retired, the general conclusion is that even at the end of that 30 years the money invested will have grown because the average drawdown rate of 4% is lower than the average growth rate of your investments.
So, for example, if your investments grew by 7% in the last year then taking 4% means you are still ahead.
The beauty of drawing down rather than buying an annuity is that whatever is left when you die can be passed on to children, charities or whatever you choose. With an annuity, the payments die with you. For example, if you bought the annuity of £9,300/year today and died next month, tata £260,000 – that’s it. The full benefit of your early demise goes to the financial institution that sold you the annuity in the first place. Rubbish, right, well that’s what you get for playing it too safe!
If we take the £260,000 lump sum we have been using and continue with it for example purposes, then a 4% drawdown would produce £10,400/year in the first year which is better than the £9,300 you were getting from the annuity that ‘this is money’ talked about. Not only that, in the following year it could be that you will base the drawdown on a bigger number than £260,000 because the investments will have grown in value. The average growth rate of the stock market over the last few decades has been 10% before accounting for inflation. Of course, this says nothing about the future as stock market returns in the future could be better than or worse than this.
Rather than working backward from what income a given lump sum will give you? Let’s figure out how much you will probably need to spend in retirement, that is, let’s work out your desired retirement income.
Once we have your desired income we will subtract income from your state pension and any other pensions.
We will then divide the gap by 4% and this will give you the value of investment assets that you need.
I’ll share two sources that I have found for trying to work out how much money you will need each year in retirement.
SOURCE 1 – on how much money you need for retirement
“According to research carried out by Loughborough University and the Pensions and Lifetime Savings Association (PLSA), workers who only manage to save enough for a retirement income that provides them with £10,200 a year (£15,700 for couples) will achieve a minimum living standard, those who managed to save enough for £20,200 a year (£29,100 for couples) will be able to live a moderate lifestyle during retirement and those who are able to save enough for £33,000 a year (£47,500 for couples) will be able to enjoy a comfortable retirement.” (source: moneyfacts.co.uk)
This £33,000 a year (£47,500 for couples) includes holidays abroad, a generous clothing allowance and a car.
These are the lifestyles that the Loughborough University and PLSA study creates:
I don’t know about you but I would like to target the comfortable lifestyle or better!
Using the 4% rule, if you are targeting a comfortable lifestyle then:
Before you give up before you’ve even started because these numbers sound too hard to achieve, keep listening, I’ll give you an example at the end of how much you need to save now and it will sound much more achievable.
If you are targeting a moderate or minimum living standard, you can calculate the equivalent numbers by following this formula:
As a reminder, the full state pension is currently £8,767.20 per year but I used £8,500 in my examples for simplicity.
If you plan to retire based on the minimum standard of living at say 60, then when you start getting the state pension as well if you are a single person, you would be boosted to close the moderate living standard; and if you are in a couple, you would be boosted just beyond the moderate living standard by receiving two state pensions – assuming both people are entitled to the full state pension or close.
SOURCE 2 – on how much money you need for retirement
Using a report from the Joseph Rowntree Foundation, a respected charity, Fidelity.co.uk allows you to start of with a basic standard of living which costs £16,300 and allows you to add annual costs to this depending on the lifestyle you want.
This £16,300 accommodates basic rental accommodation, basic costs for food, alcohol, clothing, water, gas, electricity, council tax, household insurances and other housing costs, public transport costs and an occasional visit to the cinema.
The basic £16,300 cost of living assumes a single person not a couple. Within this figure you don’t run a car, you don’t eat out much at all, you don’t smoke and you don’t have internet access or paid-for film channels (I guess you would watch only free channels and have to go to the local library for the internet).
Note that this £16,300 is higher than the £10,200 suggested by the Loughborough University study for a basic standard of living but lower than the £20,200 suggested for a moderate standard of living so we can call it basic Plus.
I would guess the Loughborough study assumes you have paid your home off in their basic living assumption which could explain the difference.
So, how do we boost the £16,300 basic income to improve our life style?
If you added on every single one of these extras, you’ll be at a very comfortable £37,500/year which is not too far off the £33,000 suggested by the Loughborough University study for a comfortable retirement.
This would be equivalent to £54,000 for couple if we increase in direct proportion to the Loughborough study (37,500 * (47.5/33)).
What level of investment assets do you need to achieve this?
You need c.£940k if you are a single person or £1.35m if you are a couple before the benefit of a state pension. This £1.35m is very aligned with the £1.2m we got using the Loughborough University study. State pension income reduces your need to save and invest by about £200,000.
If you keep a budget it might be easy to calculate what your monthly spending in retirement will be; just remove all the things you spend on now that you won’t need to spend on in retirement, like travel to work or rent or a mortgage payment if you plan to own your home outright at the point of retiring.
There are a lot of numbers here but it’s more or less pretty straight forward once you have worked through it systematically. How much do you need to save now to live your ideal lifestyle and to hit your goal by retirement? You’ll need to take the next step and figure that out. If you want me to help you do this, request a call.
As an example, if you are a 22-year old couple now and plan to retire at 67, you only need to be saving £285/month in total into pensions (that’s only £140/each). This has to be into pensions and not into an ISA as I am assuming you get the tax benefit of saving into a pension. My calculation assumes you get an average market return over those 45 years of 7%. If returns average 10% as they have in the last 45 years, you would completely overshoot and end up with a retirement pot of £3.7m – how’s that for compound interest?!
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I hope this helps!
Have a money question for me?
My name’s Grace. I recently started investing in stocks and shares and want to know the type of returns I should realistically expect? I’m especially interested in how long it will take for my money to double in value.
Great question Grace, thank you for asking it.
I will start by telling you a little story. When I first started working, I didn’t believe in long-term investing on the stock market. My philosophy was that you buy shares at a good price and when the price has gone up high enough, you sell, take the profits and move on. You know, the buy low, sell high philosophy.
My philosophy has since changed. I believe you should buy shares and ideally never sell them except to manufacture a dividend while you are in retirement and I’ll give you two experiences that turned my thinking on this so radically.
In about 2006, I bought about $2,000 worth of Apple shares. The price at the time was $70-something. I sold a couple of years later when the price had trebled feeling like a complete winner. If I had held onto those shares they would now be worth about $30,000 (maybe more, it hurts too much to sit down and calculate the exact amount) AND I would have additionally enjoyed about 14 years of dividends from Apple which I would have reinvested back into the stock as I always do. Note that the price you see now shouldn’t be compared to the price I paid directly because Apple had a 7 for 1 stock split in 2014.
The way that works is that for every share you own, they split it into 7 shares and the price for each becomes one-seventh of what it was. The lower price is designed to make buying shares more palatable to smaller investors.
Anyhow, had I held the shares to retirement, I could have either benefitted from the dividends to support my living or sold them slowly for income to support my lifestyle in retirement (this is called manufacturing your own dividend). FYI, I’m only 36 so retirement is still a while away for me as I enjoy working and don’t plan to stop working for a while yet.
The second story is what happened to my pension savings from a job I had that had a defined contribution plan – this is a retirement plan that depends on how the stock market. Unlike the traditional workplace pensions the income in retirement is not based on a fixed formula.
Anyhow, I didn’t know much about pensions at the time but a colleague called Karen Matthey told me that even if I didn’t believe in pensions I should pay in up until the match “because it was free money” – I think the company matched contributions into the pension scheme up to a maximum of 3%. I didn’t even know what “up until the match meant” – I was 24 and clueless but I listened to her and did just that. By the time I left that job in 2012 I had just shy of £30,000 in my pension account and within 5 years that had grown to £60,000, that is, it had doubled. I didn’t expect this performance at all and it’s at this point that I started taking the whole investing long-term thing seriously.
Now, this made me curious to find how long it takes for an invested amount to double, which is exactly what you’re asking, Grace, and it’s at this point that I discovered what they call the rule of 72.
With the rule of 72, you take the investment return you expect, divide it into 72 and that’s how long it will take for you money to double. So, if you expect a 10% return, then your money will double in about 7 years. (72/10); if you expect a 7% return then you money will double in 10 years, it ‘s a very easy calculation.
Because my money doubled in 5 years, it’s also quick to calculate that I earned an average return of 14.4% (72/x = 5).
And keep in mind that I wasn’t invested in anything fancy: all my money in this pension was in a passive global equity tracker, it still is – and my old employer pays all the fees so I just let that pension pot sit there, I can’t touch it until I am at least 55.
If that money earns at least an average return of 10% (this is the actual historical stock market return), then over 21 years the money will double three times: 60k will double to 120k in 7 years (that’s by 2024, and it’s actually growing faster than this right now) which will double to 240k 7 years after that which will double to 480k 7 years after that (that’s by 2038 when I’ll be hitting 55). That’s insane, all from an initial 30k investment! After I figured this out I was annoyed at myself for not taking the stock market and pension investing more seriously and I’ve been making up aggressively for the last 3 years.
At the end of the day though, it’s not about crazy returns for me, it’s about making a commitment to investing healthy amounts monthly.
It’s very hard for most people, my younger self included, to believe that even £100/month invested over 30 or 40 years will amount to much but it is really surprising how these small amounts add up.
What stock market return should you expect?
There are no guarantees in the market, but the 10% average has been remarkably steady for a long time. That said, from year to year returns are very volatile. You will only get the average market return if you buy and hold, do not try to time the market.
Personally, I model my investments in excel based on a 7% gross return (gross return meaning the return before adjusting for inflation) this would be about 4% after inflation of 3%. My general reading suggests that expecting a return after inflation of 6% is realistic: my 4% net return is therefore not over optimistic.
If the experts are telling you to expect a real return of 6% that would make it a gross return of 9% because inflation tends to average 3%, using the rule of 72 you would expect your money to double every 8 years. Simples.
To ensure you end up with enough money in retirement, perhaps base your returns on a lower number so that either you end up with more money than you need or so that you can retire early because you reach your goal much sooner.
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I hope this helps!
Have a money question for me?
My name’s Sam. Can you talk about financial independence and the steps one has to move through to get there?
Thanks for this question, Sam.
In the past, I used to think about financial independence in a one-dimensional way: you were financially independent if your income from passive investments exceeded what you need to maintain the lifestyle you want indefinitely.
It wasn’t until I heard JD Roth the founder of Get Rich Slowly on Paula Pant’s Afford Anything podcast that I started thinking about financial independence as something that can be broken down into stages. I like his idea so rather than re-invent the wheel, I’ll share his wisdom with you and you can decide where you are on this continuum:
Stage 0 – Dependence
In the dependence stage, your lifestyle depends on other people for financial support. Absolutely everyone starts here, we are born fully dependent on our parents and people break out of parental dependence at different stage. I dare say you can break out of being dependent from parents and fall back into dependence in your 40s and 50s because of a life incident or poor planning.
However, if even if you don’t live at home with family you would still be in the dependence stage if your spending exceeds your income.
Following the dependence stage, stage 0, there are six stages to full financial independence in JD Roth’s model. The first three stages of the journey are the “surviving” stages.
Stage 1 – Solvency
You’re solvent if you can meet your financial commitments, that is, you have enough earnings to pay your bills. You will have reached this stage when you no longer rely on anyone else or on credit for financial support.
You are a solvent person if your income exceeds expenses, and you are no longer accumulating debt. I reached this stage when I was 18 thanks to an academic scholarship. My scholarship paid for all fees and gave me a lump sum to cover accommodation, food and a plane ticket home every year. In December 2002 when my dad sent me a gift of money with my mother who was visiting me at school, I told her that from here on out I don’t need money from you and dad; I will survive within the means of my scholarship – I asked that they saved the money for my sisters’ education and I haven’t looked back since.
My dad took that thanks and ran!
While some people will reach this stage in their teens, as I did, most people reach this stage when they start the first job that allows them to leave home. Some never reach it and are dependent on others for survival from cradle to grave.
Stage 2 – Stability
You have achieved financial stability once you've repaid all your consumer debt and have some money set aside for emergencies, and continue to earn enough to save – you can think of your savings as your profits.
You may still possess some “good debt” — student loans, a mortgage — but you've eliminated other obligations and built a buffer of savings to protect you from unfortunate events. Dave Ramsey suggests a buffer of £1,000 and I would agree with that as being adequate to cover most emergencies. I would recommend buying insurance cover for things that could cost more than this, e.g. buildings and contents insurance to cover damage to your home and your personal possessions.
As I have never been in debt, again thanks to my scholarship, I could say I reached this stage at 18 as well. As a Malawian student living in Britain I had no credit history so no bank would give me access to a credit card or even an overdraft facility and no store would allow me store credit.
You know how you get to stores and they ask you if you want to get 10% off by signing up to a store card? Well, I said yes and I got rejected with the net result that I always said no after that because I felt so ashamed when she walked back to the counter to tell me I didn’t qualify in front of other customers.
Thank God for small mercies. I was an unsuspecting teenager in a foreign country and I don’t know what debt I could have landed myself in had that request for store credit gone through.
Stage 3 – Agency
The final “surviving” stage in JD Roth’s model is free agency. He describes this as the ability to work and live how and where you want. In the free agency stage, you've cleared all debt (including student loans and your home mortgage) and you have enough banked that you could quit your job at a moment's notice without hesitation. Apparently, some call this “screw-you money”.
I was about to disagree with the free agency stage until I saw JD’s note that: “he knows first-hand there are times when you might prefer to carry a mortgage even if you don't have to. So, for the purposes of this stage, if you have enough saved and invested to pay off your mortgage, it's the same thing as not having one.
Technically, I would say I initially reached this stage when I was about 30 because I had enough equity in a home I bought when I was 23 to pay off our home mortgage free and clear and I had enough passive income from a small business I set up at when I was 26 (but spent only 10 minutes a month on) to meet the other financial needs that I had at the time. I say technically because in practice, I would never have done that as even then, I knew I would probably want kids and I would need more money to give them the life I wanted them to have, essentially, even if you are in the agency stage but you know your future financial needs will be greater, you’re probably not fully there yet.
In JD’s six-stage model to financial independence, you move from surviving to thriving in stages 4 to 6. As you work your way through these stages, money is no longer a safety net, but a tool to help you build the life you imagined for yourself and for your family.
Each of the next series of stages assumes no debt or enough cash on hand to instantly repay all debts.
Stage 4 – Security
You have achieved financial security when your investment income can cover your basic needs. Investment income is money that you don’t need to actively work for; it arrives like clock work without any further input from you.
So, in the security stage, based on how much you have saved and invested, you could live a meagre existence for the rest of your life. Even if you never worked another day in your life, you have enough to afford simple housing, basic food, essential clothing, and insurance.
I would say we are currently working towards stage 4.
If we both quit our jobs and took our children out of a fee-paying school, rental income would cover our cost of living and we have some decent savings to cover tenancy gaps BUT our whole life would come tumbling down if interest rates rose because of the buy-to-let mortgages and our mortgage so we are not here yet.
In the security stage you should be able to cover all basics regardless what interests and other economic indicators are doing.
Stage 5 – Independence
Financial independence is the ultimate goal for most people. At this stage, your investment income is enough to fund your current standard of living for the rest of your life. You cannot only afford the basics, but you can afford some comforts such as holidays abroad too. You have “Enough” with a capital E.
Stage 6 – Abundance
In JD Roth’s sixth and final stage of financial freedom, you have “enough — and then some”. At the abundance stage your passive income from all sources not only funds your lifestyle indefinitely, but it grants you the freedom to do whatever you want. Besides sharing your wealth with others – which you should be doing whatever your stage of wealth but can really ramp up once you’re in the abundance stage – you can indulge in luxuries, explore the world.
When you see me wearing a Patek Philippe, we have arrived here. Both children will be in university at this stage (think early 50s) and I will spend a full year of school fees on one watch! Okay, so in a world with starving children, even writing that doesn’t feel quite right – I’ll downgrade that aspiration to a Rolex which I could buy now but that will be my gift to myself for getting to Abundance!
Jokes aside, the more money you can save either by clearing mortgages on your home or rental properties or by investing in stocks and shares and shares, the more your financial independence increases. As you become more financially independent your happiness levels are likely to increase because you can make decisions based on life fulfilment rather than what makes financial sense.
Being financially independent doesn’t mean you will quit working, it just means that you can if you wanted to!
Now, I can’t talk about financial independence without talking about the FIRE movement. FIRE stands for Financial Independence, Retire Early. The movement is a lifestyle movement whose goal is financial independence and retiring early. Most people agree on the financial independence bit of the equation but RE means different things to different people.
To some, retire early actually means quitting work and living a hobby life of travel and blogging, to others it’s simply a reference to reaching the ‘Abundance’ stage of financial freedom.
I am totally into the FIRE movement because I love how they’ve changed the meaning of what it means to live rich, many in the community live humble lifestyles in the secure knowledge that they are building real wealth. FIRE is not about conspicuous consumption it’s about real wealth and achieving meaning in your day to day life.
Let’s wrap up with some key takeaways on what you can do to move towards financial independence?
The philosophy is simple and as you put ‘spend less’ principles into practice, it gets easier and easier not to spend over time.
I hope this helps!
Have a money question for me?
My name’s Edna. I was wondering if you could talk about what net worth is? Why it matters and how I can improve my net worth?
Thanks for this question Edna.
The net worth of a person is the value of what they own (these are their assets) minus the value of what they owe others (these are their liabilities).
Now, most people don’t sit around calculating their net worth for the simple reason that most people don’t tend to think about their money situation but the calculation is very simple.
I recommend you use a spread sheet when you do your calculation but you can also use a pen and paper. The only problem with pen and paper is that all the addition and subtraction is more tedious.
Starting with the asset side, list down:
Personally, I don’t include things that fall in value like cars and computers but you can add them to the list as well especially if you own very expensive equipment that holds its value even when sold as second hand.
I also don’t include personal possessions like books and clothing because I see them as being very transient and I would suggest you don’t bother with those type of thing either.
Once you have listed everything that you own, find out what its value is and sum it up, this is your TOTAL ASSET VALUE.
Then moving on to the liabilities side, list down:
Your home mortgage
Each of your buy-to-let mortgages
All personal loans – from banks or stores
All credit cards and store cards
Money that you owe to friends and family
Once you have listed everything that you owe, find out what the balance owed is and sum up all your liabilities, this is your TOTAL LIABILITY VALUE.
To get your net worth subtract your total liability value from your total asset value, and voila! You have your net worth.
For some people this value will be positive, for others it will be negative because the value of their debts exceeds the value of their assets.
A negative value doesn’t mean you’ve been bad with money, it could just mean you’re young, have student debt and haven’t had a chance to build wealth, assets and earnings to pay off the student debt.
A negative value also doesn’t mean you’re suffering. In fact, a zero net worth could be worse than a negative net worth. Lots of people in developing countries have no assets and no debts but they may be living a very difficult life without basics like enough food. In developed countries, access to cheap credit means people can live an amazing and lavish life although in reality this is sustained by debt. As long as the person earns enough to pay their interest every month this can go on for very long periods of time.
And, the reality is, some people aren’t scared of debt, it doesn’t stress them out at all; what would stress then out is if they lost their job, or worse, reached retirement in this dire financial situation and found themselves pursued by people they owed money and possibly made homeless.
Why can knowing your net worth be valuable to you?
Because you can now track it, set a goal for it and improve it.
If you have a negative net worth then you might want to aggressively tackle paying debts off. As you get rid of debts you’d also be getting rid of interest payments and would therefore have more disposable income to save and invest.
Personally, I didn’t start intentionally tracking my net worth until I was 35 but I have always avoided debt, saved and invested from the very first year I worked so it wasn’t a trigger for me to be sensible but it definitely drove me to do better. Something weird really happens when you know your net worth, you become motivated to improve it and it makes it slightly easier to avoid excessive spending.
How often should you track your net worth?
I’d say once or twice a year is enough. Personally I refresh my asset and liability values on 30 September and 31 March – 31 March is ideal because it’s the end of the tax year and as I wanted equally spaced values, the second date became 30 September by default.
When I track my net worth, I don’t regularly change the value of properties because it can distort the net worth calculation by inflating supposed increases in property value. If you plan on selling a property then you might be interested in updating the value but other than that, I’d just leave it.
I also don’t update the value of defined benefit plans (aka final salary scheme or workplace pensions) because their value paper value can bear no relation to your ability to spend them. What is better is to get a general idea of what your fixed pension payment is likely to be based on the number of years you plan to stay in the job and keep this in mind as cash flow that you can expect at retirement.
Also, ignore the state pension. You have no idea what the format of state pension will be when you get to retirement age unless you’re retiring in the next 10 or so years. I’d also just keep the number in mind.
What does improving your net worth involve?
To improve your net worth you either need to increase the value of assets or reduce the value of liabilities.
Every time you reduce or clear a debt, you improve your net worth. Even if you aren’t saving but are focused on clearing personal loans and credit cards, you are improving your net worth.
If you aren’t saving, or paying off debts but you own your own home and have a repayment mortgage on it, the act of paying your mortgage off means you are increasing your net worth.
What’s your goal?
Is it just to increase your net worth ? Or do you have a more specific goal, like increasing the value of assets in a specific area but not another, e.g. at a given point you might want more property and less shares or the other way round.
Or is you ‘net worth’ goal more like mine?
While some people will focus on increasing the gap between their assets and liabilities and don’t mind getting to retirement with debts. My personal goals is have the liability side of my balance sheet equal to zero by my effective retirement date of 50. At that point, I don’t plan to carry any liabilities. I will probably still want to work after that date but we will own our home and any rental properties outright and we’ll maintain our current no debt lifestyle.
If you’re wondering how wealthy you are relative to other people in Britain I have some interesting data for you that I found on a BBC article dated July 2019:
Apparently, wealth of £105,000 per adult would put your family in the top half of the population. By contrast, debt and a lack of property and pension wealth means the bottom 10% of families have less than £3 per adult.
This says two things about wealth to me:
For the UK:
These statistics ignore age but we all know that wealth accumulation is a slow boring process so wealth levels tend to increase as people get older.
So, it’s no surprise that 60-somethings (those born in the 50s) are the wealthiest age group, with average wealth equivalent to £332,000 per adult. Many 60-somethings are approaching the end of a career and have had time to accumulate savings, pensions and property.
Inheritance is going to be a big source of wealth going forward but again, property ownership matters a lot here. According to the BBC article which was itself quoting the Resolution Foundation, “millennials - the generation currently aged 19-38 - are set for an inheritance boom in the future. But it's a long way off, with the average millennial not expected to receive it until they reach 61.”
It adds that, “Nearly half of millennials who don't yet own homes have parents with no property wealth, meaning they are unlikely to receive a significant inheritance. By contrast, those with home-owning parents are three times as likely to own a home by the age of 30.”
Guys, if you hearing anything from this it’s beg, borrow, steal, scrimp and save and get yourselves on the property ladder to build a security blanket for yourselves – no pressure!
Also, don’t shoot the messenger. Said BBC article had a large number of cynical comments under it – and a few helpful ones.
How about wealth by race?!! …
It was hard to find UK wealth data sorted by race but I did find home ownership stats:
Overall, 63% of households in England were homeowners in 2016/18 (around 14.6 million households)
Top three home owning groups in 2016 to 2018 were:
The bottom home owning groups were:
My group ‘Mixed white/black African were not much better at 34%
All interesting things.
So, in summary, if you want to increase your net worth without putting excessive effort into it, I would suggest as follows:
I hope this helps!
Have a money question for me?
Happy new year!
I’m a big fan of yours and have been following you for a while. I bought all your three books.
I would like to open a stocks and shares ISA for myself and two children aged 16 & 14 but I don’t know where to start due to fear of risk. I want to invest 15% of my income in stocks and also considering real estate.
I have seen some recommendations like Vanguard or Hargreaves Lansdowne but I’m clueless on what to go for. I am a nurse and the only debt I have is a repayment mortgage. I just finished paying off credit card debt.
I saw your post on Malawi Queens.
My name’s Angela by the way.
Angela – congratulations on getting rid of all your credit card debt, you must be super proud of yourself.
And a massive thank you for supporting me by buying my books. Book sales are helping to pay for the production of “The Money Spot” podcast so I don’t take your purchase for granted – it’s really appreciated.
Stocks and shares ISA
When it comes to investing in stocks and shares ISAs, target a minimum investment period of 5 years and ideally your should invest for much longer than that.
Is the money that you want to save for your children for university or for something else?
I will assume it’s to contribute towards the cost of university. One important thing that you need to keep in mind is that although tuition fees are given to students as long as they apply for them, the maintenance loan is assessed according to household wealth; basically, children that come from wealthier households are eligible for a smaller maintenance allowance. Only children from households with a total income of less than £25,000 qualify for the full maintenance loan.
In addition, students that live at home get a smaller maintenance allowance and those that attend universities outside of London qualify for a lower maintenance loan.
In my opinion, the less debt children can get themselves into by the time they graduate, the more disposable income they’ll have when they land their first jobs and the faster they can save for a deposit on a mortgage.
If you want to read a little more about what you might need to contribute towards university costs, have a look at the moneysavingexpert.com website. The site has a ready-made calculator that will tell you exactly how much you need to save for each child to contribute towards university. Or, for parents that don’t want to contribute then it’s how much their children will need to earn from a uni job to fill the gap.
The calculator will also tell you exactly how much you need to save every month from now to make sure you have enough by the time your child starts university.
Child aged 16
For your 16 year old, saving into a stocks and shares ISA is too risky because university is just around the corner – the stock market generally doesn’t offer good returns for periods of less than 5 years.
The safest option for the 16 year old is probably to save into a high interest account, this might not be a cash ISA so shop around. The best rate you will find at the moment is between 1.45% to 1.65%.
Child aged 14
As you could put money away for five years for your 14 year old, a stocks and shares ISA makes sense here. Again, use the calculator on money saving expert for an idea of how much you will need to contribute each month if you don’t want your children to have to work through university.
For your own ISA, you have a limit of £20,000 per year. If you prefer, you can save all the money into your own ISA rather than into junior ISAs so that you have more control over it.
Money saved into a Junior ISA is legally belongs to the child named on the account when they turn 18 and you would have no control over how they choose to spend it.
Before I tackle where you should save I will say that you have every right to fear taking risk with your money, you’ve worked hard to earn it so you should rightfully want to preserve what you have earned.
The safest path if you are investing in shares is to avoid single stocks and to invest in diversified index funds. There are two main types of fund to choose between, actively managed funds and passively managed funds.
Passively managed funds track a whole market such as the S&P500 for the USA or the FTSE100 for the UK; alternatively, instead of tracking the whole market in a given country you can choose to invest in a specific sector such as utilities or technology or retail.
Actively managed funds have a an actual person choosing what shares will outperform the market and investing exclusively in those. The objective of an active manager is to beat the index, while the objective of a passive fund is to match the return on an index.
Now, you would think the funds managed by clever fund managers are the ones to go for, right? Wrong! History suggests that over 95% of the time fund managers do not beat the index. Not only that, fees on actively managed funds are higher. The cheapest are about 0.5% nowadays and the most expensive charge in the region of 2%. Many passive funds now charge less 0.2% or what industry professionals call 20 basis points or bps.
How can you improve your risk appetite?
Improve your understanding of how stock markets work. I would recommend two investment books, if you can, get the audio versions:
Charlie Munger: The Complete Investor by Tren Griffin and
Common Sense Investing By John Bogle (the inventor of passive investing)
Which platform should you use for investing?
I personally use iWeb for share dealing because they are the cheapest but I wouldn’t recommend iWeb for most people because you can’t automate your investing. That said, iWeb have good fund centre that helps you sort through the different indices and allows you to order them in different ways, for example, you can sort funds or shares from those with the lowest fees or starting from those that are enjoying the highest return down, you can also exclusively analyse the different sectors that you might want to invest in – technology is enjoying pretty good returns at the moment but I don’t put too much into tech because it’s volatile it goes up fast and can also come down fast.
Even if you ultimately choose to invest using a different platform you might want to use iWeb for stock selection if their analysis tools are better than where you end up.
iWeb’s fund centre is actually easier for discovery than HL – HL seem to have a vested interest in people selecting actively managed funds so those show up more prominently on their site. They don’t seem, for example, to have a tool that allows you to just look at absolutely every fund they offer ordered by fees. If I just haven’t found this function, someone please help a sister out and send me the link.
So, what platform should you use?
The two options you have suggested (HL and vanguard) are very different.
The likes of Vanguard only offer their own funds. This isn’t a bad thing necessarily but it would mean you need to be sure you won’t want to invest any other fund manager’s products and that is a hard position for a beginner to take.
The likes of Hargreaves Lansdown offer you access to a large universe of fund managers. HL don’t create funds, they are essentially a supermarket for other fund managers. It’s the difference between shopping at Aldi and Sainsbury’s. If you want choice, you go to Sainsbury’s; if you’re not too bothered about choice and want to save money, you go to Aldi, but you’re mostly only going to find Aldi’s own-brand products at Aldi – this is not a perfect analogy but it’s not a bad one.
Vanguard’s passively managed index funds are known for being very cost effective but they’re platform charges are not the cheapest. At least not in the UK.
The likes of Fidelity have a hybrid model: they offer their own funds and other fund managers’ products BUT if you use their tools for selecting funds, which I did to write this piece, the resulting suggestion is one of their own funds.
The biggest driver for where you invest should be fees, customer service and ease of use of the platform.
Platform fees are the fees you get charged for using a given platform.
HL 0.45% (if less than £250k and 0 if > £2m)
Either way, if you have less than £50,000 invested the differences in fees aren’t that dramatic but as you start approaching £250,000 in investments you will feel the difference. Once you have £250k invested, and trust me you will get there, on iWeb you would be paying £60/year (if you trade once a month) and on HL you would be paying £1,125 for the same assets invested.
Little tip, because I invest for both my husband and I, instead of splitting monthly investments in half, so half goes to his account and half to me, each month I do one trade for either me or for him so that the net result is that we do 6 trades each. This saves £60 in dealing costs every year. Obviously I could save even more by doing one trade a year but as our incomes are paid monthly it’s better to invest monthly rather than just keep the money in a savings account for one trade at the end of the year. I’d lose all the gains I make within the year.
Transaction fees are the fees you pay for buying an investment product – these can be a fixed sum or a percentage. Some platforms will have one charge for buying and selling shares and another for funds.
Vanguard depends on the product – 0.02% to close to 2%
HL 0 for funds, £12/share falling to £6 a share for 20 trades +
Halifax £12.50/share or £2/month for scheduled investment
Fidelity £10/share or £1.50/month for scheduled investment
Because Fidelity’s platform fees are cheaper than HL, I am tempted to recommend them but I think you should make the decision. Why don’t you spend an hour a day on each of the following three site: HL, Fidelity and Halifax. Download their apps and see what you think of them. If by the end of that analysis you’re not sure then I will suggest you use HL as a beginner and as you figure out how things work move platforms, it’s very easy to do that.
Also, it’s worth mentioning that I pulled a couple of funds that I invest in on Fidelity and you pay more for them via Fidelity because HL negotiates discounts with actively managed funds due to the volume of business they direct their way.
NOW – I have spoken a lot about investing as I felt that that’s what you wanted me to focus on but I think this discussion would not be complete without me saying that, ultimately, if the stock market scares you, then you can go the property route.
There are many strategies you can follow with property. You can rent to families, or students or even another subset of people. One of my friends specialises in letting property to truck drivers. Letting to students or a migrant group like truck drivers has high turnover which means you need a lot of time to manage the property. And if you went down the AirBnB route that’s like managing a hotel because you have to think about changing sheets and cleaning literally week-on-week – as involving as it sounds, I have a friend who has a full time job as a professor and has also grown a good property portfolio on the side with a mix of AirBnB and family lets.
The key is to start with your first property.
Have you heard of the 3 for 1 property strategy?
With this strategy you set a goal of investing in 3 buy to let properties and you work to have all mortgages paid off by the time you retire.
This would mean that you live in one fully paid off house and you would live off the rent of the three properties – this reduces the risk somewhat. For each buy-to-let property you would target a given amount of rental earnings that you can choose yourself . For example if each property earned £800 per month, then you would retire on £2,400 / month. This would be linked to inflation because as prices rise, rents also tend to rise and sometimes rental increases rise far faster [example].
If this feels safer for you and you have at least 20 years until retirement then think about either just going for the 3 for 1 property strategy with a good lump-sum saved in a savings account for emergencies might feel less risky OR follow a combination of investing small amount in the stock market with property as your security blanket.
Massively enjoyed answering this question, Angela, especially from a fellow Malawian. It’s nice to know other people are investing and getting wealth focused.
Let’s summarise what you need to do:
I hope this helps!
Have a money question for me?
Q&A: What are the 9 biggest money mistakes people make that prevent them from saving and building wealth?
My name’s Wendie. I am a support worker and earn about £1,600. I struggle to make savings due to all my commitments but I desire to start no matter how small. Please advise.
Thanks for this question Wendie…rather than talking about all the different ways you can save, I thought I would tackle your question by talking about 9 of the top mistakes that people make with money. Also, you haven’t given me any extra detail about your life like your marital status, age and whether or not you have kids so some of these things may not apply to you.
So, what are 9 of the most common mistakes people make with money?
1. Not believing you can achieve financial independence
If you don’t believe, you don’t bother. If you don’t bother you’re less likely to achieve.
Wealth is very rarely ever an accident and when it is an accident, like when you win the lottery without having pre-planned how that money will be spent, you usually lose it.
According to cnbc.com, “Lottery winners are more likely to declare bankruptcy within three to five years than the average American.” This result is not going to be very different for the average Briton. Easy come, easy go, as they say.
2. Not thinking about money
You don’t want to overdo thinking about money but it is important to think about it at least a few times a year to make sure you don’t get to retirement age and realise you’re done working or worse, that your body’s done working but you don’t have the resources to stop working.
3. Not talking about money or at least reading about money
A LOT of the things I have learnt about money come from people I just chat with and even more from reading random books on money. I have had tips shared with me on what to invest in, what to read, how to save money and so on. And, if you want something to read that will inspire you I’d recommend to classics:
The Richest Man in Babylon by George Clason and The Millionaire Next Door by Thomas Stanley and William Danko – I read both of those within a couple of years of graduating from university (15 years ago this year) and I still inspired by those books today.
4. Not getting a will
If you have anyone that depends on you to survive, you need a will, period. This is especially important if you have children under 18 and amplified if you’re not married but in a relationship, possibly to a man that isn’t the father of your children.
5. Not getting life insurance
Again, if you have anyone that depends on you to survive, you need life insurance, period.
I went onto moneysupermarket.com to work out the cost of £250,000 of level term insurance for 25 years for a 40 year old healthy but overweight support worker. The cost was only £19 from a reputable insurer like AIG.
6. Not getting critical illness cover on your main home
The most shocking thing about getting seriously ill is that absolutely no one ever expects it to be them, no one. That’s why it’s a good idea to have it.
Most people get enough to cover the cost of paying their home off if they get critically ill and to keep the price low they get decreasing term cover. With this type of cover the amount of insurance money you get falls over time just as your mortgage would. It makes the cover more affordable.
7. Not tackling debt
Debt increases your risk of ruin. Risk of ruin is a concept from the fields of gambling, insurance, and finance and it relates to the likelihood that someone will lose all of their investment capital. For general life, I use risk of ruin to mean that you end up in extreme financial problems. A few financial setbacks can lead to you not having the money to pay of bills, credit cards and loans and the more debts you have, the higher the chance that even small setbacks will send your financial life tumbling.
If you have debts, it’s a good idea to get rid of them and never get back into debt again. If you can avoid credit cards, your chances of accumulating debt will fall. Although credit cards can build up points, travel miles, the fact is, the biggest thing that they build up is long-term, excruciatingly expensive debt. They’re debt traps. They can catch out even the smartest of people and they often do.
8. Not buying a home
I think this is the biggest mistake you can make. Rent or mortgage payments are typically people’s largest expense. If you can wipe this cost away then you need so much less money to live in old age or whenever you’ve wiped the mortgage off.
9. Not investing in your self
Investing in your self is about getting the qualifications and the type of experience that will lead to higher paid opportunities.
If you think you don’t have the money to pay for education looks into grants.
I decided to check out the cost of taking a degree course at the Open University and it looks like a degree taken part-time over 6 years would cost about £6,000 in total over those 6 years (that’s about 1,000 a year) which is 5 times cheaper than the £28,000 that students now pay for a three-year degree from a regular university.
If your personal income is £25,000 or less, or you’re on certain benefits, you could qualify for the Part-Time Fee Grant and funding to cover 100% of your course fees.
Definitely look into how you can improve your CV to move up the food chain in the job market.
Last but not least, I decided to look into what Support Workers earn to see what a career path in Support Work could look like.
In one google search I found the following Support worker salary statistics on adzuna.co.uk. These were the live stats on 1 February 2020 from Adzuna’s database of over 1 million job ads.
The salary varied a lot from area to area:
The average in Newbury was £28,500 based on 67 jobs and the average in Caerphilly County was £54,000 based on 51 jobs – have you thought about moving areas? This is a huge difference in earnings, it’s the difference between struggling to pay off debt and saving well.
Go to adzuna’s salary stats centre and study your profession. [link in blog]
1. Not believing you can achieve financial independence
2. Not thinking about money
3. Not talking about money or at least reading about money
4. Not getting a will
5. Not getting life insurance
6. Not getting critical illness cover on your main home
7. Not tackling debt
8. Not buying a home
9. Not investing in your self
Hope this helps, Wendie. Good luck hitting your saving goals
Have a money question for me?
My name’s Barry and I hate budgeting…it’s not so much the budgeting but tracking all my spending; it kind of sucks the joy out of life. I can’t stand having to think through how my money will be spent and not being able to buy what I want just because it wasn’t budgeted for – am I doomed to always be broke because I don’t budget? Do you have any suggestions for me?
Barry you raise a very interesting question.
In fact, I had to think about whether I actually like budgeting myself or whether it’s just a habit I have got into over time.
My answer is that I don’t think anyone loves budgeting or having to watch every single penny but when people see the benefits of operating a budget they get into. When you know your income will last until the next pay day because you’ve planned well you’re less stressed out about your finances.
I have a certain friend who puts every single penny that he spends into a spreadsheet, well, it was a spreadsheet back in the day when he told me how he was managing his money, I hope he’s now found some reliable app for that purpose. When I saw his system of managing money I literally lost the will to live and that’s how I came up with what I call the “set and forget budget” or “loose budgeting” for my own money management.
I love the quote "A budget is telling your money where to go, instead of wondering where it went." It was first said by John Maxwell but Dave Ramsey popularised it.
Anyhow, rather than watch every single penny, the “loose budgeting method” involves creating spending buckets and allocating a fixed amount to each bucket with loose rules around how that money can be spent.
If you do it properly, this “set and forget” way of managing money means you will only need to make changes monthly if your income changes a lot from month to month or annually if you are on a stable and fixed income. You might do it a little more frequently at the outset as you’ll need to tweak the different buckets until they are just right.
But first, what is the point of the whole ‘set and forget’ budget?
The objective, once you’re done dividing your cash into different buckets is to figure out your financial lane so that you can stay in it!
You’ll know once done whether your finances can support a daily latte habit or a weekly shopping for clothes habit. You’ll know whether buying lunch every day when you work makes sense for you or not. Once you figure out what lifestyle your finances can support then you can start working building the habits that will help you reach your goals.
Step 1: figure out total income after taxes and deductions
Before you create the loose budget you need to figure out what you earn annually after tax, pension contributions and any other deductions such as student loan payments. Basically, figure what lands in your bank account.
If you are paid a fixed wage this is relatively easy to calculate using listentotaxman.com.
If you’re married and manage your income as a single unit, like my husband and I, you’ll need to add up the two incomes.
Step 2: decide what will be saved the allocate the other buckets
When you have total income deduct the total amount you want to dedicate to saving and the total to any other big expenses you want to commit to like school fees or buying a car.
Once you’ve done this you’ll know what total is left for household spending and you’re ready to create buckets.
You might need to tweak the savings amount if after doing this exercise you realise you’re over saving and haven’t left enough for household necessities or if you are under saving and could save more.
This is what my household’s buckets look like, keep in mind that each bucket is for monthly spending and I track it in Excel because it’s convenient and because with the loose budget you don’t need to track spending so much. My husband and I manage our total earnings as one pot after deducting a little bit of pocket money that we each keep for personal hobbies and such like:
1. Children’s saving
This will be a bucket for some and not for others (podcast episode 2).
2. Your savings
Once this is set you’ll set a standing order so that savings leave your account as soon as you are paid.
3. School expenses for yourself or children
If you pay any sort of fees it’s best to pay the fees to another current account as soon as you’re paid. For example, if you pay fees 3 times a year spread the cost of fees out across several months so fees don’t come as a shock every time.
This will be fixed based on your mortgage agreement. Our household rule is to keep mortgage payments low enough so that one person can pay them. So if you’re in a relationship, the loss of one job wouldn’t be devastating because payments are within the means of one earner.
I also like Dave Ramsey’s rule of keeping payments to within 25% of household income based on 15-year repayment plan BUT I think a 15-year mortgage is not affordable for many people because the ratio of house prices to income in the UK has gone a little crazy; what might might be a better target is getting mortgage free by age 50 or 55.
5. Council tax
This is fixed and unavoidable.
Pretty fixed and unavoidable if you're not on a meter but if you have a meter you can make cuts. Budget for the maximum water bill you expect.
7. Gas & Electricity
Pretty fixed and unavoidable. Budget for the maximum energy bill you expect.
8. Homecare insurance
I always have homecare insurance so that unexpected heating and plumbing leaks and breakdowns are covered.
9. Life Insurance or mortgage insurance
If you have this it’ll be fixed.
This is relatively fixed but you should shop around for a cheaper deal at least once a year.
11. TV licence
This is completely fixed.
Groceries includes food and any basic toiletries and household cleaning products. Set your groceries budget high enough that you can buy treats from the supermarket – by treats I mean the type of high quality foods that will help you avoid spending on takeaways or restaurants meals. Things you really like. It doesn’t make sense not to buy the £10 salmon that will feed a family of 4 and then go out to a restaurant and spend £40 or £50 to eat the same thing. That’s the definition of false economy.
13. Ad hoc expenses
The ad hoc account is for annual expenses such car services, car tax, car insurance and MOTs. If you want to do any basic house improvements I would
This is all the non-negotiable hard-to-cut-back stuff added to the budget. Savings can obviously be amended but if you set a realistic savings goals to begin with, you shouldn’t need to change that.
This pot might have flexibility if you can choose between public transp
To the extent that you make lots of non-work or childcare-related trips, this is flexible.
This is the ultimate luxury and if you were strapped for cash would be an obvious thing you could cut out of your life.
17. Meals Out
Based on how much money is left after all the important stuff this might have to be zero in some months. Before we had kids my husband and I spent a lot on eating out now we have months when not a penny is spent in eateries including coffee shops.
18. Memberships and subscriptions to magazines, newspapers, Amazon prime, Audible, Netflix, sky or virgin TV, etc.
This is flexible in theory but in practice is hard to reduce.
20. Other stuff ... Clothes? Make-up
This exercise would get tedious if you were trying to do it all the time but as a one-off it can be quite fun. I have found the money dashboard app helpful for getting an overview of what I spend in various areas. Maybe it can help you too.
Once you've done this exercise it will hopeful draw out where you can cut expenses and hopefully it might bring any bad spending habits to light.
Because the British tax year goes from April to April I usually pay closest attention to my budget just before the tax year and in November as I prepare for Christmas because that's when i am most likely to lose it with my spending.
I hope this helps, Barry.
Have a money question for me?
I’m Melissa. As a full-time entrepreneur myself, I often find a difficulty in deciding how much monthly income to re-invest into my business and not OVERDO IT.
This reminds me of why I often lose at the board game "Monopoly", ha! Because I'll spend every last dollar on buying up houses and hotels and when I fall on someone else's property, I don't have the money to pay them. And it's a downward spiral from there, haha.
I'm sure you know just as well as I do that our businesses are our babies and sometimes we think we aren't feeding them enough to grow as fast as they can. But at times, over-investing can cause immediate problems.
What should I do to find a balance between re-investing as a business owner and putting money aside?
The trick to answering this question is uncovering what your goals are for the business and what your goals are for your private life. This will both allow you to decide how much to take out of the business and also when to exit the business, if ever.
I ran my own business from 2012 to 2017 and I had to answer this question myself. In the first year of the business I earned very little but I had saved over GBP60,000 because I knew I wouldn't make money from the get go. This is the reality for most businesses but from your question it sounds like you are past this stage and have some cash coming in, well done! You've gone past the first hurdle.
So, what kind of business are you running?
I’ll define the three categories:
The Lifestyle Business
A lifestyle business to me is one where you want to earn enough to support all your needs and a good portion of your wants. You don't hire too many permanent staff - perhaps you have a couple of virtual assistants - for your social media and bookkeeping and use freelancers for everything else.
The 'grow and sell' business
With a ‘grow and sell business’ you’re a little more focused on the business than on yourself so you’re a little more willing to “suffer” for a period of time by cutting off all wants and just extracting enough for your needs because the business comes first.
You want to get a consistent level of year-on-year growth and you want to track several observable metrics that will make it easier to sell your business in a time frame which you set. Sales numbers are the best metric to track but even social media statistics can be something worth measuring: healthy email lists, social media accounts with real followers, that kind of thing.
The legacy business
A legacy business is one that has to satisfy your income requirements for a prolonged period of time with a view to passing the business on to your children or selling far in the future if your children are not interested in running a business.
Once you’ve decided the type of business you’re running, then you need to go through the following process:
1. Figure out how much cash your business needs every month? This is your, “monthly cost of operations”
Some people think running an online business is virtually cost free but you and I both know it isn't so.
Sit down and calculate the minimum amount of cash the business needs to have just to keep chugging along. This should include the cost of all your tools: email marketing software, social media software, graphics tools, website hosts, budget for freelancers and other staff costs, advertising!
Back in 2012 when I started my business you could get a decent level of exposure for free, Facebook posts on pages were actually shown to people that had liked the page and you could monetise that exposure. Nowadays you have to spend money to get even low levels of exposure.
You probably also need a budget for taking courses that will help you grow your business. The marketing techniques that work are constantly changing and you will need to keep on top of marketing intelligence to grow your business.
So, it really is worth sitting down to figure these costs out. Once you have the number, you’ll know the minimum level of money you need to leave in your business bank account every month. Divide annual costs by 12 so that you have a reliable monthly cost of operations figure.
2. Figure out how much you need to live. This is your “monthly cost of living”
If you are fortunate enough to have your living costs mostly met by your parents or your partner then this won't be a large number.
My husband supported us for a good portion of my self-employment but I paid myself enough to cover my lifestyle costs: beauty products, going to cafes with friends, clothes, that type of thing and when we had our son, I made sure that the business covered his nursery costs too because the only reason he was going to nursery was because I needed to work.
Ultimately, this meant I took out about £600/month to cover four half-days of nursery each week and £670/month for myself.
The amount I paid myself wasn’t random: my accountant set my wage level just low enough not to have to pay national insurance tax. You will have to consider the tax impacts for yourself. That threshold moves every year. You could pay yourself more through dividends but speak to an accountant to get the balance right because if you pay dividends too often the taxman could say it looks like a salary and should therefore be taxed at the higher earned income tax rates.
If you can live on less than the sort of figure I am suggesting, even better.
If you're not living in a supported situation and have to pay all your own bills then this number could be much larger.
So, having done steps 1 and 2 you will know the minimum amount you need to keep the business going and plus the minimum amount the business needs to make to keep you going too. Is your business producing at least this much? I hope so.
3. How much do you want to save?
The next step is one I regret not having given enough focus when I was self-employed. I didn't save much at all for the household in that entire time. In fact, the only person that built up any savings is our son who had about £12,000 by the time I ditched the business and went back to work.
In fairness, the business was not making enough for me to save but if I think back I could probably have managed to put away £300-500/month for the family if I really wanted to. I didn't suddenly start earning more when my son was born so the fact that we managed to find over £300/month to grow his savings shows the money was there.
To decide on the ideal amount of money to save every month, project how much money you want to have at the age when you want to retire then using an online retirement calculator to figure out how much you ought to be saving every month. I found a good UK pension calculator on PensionBee.com and a good US retirement calculator on vanguard.com.
If you are running a lifestyle or legacy business and the business is generating not only enough to support operations but enough to save and live. Fab!
So, how's this different for a 'grow and flip' business?
If you are building a 'grow and flip' business then I wouldn't worry too much about the savings elements. If you can sustain operations and yourself then you can continue running the business and ploughing all excess money back into it in the hope that you will sell the business for a good lump-sum in say, 5 to 7 years.
Because this is a higher risk strategy you need to decide when you will quit the business. You can't continue running a business that doesn't allow you to put money into savings and investments indefinitely. You need to decide for yourself the point at which you will decide it isn't work.
What you take out of the business depends on:
1. What the business needs to keep going.
2. What you need to live.
3. What you need and want to save.
To attach some numbers to this discussion:
If your business is generating at least £1,500 every month (for example purposes) and it needs £800 to just keep moving then there's £700 left for you to either take for yourself or re-invest in the business.
If £700/month isn't enough to meet your living costs then you need to figure out how long your savings can support you while you give the business a chance to grow.
If your business is generating at least £5,000 or more every month and it needs £1,000 per month to sustain operations and you need another £2,000 for yourself then there's still £2,000 to play with. In this scenario, even if I was running a 'grow and flip' business I would save to hedge myself against the risk that my business isn't sellable.
A final thought. Ultimately, I left my business because it produced lower profits than I could earn in "regular job" and fortunately for me, I discovered that I actually love the routine of going to work and communing with my colleagues.
If over a two to three year period the business is generating you, say, £30,000/year and you know you could earn £50,000, £60,000 or even £100,000/year working, have a deep think through whether the long hours of building the business are worth it.
Many glamorise entrepreneurship but we both know the hours can be long and hard and the returns inconsistent from month to month and year to year.
For knowledge workers (Economists, lawyers, researchers etc. – desk-type jobs), the in-work flexibility is unreal nowadays and you could pretty much set up your life to be more flexible than an entrepreneurial life, with much more free time and real holidays where you actually leave your laptop at home!
Sorry if any of this last bit sound discouraging but I promised myself that when I blog about business I will always give people a real sense of what it's like. There are enough blogs out there pretending every 'trep is a millionaire when the reality is that the average self-employed person in both the UK and the US earns less than the average worker – shocking, right?
Hope this helps, Melissa.
Have a money question for me?
My husband and I want to buy a house, how can we go about improving our credit score?
This is an awesome question. I think lots of people come up against this issue at one point or another. Before I get into the detail, straight off the bat I’ll tell you what you don’t need to do, you don’t need to get a credit card. You can build excellent credit without a credit card despite what people say about needing a credit card to build a credit record and strong credit score. Now that I’ve got that off my chest let’s start from the beginning?
Firstly, what is a credit score and what’s it trying to achieve?
A credit score is a number that’s designed to be an indicator of your creditworthiness. This means that the credit score gives lenders an indication of how good you are at paying your debts and how likely you are to default and not pay them. Lenders only want to lend to people that are likely to repay that money and the credit score is an indicator of your likelihood to repay.
Your credit score is built up using all the information a credit reference agency has collected about you over time especially over the last 6 years; information older than 6 years usually doesn’t weigh into your score.
The credit reference agencies that you might have heard about are:
You can also go directly to Transunion or Crediva to get a credit report from but they don’t give you a score directly – they only do so via CreditKarma and checkmyfile, respectively.
If you want to improve your credit score you need to know what your current score is so you can track it. You can’t improve something if you haven’t measured. Credit scores work in the following way:
How come ClearScore and CreditKarma are free?
Both make money by selling products to their customers. But, in my opinion, the way ClearScore goes about it could land you in unnecessary debt so I wouldn’t recommend them. Under the credit information, there’s a section on ClearScore that asks you “How can I improve my credit score” and one of their pointers if you don’t have a credit card, is that you get one. CreditKarma aren’t so brazen.
I feel as though ClearScore keep my score artificially and strategically low to nudge me towards that credit card. So, if you do use ClearScore, know that even if you pay your debts on time, are current on all your bills and are essentially doing everything you should to be classified as financially responsible, you won’t get the top credit score if you don’t have a credit card. I am very anti-credit cards so I would never get one and this one aspect of ClearScore annoys me and stops me from using them.
With all this knowledge about the agencies, this is what I recommend you do to improve your credit score:
Firstly, get a CheckMyFile credit report and credit score. As I mentioned, CheckMyFile’s score is out of 1,000 and based on information from 4 agencies; you will be able to view a lot of the information that all 4 agencies hold on you.
Second, I suggest you check your credit score only (not the credit report) at Experian. Experian have a service where you can view your score anytime for free but you won’t be able to see the full credit report under that service. Because you are getting an Experian report via CheckMyFile there is no need to get it directly from Experian too, at least not in the same month.
The reason I am suggesting you get your Experian score (which is out off 999) is that I find their score very responsive to changes in your financial footprint. If you pay off debts and so on, the Experian credit score improves within a month or two and it’s actually possible to get a perfect Experian score of 999, I have had that several times.
In my experience, Experian’s credit scoring system is the most legitimate and reliable.
Make sure you unsubscribe from CheckMyFile before a month is up because they will start charging you £15 per month after that.
This will mean you lose access to credit reports and the checkmyfile score but that’s okay because you will have the Experian score and to check your credit report on a regular basis, just use CreditKarma. The level of detail Credit Karma has is actually very impressive. They actually have financial details on my profile that Experian seem to have missed and yet, outside of the little bits of missing data, Experian is generally the most comprehensive. FYI, Experian is not paying me to say any of this.
Okay, so what can you do to improve your credit score?
These are the things that will have a huge negative impact on your credit score:
In summary, what should you do to improve your credit score:
Hope this helps, Chrissy.
Have a money question for me?
Based on the things you told us about investing, my husband and I started putting £125 per month each into our SIPP pension. I hope this isn’t a silly question but what are these savings for? When can we expect to start spending that money and should we try to spend it in specific ways or on specific things? Both my husband and I are 30, we don’t plan on having children and our jobs have fixed pension benefits.
That’s a great question. While everyone has a different value system, there are two main reasons that I strongly recommend that people put money into a self-invested pension plan or SIPP a) flexibility and b) security including funds to help pay a mortgage off early.
A SIPP can be better than a stocks and shares ISA, in some cases, because you effectively pay less tax and because you can’t use the money until you are about 58 so it forces you to save.
Let’s talk about each reason in turn:
The first reason: is flexibility over when to retire
In the past, a lot of work-based pensions (aka defined benefit pension plans) used to allow early retirement from between the ages of 55 and 60, most of these type of scheme are being completely phased out and are instead being linked to the state retirement age which for you is currently expected to be 68. There is talk of moving this to age 70, so this is a future possibility.
Whatever happens, the funds that you build up in your SIPP can be taken from 10 years before the state retirement age. This means if the state retirement age moves to 70 you will still be able to use money that’s sitting in your SIPP from the age of 60.
If you and your husband are putting £125 each into a SIPP then when you are 55 years old, you and your husband’s combined pot of savings would be worth £135,000 if the pot of money only grows fast enough to keep up with inflation of about 3%; if you get growth equivalent to the average stock market return of 7% then you would have £250,000 at the age of 55 and if you get an average stock market return of 10% you would have £410,000 saved up.
At age 60 the figures would be £180,000 @ 3%, £375,000 @ 7% and £700,000 @ 10%.
These sort of returns aren’t cuckoo. According thebalance.com, “the S&P 500 Index, delivered its worst twenty-year return of 6.4% a year over the twenty years ending in May 1979. The best twenty-year return of 18% a year occurred over the twenty years ending in March 2000.”
Various sources suggest the S&P 500 has returned 10% before inflation if you buy and hold the money you invest into it. But of course, it’s useful to remember that this past success doesn’t guarantee that future returns will be as good.
Right now you would struggle to find a bank account that gives you an interest rate of 1.5%.
Back to flexibility on when you retire, however, unless you believe the US has no room for growth, then this total of £250/month you are saving could amount to a lot of money over a 25 to 30 year period and this would allow you to retire with a decent income well before the state retirement age.
If your mortgage is fully paid off by the time you retire then your cost of living could be low enough that even a modest growth in the SIPP would provide a comfortable income before your state pensions and work-place pensions kick in.
The second reason: to save the money is the added security from having extra retirement income
Having money in a SIPP means you can top up your retirement income.
Having the SIPP would mean you have 5 sources of income:
If the pension income from your jobs is lower than your final salary having access to extra funds will mean you can more or less maintain your lifestyle. This will be especially important if one person lives a lot longer than the other.
There is one special feature that the SIPP has but all the other 4 pensions do not: and that’s the fact that if you or your husband dies the state pension stops coming through and the work-place pension either stops completely or is massively reduced. However, whatever money is outstanding in the SIPP would fully transfer to the spouse without penalty.
Just to be clear, I will make that point twice: a work-place pension either dies with the person and at that point the spouse receives nothing or, from that point, the spouse gets a heavily reduced benefit – usually 50% of one-third of the amount that was being received before their spouse died.
A LOT OF PEOPLE forget this about SIPPs and other defined contribution pensions. I won’t go into the differences between defined benefit and defined contribution pension plans here but if someone is interested go to themoneyspot.co.uk and leave me a voicemail with your request.
Finally, when can you expect to start spending that money and should you try to spend it in specific ways or on specific things?
Technically, the plan is that you will never have to spend the capital but can just spend the growth.
If the fund is worth £250,000 when you start drawing from it and you are earning a 10% return per year at that point, then you could just withdraw the 10% (i.e. £25,000) or less and spend that.
If your withdrawal rate is lower than the growth rate of the fund then your retirement would continue to grow even as you take money out.
Note that some research suggests that the ideal withdrawal rate to maximise the likelihood that the money will never run out is 4%. But given you have pension income from your jobs in addition to the state retirement and you’re not worried about passing wealth on to children you could be more aggressive than this.
As for how you spend that money, well that is up to you and is a great problem to have. Having more money doesn’t only mean more holidays, it also means you can buy private health insurance which might be a necessity to avoid NHS waiting lists at a time when health problems are more likely. This would give you a lot of peace of mind.
Ability to pay mortgage off early
One thing worth adding, is a note that once you can withdraw money from your SIPP you are allowed to take 25% out as a tax-free lump sum. If your household had £250,000 saved up, you could take £62,500 out in one go which could be used to clear all or most of your mortgage.
You would then be allowed to take the rest out as an income or you could buy an annuity – with an annuity you essentially buy a fixed income which keeps being paid to you for the rest of your life.
I wouldn’t recommend an annuity for you given you have two fixed pensions coming in already, you don’t need the extra security and annuities don’t tend to be worth the money now that interest rates are so low. What you could do instead of buying an annuity is withdraw what you need from the SIPP every year. You would pay taxes based only on what you take out and could manage the withdrawals to minimise the tax bill.
I hope this helps.
Have a money question?
Heather on Wealth
I enjoy helping people think through their personal finances and blog about that here. Join my personal finance community at The Money Spot™.