3 Developing a savings and investment plan
In the previous session we looked at how a savings buffer will help cover unexpected costs. Here we are going to look at saving and investing more widely to provide the money to support those big events you listed in the previous section.
Your strategy for these will reflect your personal circumstances and your appetite for taking risks.
There are, though, a number of key points that everyone should consider when deciding where to place any potential savings.
Diversify your savings once you have more than the rainy-day cushion
Once you have more savings than you need for your emergency rainy-day fund you can start diversifying the types of accounts you hold. You could look at opening fixed rate accounts where the interest rate offered stays the same over the life of the account. With fixed rate accounts your money is tied up for a period of time. You may be offered a better rate of interest than an instant access account but the trade-off is that you won’t have immediate access to your money if you need it. Mixing fixed and variable rate accounts means you are hedging your bets on the future direction of interest rates. Interest rates on savings accounts are often lower than the rate of rate of inflation. This means that the value of savings is falling in ‘real’ terms (i.e. after adjusting for the impact of inflation). This makes it particularly important to find the best rates for cash savings.
Avoid paying tax on your savings
Most people can avoid paying tax on what they earn from their savings.
The Personal Savings Allowance (PSA) currently allows £1000 of interest for basic rate income taxpayers or £500 for higher-rate taxpayers to be exempt from income tax.
Additionally you can invest up to £20,000 in each tax year in Individual Savings Accounts (ISA) where the earnings are free from income and capital gains tax. A ‘Cash ISA’ is the savings account type of ISA. These can offer both fixed and variable rates of interest and there is no risk of the cash value of your savings falling. However Cash ISA accounts often offer lower interest rates than standard savings accounts so make sure you look around for the best deal. You can also move your money if the rates are better with another provider.
Diversify into other investments brings risks and returns
Once you have built up your savings accounts what should you do next if you still have spare cash to invest?
You’ll see in Session 3 that the income tax relief on pension contributions make investing further into your pension fund a good option. However, you may not want to plough all your available cash into your pension savings, particularly if you anticipate needing this money before you plan to retire – for example to buy a holiday home or pay for a wedding.
You may want to diversify your savings into investments like company shares and bonds. There are various ways to do this, like simply buying shares through online platforms, or buying into funds like unit trusts and investment trusts. One easy way to make investments like this is through ‘Stocks & Shares ISAs’. These, as you just saw, are tax-free investments so you won’t pay tax on any gains made. Additionally, when investing in these your money is placed in a fund which is usually split over many different companies, so your investment risk is spread.
There are abundant accounts on offer – just use your search engine to research ‘Stocks & Shares ISAs’. Remember that the money you invest will move up and down in value in line with the market prices of the stocks and shares in the funds you invest in. To help make decisions you can research the past performance of potential investments via the websites of financial services firms and brokers. The weekend press is also a good source of information about investments.
Stocks & Shares ISAs are more suited to longer term savings– ideally at least five years. Over such time periods the returns from these investments usually outperform those on savings accounts.
And do check out the fees you are charged on these investments.
Manage your investment risk as you get older
When thinking about your investments you should certainly consider ‘age-profiling’.
In the past the general rule was to reduce the amounts invested in high-risk investments. The logic for this was that greater certainty about the money you were going to have at your disposal was needed as you got older – so high-risk investments with volatile prices were best avoided.
The position has changed in recent years. Longer life expectancy plus greater freedom to use your pension savings means that automatically minimising investment risk as you move into your 50s and 60s may not be the best choice for you. Staying with at least some high-risk investments with their higher expected returns can make sense. If you go down this route, though, you should also aim to build up your rainy-day fund - to perhaps the equivalent of two or three years of household spending - to provide a big cushion if the stock market has a major dip just when you need to cash in your investments.
Investing in companies that share your values
You may also want to hold investments that are consistent with your values. For example you might only want to invest in companies engaged in ethical businesses. So this could, for example, rule out investing in companies that make armaments or perhaps those in the tobacco industry. You might also want to invest only in companies that are considered ‘green’ and who do not engage in activities that harm the environment or contribute to global warming.
The good news is that ethical investing is a well-established practice and there are numerous products, including many Stocks & Shares ISAs, available for ethical investors.