Sorting Out Your Finances For Dummies

By Melanie Bien

Being good with money is about getting into good habits and understanding the choices you make.  Fully updated to cover the latest financial trends and developments, this book gives you the confidence to plot where your money goes, to know your limits, and to choose the right financial products for a wealthier future.

It will help you learn how to analyse your financial situation, isolate problem areas, properly structure your debt, investments and retirement plans, and adopt good money habits whatever your age or financial situation. Once you’ve sorted out your finances you’ll get much more pleasure from the money you spend and the money you save.

Discover how to:

• Make your salary go further
• Set financial goals and reach them
• Get out of debt
• Start an investment portfolio
• Prepare for the unexpected

• Language: English
• Publisher: Wiley
• Release date: Feb 15, 2011
• ISBN: 9781119998228

Book preview

Part I

Organising Your Finances

In this part . . .

Before you sort out your debts and investments, you need to get the basics in order. In this part, I guide you through the process of establishing your financial goals and how an independent financial adviser can help you reach them. I include hints on choosing an adviser and the qualifications to look for.

I also give you tips on choosing the best current account for your circumstances, and making sure you’ve got enough insurance in place to guard against the unknown.

If you’re thinking about getting your finances in order, but are not quite sure where to begin, this is the part for you.

Chapter 1

Exploring the Basics

In This Chapter

bullet Benefiting from getting a grasp on your finances

bullet Looking at your financial picture

bullet Working out how you can get out of debt

bullet Figuring out what you want from your finances

bullet Investing the tax-free way

bullet Understanding the importance of financial advice

C ongratulations! You’ve decided to get to grips with your finances and start building up your savings and investments for the future. Making sure you’re in control of your finances enables you to do what you want – upgrade your car, get on the first step of the property ladder, or start building funds for retirement.

In this chapter I start by giving you the lowdown on working out what your financial goals are and how you can achieve them. I offer advice on clearing your debts before you begin building up your savings and investments, and the importance of seeking independent financial advice. Only when you have the basics under your belt can you ensure your finances work for you – rather than limiting you from doing all the things you want to do.

Looking at the Benefits of Being on Top of Your Finances

Sorting out your money by clearing your debt and building up your savings and investments makes you the master of your financial future, and brings several benefits:

bullet You stop paying expensive fees and charges for being in debt. Debt is pricey, with high rates of interest and often extra fees and charges. If you’re in a lot of debt and pay a significant amount of interest on it, you may find that you simply can’t clear what you owe as all your money goes towards servicing the debt and paying the interest. Clearing your debt removes the debt itself and the cost of financing it.

bullet You get rid of your guilt. Being in debt can be a worry, particularly if your debt has got out of hand and you can’t see any way of escaping the situation. Some people also regard being in debt as a stigma – something to be ashamed of and hidden from friends, family, and colleagues. Any way you look at it, debt is a burden and getting rid of it can be a huge weight off your shoulders.

bullet You feel more confident about the future. With the state providing little financial support in retirement (see Chapter 15 for more on this), you may be concerned about how you’re going to make ends meet. But if you have savings and investments spread across a range of funds, pensions, and property, you can rest easy with regard to the future. You may even be able to look forward to giving up work, rather than dread it.

bullet You open up a range of financial options. If your finances are in order, you can afford to take time off to travel or try a new career. But if you have lots of debt or little in the way of savings, you may not have the option to do what you like. This can make you feel rather resentful.

Pondering Money Matters

To stay on top of your finances, you need to review major investments – such as savings accounts, unit and investment trusts, shares, and your pension – at least once a year, to ensure that you’re still earning the best returns. Getting into the habit of spending a couple of hours a week keeping things ticking over is also a worthwhile idea: Paying bills before they’re late or moving surplus cash from your current account to a high-interest-paying savings account. You should also use this time to plan what you’re going to do next.

Remember

When you find the best financial products available, keep a careful eye on them. As soon as they start to look uncompetitive, consider switching to a better deal with a more attractive rate of interest. Don’t become complacent, or you could lose out.

If you aren’t prepared to track your own financial investments, consider using an independent financial adviser (IFA) to do this for you. An IFA can make suggestions as to what you should be investing in and whether you should move out of existing investments. See ‘Using a financial adviser’ later in this chapter for more details.

In the following sections, I look at how you can start getting on top of your finances.

Working out how much money you have

You should know off the top of your head roughly how much your assets are worth, but if you aren’t on top of your finances you may not have a clue. Or if you’re in a lot of debt you may know the depressing answer straight away – nothing.

Many people have lots of savings accounts and investments dotted around with a few pounds in each. The money in such accounts often has been languishing there for years and earning a poor rate of interest. If the interest rate is halfway decent, it’s more likely to be down to luck than careful financial planning.

Tip

As a first step to getting a clear view of your finances, make an inventory of what you have: List all your savings and investments so that you can see all your assets at a glance. Don’t forget those windfall (free) shares you got when your building society demutualised (listed on the stock market), those premium bonds granny bought you when you were born, or that odd £20 sitting in a National Savings account. It all adds up.

Remember

Don’t forget payments into your pension (if you have one) and equity in your home (you can work this out by subtracting your outstanding mortgage from the market value of your property). These are all assets.

From there, you can assess whether your money is in the best place to earn you the highest returns.

Calculating your debts

If you’re like most people, you have a bit of debt. Or you may have quite a lot of debt, depending on your financial situation and attitude towards credit.

Remember

Debt isn’t always bad: The low interest rates of the past few years made it possible to pick up cheap personal loans or credit cards charging 0 per cent for an introductory period on new purchases or balance transfers. Making use of cheap money is a smart financial move, so long as you keep up with the payments and avoid expensive fees. And make sure you switch to another 0 per cent deal when the introductory period on your credit card runs out so that you don’t find yourself paying a much higher rate of interest.

Warning(bomb)

On the other hand, you never get out of debt if you ignore bills and credit card statements for fear of what you might find within the envelope. It may not make for pretty reading, but facing up to your debts is the first step to getting rid of them. A bit of short-term pain now leads to stronger finances in the longer term. Bite the bullet and open the envelope.

Before you can attack your debts – getting rid of the most expensive ones and chipping away at the rest – you need to make a list of exactly what you owe.

Tip

Compile and arrange a list so that your most expensive – rather than your greatest – debt is at the top. For example, you may owe £150,000 on your mortgage and £2,000 on a store card, but paying off the store card is more of a priority because you pay a lot higher interest on it. While you may be paying around 5 to 6 per cent interest on your mortgage, you might be paying six or seven times this much on the store card. Clearing the store card debt in the short term, and the mortgage debt in the longer term, therefore makes sense. (Go to Chapter 8 for more on store cards and Chapter 14 for the lowdown on mortgages.)

Clearing Your Debt – and Starting to Save

When you know how much debt you’ve got and what savings you have, use the latter to clear the former. This is particularly worthwhile if your savings are languishing in uncompetitive accounts while your debt is expensive.

If you don’t have enough surplus savings to make much of an impact on your debt, at least shift store and credit card balances onto cheaper plastic. This reduces the interest you pay: Instead of paying back just the interest each month, you can chip away at the outstanding debt as well.

Remember

Having some savings set aside is always reassuring, but if you’ve got expensive debt it doesn’t make much sense to have money just sitting in an account. Use the savings to clear some of the expensive, short-term debt, as you generally pay more interest on the debt than you earn on your savings. Only after you clear your expensive short-term debts should you start building up savings for an emergency or rainy day. (The chapters in Part II give tips for clearing your debt.)

After you clear your debt, your next step is to start your emergency fund – for if the boiler packs up, for example – which is vital to your financial health. Having an emergency fund prevents you from slipping into expensive debt in the first place.

Tip

Make sure your emergency savings are easily accessible. There’s no point choosing an account where you have to give 90 days’ notice before you can get your money – it defeats the whole object. The amount you save should be the equivalent of three to six months’ worth of outgoings: The exact amount you need depends on what you’re personally comfortable with and how much you spend each month. If you’re the main breadwinner, you may need more cash than someone with a wealthy partner with a good income. Chapter 9 has more on saving for a rainy day.

Establishing Your Financial Goals

Deciding how you should proceed is impossible until you know what you’re saving or investing for. Thus, you need to decide what you want before you begin.

When you’ve got your emergency savings covered, you can be more adventurous with your money. However, before you get carried away, remember that how you invest depends on what you want the money for and when you want it:

bullet If you’re investing for the short term – less than five years – to pay for a holiday or new car, for example, some form of high-interest savings account is your best bet, rather than stocks and shares, which can go down in value as well as up. If you need to raise a set amount of cash in the short term you can’t afford to take risks. Instead, opt for low-risk investments so that you end up with enough cash to enable you to achieve your goals.

bullet If you want to raise a sum of money for use in 10 or 15 years’ time or more, you need to invest for the long term. You may want to raise cash to pay for your children’s school fees or cash to put towards your pension. You can afford to take on more risk if you don’t need the money for a few years. The idea is that you have longer to ride out the ups and downs of the stock market.

Warning(bomb)

Riskier investments should generate greater returns in the long run, but make sure that you don’t need to get your hands on the cash in the short term and that you aren’t investing cash you can’t afford to lose.

Assessing how much risk you’re happy with

A crucial factor to finding the right investments to suit you is how much risk you’re willing to take on.

You can afford to take on more risk the longer you can allow your money to stay invested. As you near retirement, or need to get hold of your cash, you should switch to less risky investments so you have less chance of losing your money.

Planning for retirement

One of the main reasons people invest is to ensure they have enough income in retirement. You can’t rely on the state to provide a generous enough pension – you have to make your own provision.

Remember

A pension is one way of generating retirement income, but not the only one. Diversifying and spreading your risk across a broad range of investments is always a sensible idea.

Pensions come with excellent tax breaks (see Chapter 15 for details) but they are inflexible. If you tie up all your spare cash in a pension, and need some money in an emergency before you reach retirement age, you may not be able to get hold of it.

Tip

A sensible approach is to combine pensions with property, individual savings accounts (ISAs), and other investments to build a broad portfolio of products to provide you with an income in retirement. That way you won’t put all your eggs in one basket but will expose yourself to a diverse range of products.

Taking Advantage of the Tax Breaks on Saving and Investing

Never look a gift horse in the mouth, particularly when it comes to savings and investments. You have to pay enough tax to the Government without paying more than you need to. You can save tax on your investment returns – completely legitimately – by opting for tax-free products.

Remember

If you don’t pay income tax as a general rule, you don’t have to pay tax on your savings. Ensure your savings account provider knows this by filling out form IR85 – available from your bank or building society, or HM Revenue & Customs (www.hmrc.gov.uk).

If you do pay tax, opt for tax-free investments where possible, such as individual savings accounts (ISAs). These enable you to invest in cash or equities up to a maximum of £7,200 each tax year (6 April to 5 April the following year).

Other tax-free investments, such as those offered by National Savings and Investments, are available. But the rates on these aren’t always the most competitive (Chapter 10 has more on these) so don’t be blinded by the tax-free benefits.

Warning(bomb)

Choosing an investment simply because returns are tax free isn’t wise, and may not suit your attitude to risk or your investment aims, or fit in with the other products in your portfolio. Consider each investment as part of the wider picture and you minimise your chances of opting for the wrong product.

Using a Financial Adviser

One of the easiest ways to choose the right investments for you is to use an independent financial adviser (IFA). I advise opting for one who is totally independent and can recommend you any product on the market, rather than a salesperson who is restricted to a limited range of investment products.

Tip

You don’t always need a financial adviser. If you opt for simple products, such as a savings account, credit card, or personal loan, you should be able to choose one yourself. Do your research beforehand and opt for a product only if you understand exactly how much that product is going to cost you in the long term.

If you’re an experienced investor, you may not need advice either. But most people could always use a bit of advice, so paying a bit of cash to ensure you get the best investment may be worthwhile, and could save you money in the long run. (Go to Chapter 2 for more on choosing an IFA.)

Chapter 2

Taking Stock of Your Financial Goals and Seeking Advice

In This Chapter

bullet Working out a budget

bullet Figuring out what you want from your finances

bullet Considering the importance of financial advice

bullet Choosing an adviser or advising yourself

W hen you’ve decided to get to grips with your finances, you might get excited about what shares you’re going to buy in which company. But while you may be eager to start dabbling in exotic investments, you must first sort out more mundane matters.

In this chapter I discuss how to establish your financial goals and how to achieve them. I also offer tips on choosing an adviser, deciding whether to opt for fees or commission, and how to make a complaint if you feel you’ve been given the wrong advice.

Drawing Up a Budget

The only way to manage your finances is to draw up a budget that you can stick to.

People who get into debt generally do so because they live beyond their means – spending more than they earn. Drawing up a budget and sticking to it helps to ensure that this doesn’t happen to you. If you’re in debt already, following a budget can help you to get out of that situation and develop habits that help you stay out.

Tip

In drawing up a budget, record your income and expenditure for a set period – usually a month. You can then calculate how much money you have left over each month after subtracting all your outgoings from your income. This surplus is money you can use to clear away your debts or to start saving or investing.

Table 2-1 lists common outgoings. Go through this and answer honestly how much you spend on each item every month.

Remember

If the figures don’t add up, and you find that you spend more than you’ve got coming in, all is not lost. Look for ways to economise in certain areas, though be sure you’re realistic about what you can achieve: Don’t fool yourself into thinking that you’ll be happy to stay in every single night if you’re usually a party animal. It simply won’t be possible. While you might not be able to stay in every night, saying that you’re going to stay in one night a week when you would normally go out may be a realistic goal. This won’t have the same dramatic results as staying in all the time but it will save you money in the long term and you are more likely to stick to this.

Establishing Your Goals

Before you can start saving or investing for the future, you need to work out what your aims are. Only if you know what you are saving and investing for can you choose the best products to help you realise your goals. Otherwise, you’re likely to end up with completely unsuitable products.

Some of the financial goals you have may include clearing your debts, buying a house, starting a pension, or helping out your children.

Remember

Before you can start investing you need to clear your existing debts. In the next sections, I look at how to start clearing your debt and how to put your goals in proper order.

Prioritising your debts

If you have serious debts, your first financial goal has to be to pay them off. Before you can start investing, you need to clear your existing debts.

Remember

Debt can be extremely expensive. Having a few hundred pounds in savings if you owe thousands of pounds on a store card that charges you a high rate of interest makes no sense. The interest you’re charged on your debts is more expensive than the interest you earn when you’re in credit. Struggling to pay high rates of interest on your borrowings makes it even harder to clear the debt itself.

Before you can start whittling away at your debt, compile a list of exactly what you owe. Jot down all your debts, from outstanding store and credit card balances to your overdraft, personal loans, and mortgage, then prioritise them.

Tip

Organise your list so that the most expensive debt is at the top. You may be tempted to list your biggest debt – probably your mortgage – first. But bear in mind that more expensive debt – such as store card debt – needs to go before relatively cheaper debt – such as your mortgage. Your aim is to clear the expensive and unneccessary debt, such as pricey plastic and unauthorised overdrafts, first because it’s far more of a strain on your pocket.

Prioritising your goals

Most people have short and long-term financial goals. In the short term you might want to buy a new car or pay for a summer holiday, while in the longer term you may be keen to build up savings for retirement. And, you may have more than just your own future to consider: If you have children (or plan to have them at some stage), they may want go to university or need help getting on the housing ladder, and you need to plan to fulfil those goals as well.

Different goals require different investment vehicles so it’s important that you work out what you want and then prioritise them. If you’re investing for the long term – for retirement, for example – you should invest in equities because, historically, they produce the greatest returns over time. However, they aren’t suitable for short-term investment goals because they are extremely volatile – the value of your shares may plummet just when you need the cash to buy your new car. But if you don’t need the cash for many years you have plenty of notice as to when you need to sell your shares so can do so when you stand to make a profit. There may well be times during the years you own them when you suffer losses – at least on paper. But it doesn’t matter, as potential losses aren’t realised unless you actually sell up.

Tip

If you’re saving for a holiday or new car – investing for the short term – stick to a savings account paying the highest rate of interest you can find. At least you’re guaranteed to get your capital back, plus some return: You aren’t risking your cash. You won’t make the big returns you might have made on stocks and shares but at least you know there won’t be any losses either.

Seeking Advice to Help Realise Your Financial Goals

You’re likely to need advice before buying financial products, particularly if you’re inexperienced at saving and investing.

Considering the benefits

Life-changing experiences, such as buying your first home, getting married, having children, going self-employed, or retiring, often require professional advice. Potentially, you need a lot of money to see you through each of these stages and generating that money can be hard, particularly if you’re inexperienced in such matters. An independent adviser will metaphorically hold your hand and guide you through the stages. A professional puts distance between himself and your situation so he can assess the situation objectively and recommend the best financial course.

Warning(bomb)

If you’ve got friends or family who are financially literate, you could ask them for help. But unless they are experienced advisers themselves, and know all the ins and outs of your particular circumstances, they are not in a position to recommend the best products to you. For that you need a qualified adviser.

Finding out key facts

During your first consultation, a potential adviser should give you clear information about what services you’re being offered and an indication of what you’ll have to pay for them. This enables you to compare the cost of financial advice and shop around for the adviser who is best value for money.

Your adviser can explain the above by giving you two keyfacts documents concerning:

bullet Services: This document explains the type of advice you are being offered and the range of products offered.

bullet Costs: This list explains the different ways you can pay for the advice you receive and gives an indication of the fees or commission you may have to pay. If you pay by commission, it shows you how this compares to the average market commission. (See ‘Paying for advice’ later in this chapter for more information.)

Considering Advisers

Three different types of financial adviser exist: independent, tied, and multi-tied. In the following sections, I explain these in more detail.

Being truly independent

If you want unbiased financial advice and access to all the products on the market, then opt for an independent financial adviser (IFA). An IFA researches the whole market and takes his pick from what’s available to ensure that you get the best product for your needs.

Benefiting from independent advice

The big advantage of using an IFA is that you’re using a qualified practitioner to find the best products for your circumstances. Your IFA asks you a number of questions about your situation, your financial goals, and attitude to risk to ensure that he finds the most suitable products.

IFAs are answerable to the Financial Services Authority (FSA), the City regulator. IFAs have to follow FSA rules, so you have the comfort of knowing that your adviser is governed by certain procedures. If he falls foul of these rules, he will be brought to task by the FSA, and may be fined and could even lose his licence to trade. Hence, abiding by these rules is extremely important to IFAs.

Remember

When your IFA recommends products to you, he must provide reasons, in writing, as to why he suggests certain funds and investments and not others. This is to avoid the chance of mis-selling, when you are advised to take out products that aren’t suitable for you.

Avoiding the pitfalls

Not all advisers can offer independent advice on every investment product. One advisory company may offer advice on mortgages from the whole market but not be authorised to offer investment advice (see ‘Taking a more limited approach’ in the next section).

Remember

Check that your adviser is authorised with the FSA: Don’t assume this is the case – the unscrupulous have been known to lie about this. Check that he is authorised even if he has been recommended to you by a friend or relative. You can do this by checking the FSA Central Register at www.fsa.gov.uk/register or telephone [phone] for further information.

Warning(bomb)

If you sign on with an unauthorised adviser and he loses your money through negligence, you can’t claim compensation as you could in the same circumstances with an authorised IFA.

If a firm is authorised by the FSA, and you feel that