If you have managed to calculate your Saving Ratio and have tidy sum to save every month but are wondering what to do with it?
I am not a financial advisor, but these are the things I did.
Build up a 3 to 6 Month Emergency Fund
I have learned over time that life does not go the way we think it will. Sometimes people are made redundant without notice, and as a result, individuals made to survive without a regular income.
Sometimes, there are high unexpected costs that come along and disrupt our plans. Other times, there is a worldwide pandemic causing the world into lockdown! Whatever the reason, you need to have access to cash. It is good practice to build up your savings to sustain 3 to 6 months' worth of expenses. We call this the Emergency Fund.
The emergency fund should be at high interest, quick access bank account. The emergency fund allows you to access the money when you need it. Having this money lets you have the peace of mind and avoid having to take out an expensive loan to pay for emergencies.
In the example of Mr. X, with a monthly fixed cost of £1000, he would aim to build up an emergency fund of £6000.
Pay off high interest loans
Once you have built up an emergency fund, the next step is to pay off high-interest loans. For me, this included credit cards and car loans. When we are young, we are swayed by our newfound freedom to borrow more than we can afford - mainly if we are in a culture where borrowing and credit are widely accepted.
Therefore, paying off loans based on the highest interest rate helps reduce the monthly expenses related to interest payments.
If we take the example of Mr. X with a credit card bill of £6000 at 10% per year, the credit card company will charge interest of £60 per month or £600 per year. Therefore, if he were to take his saving ratio amount of £600 and pay off his credit card in 10 months, he would save himself £120 for the rest of the year.
Increase your pension contribution to the level your employer matches
When I was younger, I did not understand the benefit of pension matching by employers. I now understand that by matching the contribution my employer is will willing to offer, on my pension contribution, I am effectively getting a 100% return on my gift - it was free money.
This money can be invested in your pension and will grow over time. So if you can entirely match your employer's contribution, then do so, but remember you will only get the money when you reach retirement age.
Pay off other loans
Paying off other smaller loans offers me a sense of satisfaction and freedom. These could be students loans and mortgages where the interest rate is low. Some might argue that since the interest rate amount is small, it may be worth investing that amount and pocketing the gain. Some loans also have early repayment penalties to consider.
For example, if you have a loan for £10,000 at 3%, but you can get an interest rate of 4% at a bank, it might be worth putting the money in the bank and gaining the 1% interest over time.
Saving into ISA /Save into a low cost company pension or SIPP
Finally, it is time to tackle financial goals. In life, there are short-term financial goals, such as paying for an engagement ring, paying for a wedding, and paying for a house deposit. There are also long-term financial goals, such as retirement. To prepare for these commitments, it is worth relocating your savings into an Individual Saving Account (ISA) or pension.
If you have short term goals, it makes sense to use the tax-free ISA accounts to save money. By doing so, you do not pay tax on the money you make from it. ISA accounts allow you to save cash or invest your money up to a value of £20,000 every year. By doing this, I was able to save for my house deposit.
If you do not have any short-term goals, it may be worth investing in your pension. If you have a low-cost company pension or a Self Invested Pension Plan (SIPP), you can save it into these. By transferring into these pensions, you can save tax, mainly if you are a higher taxpayer. By allocating up to £32000 into your pension fund, the government will give you up to an additional £8000 into your pension if you are a higher rate taxpayer. Remember, there is a £40,000 yearly limit on this as well as a lifetime limit of £1 million. The only downside to this is you can't access the money until your pension age.
If you want to save further than this, I would strongly recommend talking to a financial advisor who will be able to advise the best way to save and invest your money efficiently.