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In This Chapter

▶ Calculating how much you have

▶ Drawing up a family budget

▶ Taking care of life and limb

▶ Paying into a pension investment

▶ Checking the roof over your head

Investment truth #1: Losing money is easier than making it.

Investment truth #2: More domestic break-ups and rows are caused by money, or rather the lack of it (or the spending habits of one partner), than anything else. Money is more important than love, any day.

Investment truth #3: You’ll be a better investor if you’ve secured your home base – getting a roof over your head whose costs are sustainable is the vital first move. Buying, if you can, is usually better than renting, so a mortgage is the number one investment. Provided, that is, that you can find the deposit.

Investment truth #4: Paper profits have no more value than the piece of paper they’re written on. What your investments are worth on a statement is just a row of figures. Until you turn that investment into cash by selling, it won’t put a roof over your head, put food on your table or provide an income if something happens to the breadwinner.

Investment truth #5: Borrowing money to buy investments can be a very fast route to the bankruptcy court, as can gambling on stock markets.

Feeling down after reading that? Wondering why Chapter 2 doesn’t launch straight into how to analyse stock futures and double your money in minutes? Or how to clean up with a simple, can’t-fail formula?

You’ve every right to be depressed and puzzled. But it’s a good thing you are. Investment knowledge has as much to do with when not to do something, when to hold on to what you have, and when to hold back and let the next person pick up the problem as it has to do with plunging headfirst into financial markets.

And that’s what this chapter is about. Before you invest, you need to consider all the above truths. You need to take a close look at yourself, and those around you. You should be aware that no easy routes exist in finance. But more importantly, everything revolves around you and your family – not the commission needs of assorted advisers and hucksters who claim to have the solution to all your problems.

There’s nothing new under the sun

I’ve probably been involved in investment writing for far too long. I’ve seen it all and then all over again. I can remember the great 1970s bust and boom, the 1980s boom and bust, and the 1990s boom that, inconveniently for my neat decades, only bust just after the decade ended in 2000. Then, back in 2008, we saw the great banks’ boom and bust. Add to that more than a few property bubbles, and some crazy ups and downs in gold, oil, wheat, sugar and just about everything else under the sun. Every time share or other financial market prices advance to new highs, I ask myself just how long it can last.

Unfortunately, those running our finances never see it that way. They learnt nothing from the great 2008 banking crisis (or any other). This isn’t surprising: they can’t own to up the fact that finance runs in cycles of up and down because that’s more than their very highly paid job is worth. Asking them, ‘Just how do you do it? Where does the money come from and go to?’ is like asking the emperor about his new clothes. ‘Don’t worry. Nothing will go wrong,’ they reply. After all, these people control some of the world’s biggest firms, so how could they not know? How could they be anything other than full of wisdom? How could anyone taking home millions a year in bonuses be anything other than supremely able? But reliance on these people was wrong, wrong, wrong.

Despite what politicians and bankers often say, the world will never usher in a new financial era in which boom and bust have been abolished. I wish this age could exist, but wishes don’t turn into investment success. The rules of investment that I lay down in this book must catch up sooner or later.

Everyone who tried to convince me that we were into a new world with new rules probably earned 10 or 100 times as much as I did. But they could take this devil-may-care attitude because they were playing with other people’s money (known as OPM or opium). They didn’t care what happened because they made sure that they were number one. By the time it went horribly wrong, they’d made their cash and locked it away somewhere impenetrable.

The morals of all this? Don’t chase fads. Never assume a quick or easy route to riches exists. And never give up the day job, no matter what someone offers!

Assessing Your Personal Wealth

Before you start investing, take a long, cool look at your personal wealth. Draw up a balance sheet (Figure 2-1 shows an example) so you can check how much comes in each month from work, interest payments, dividends and/or pensions. Then look at where the money goes.

Figure 2-1: Use a balance sheet like this one to keep track of how much money comes in each month and where it all goes.

Repeat this exercise over three to six months so that you balance out low-spending months in one category with months in which you had to lay out a lot. Also take into consideration months in which a big bonus or overtime payment boosts earnings. Averaging means you even out these peaks and troughs.

An essential first step before investing is knowing what your incomings and outgoings are (how much money is coming in and going out). This knowledge helps you focus on your goal of increasing your wealth. And what if your outgoings leave nothing left over? Well, you know you should consider holding back from active investment at this time. But you can still use this time to look at, find out about and get a real feel for financial markets.

Taking Care of Family before Fortune

Investing involves taking chances. Serious investing, as opposed to taking a wild punt on a short-term stock market move, ties up your money for a length of time. Assuming that you have some spare money (see the preceding section to find out whether you do), think about how investing it rather than spending it will affect your household.

Weigh up the happiness quotients for all concerned. For example, compare spending the money now on piano lessons with investing it for later use on university tuition fees. I don’t pretend this is easy.

What you do with your money should have a goal. Investment is intended for future consumption. It’s not a game where you concentrate on ego-boosting by building up a big cash score. Plenty of phone apps and computer games exist for that.

Talk over investment strategies with adult members of your household. You’ll feel much better if you get them on your side. But if they aren’t happy with your strategies and you can’t convince them then hold back.

If you have some spare cash but don’t want to take chances with it, or maybe you’re tempted to spend it, go for National Savings, now renamed National Savings & Investments. National Savings offers a number of products where you can put your money away for a set time, ranging from one to five years, and more flexible accounts are available as well. The rates are rarely chart-topping, but you have the security of the UK Treasury and Exchequer backing your decision. And for anyone who went through the misery of bust banks in 2008, that’s a great comfort blanket.

Studying How to Save without Sacrificing

Almost everyone can save some money without sacrificing too much lifestyle. Even small amounts each day can soon mount up. Here are some initial ideas – and how much you can save each week:

✔ Give up smoking. A person who smokes 20 cigarettes a day will save £60 a week.

✔ Buy milk at the supermarket instead of using home delivery. You’ll save £6 a week.

✔ Take a sandwich from home instead of buying one at work. You’ll save up to £15 a week.

✔ Go shopping with a list and stick rigidly to it. You’ll save at least £10 a week – and probably avoid some fattening snacks as well.

✔ Ditch pricey cable or satellite TV stations you hardly ever watch. You’ll save £3 to £10 a week. Freeview has more channels than you can watch.

✔ Put every £2 coin you receive into a box. When you have £50, put the money into a special bank or building society account. I did this when I was saving for my bike. I put away over £800 without noticing it.

✔ Buy a copy of Sorting Out Your Finances For Dummies (published by Wiley). You’ll save yet another fortune each week!

Think about your lifestyle and then make your own additions to the list, from saving on transportation (walk? cycle?) to checking the market for gas, electricity, mobile phones, landlines and broadband, and always using a comparison website for insurance policies. You can create big savings with some discipline – it’s the same style of discipline you need to be a winning investor.

Savings quickly mount up thanks to compound interest

Pennies really can turn into pounds and pounds into thousands. And they can grow even faster thanks to compound interest, which is interest on interest.

Suppose, for example, that you manage to save £10 a week and put it in the bank. That’s more than £40 a month and £520 a year. These sums can start you on an investment habit.

Here’s how much various weekly savings would be worth after five years with a modest 2.5 per cent interest paid each year.

✔ £10 a week: £2,733

✔ £15 a week: £4,099

✔ £20 a week: £5,466

✔ £30 a week: £8,199

✔ £40 a week: £10,932

✔ £50 a week: £13,665

Looking After Your Life and Health

None of us knows how much time we have left on this planet. The good news is that your chances of living longer have never been better. Most people nowadays are likely to live to around 77 to 82 years of age. The bad news? You can never forecast when you’re going to be hit by a bus or succumb to a mystery virus.

So you should always make sure you have sufficient life insurance and cover to replace at least some of your income if you succumb to a serious illness or worse. Life insurance won’t replace you, but it will replace your money-earning capacity.

Always shop around for all insurance. Look at any comparison site. You can easily pay twice as much for life cover of exactly the same amount with one company as with another. What’s the difference? Nothing. You have to die to get a payout with both, so the conditions are identical. No one wants to buy insurance – it’s not fun – but if you have to then don’t waste your cash.

Before buying life-insurance cover, decide how much you need. One rule of thumb is four to five times your yearly take-home pay. But also look at any death or illness benefits that come with your job. No point exists in doubling up cover unnecessarily. And know that if you have no family commitments or that your wider family will rally round if trouble occurs then life cover is just a waste of time.

As well as life cover, you can purchase critical illness policies that pay out a lump sum if you have a serious illness, such as a heart attack or cancer, and survive for a month. A huge range of prices exist for policies with standard terms, so never, ever go for the first quote you get and be careful of exclusions. Knowing what’s covered can be a minefield so taking expert advice first is worthwhile.

Some policies, known as income protection plans, promise to pay a monthly sum until your normal retirement age or for a shorter set period if you can’t work due to illness or injury. These policies can be expensive. Also be aware that although some policies pay out if you’re unable to do your own job due to illness, less generous ones only pay out if you can’t do any job at all.

Always look at all your family and personal circumstances before signing up for a policy. If you don’t really need it then don’t buy it. You could use the monthly premiums to help build up an investment nest-egg.

Paying into a Pension Plan

Your pension plan is an investment for your future but with tax relief in the here and now. This means that, if you’re a basic-rate taxpayer, you pay £80 for each £100 that you get in investment going into the plan – a pretty good deal. If you’re a 40 per cent taxpayer then the setup is even better because you only have to pay in £60 to get £100 into your account, thanks to government tax rebates.

The pension picture is changing. Under a scheme known as auto-enrolment employers have to offer all those in employment a pension plan and pay in a percentage – admittedly small – of salaries up to around £45,000 a year, provided the employee contributes some earnings to the plan as well. If you don’t want to pay in from your salary, you have to make the conscious effort to opt out. And then you don’t get the employer contribution. None of this helps the self-employed.

Those with larger sums and a do-it-yourself attitude to investment can opt for a self-invested personal pension (SIPP) where the holder gets to choose what goes in. You can start a SIPP with anything from £5,000, although £50,000 is a more normal minimum. However, on the downside, the costs can be high and if your strategy goes wrong, you have only yourself to blame.

Chapter 14 contains loads of hints and tips on how to deal with your pension, whatever the level of involvement you want.

Taking Care of Property before Profits

The roof over your head is probably your biggest monthly outlay, whether you rent or buy. And it’s also likely to be your biggest investment if you own your own home. So don’t begrudge what you spend on it. In the long run, your home should build up to be a worthwhile asset. (At the very worst, it’ll shelter you from the elements!)

The best way to save money when it comes to home-owning is paying it off early. Imagine I say to you, ‘Want an investment that pays up to 80 times as much as cash in some bank accounts but is absolutely safe and totally secure? And what about a 100 per cent guaranteed return that can be higher than financial watchdogs allow any investment company to use for forecasting future profits?’ Sounds like a snake-oil salesman scam, doesn’t it? But if your first reaction is, ‘You’ve got to be kidding’, then you’re wrong. Paying off mortgage loans with spare cash offers an unbeatable combination of high returns and super safety.

To see what I mean, take a look at the following mathematics. In this particular example, I’ve used interest-only figures for simplicity, although anyone with a repayment (capital and interest) loan will also make big gains. And, again for simplicity, I’ve assumed that the interest sums are calculated just once a year. Six per cent is at the higher end of mortgage interest now. But it’s very possible that over the life of a mortgage six per cent will be at the low end. That said, here’s the scenario:

Your home is your castle

If you rent, always look at what it would cost each month to buy the same property – assuming you can find enough for a deposit. Purchasing incurs substantial costs, such as stamp duty and legal fees, so you have to factor those in if you can afford to buy, but don’t intend to hang around for long in any one place. Whichever – buying or renting – works best for you, putting aside any cash you save through your choice for the future is always a good idea.

Homes have generally been a good medium- to long-term investment. They’ve beaten inflation over most periods and more than kept up with rising incomes in most parts of the country.

Some areas have seen spectacular gains. But even in the worst parts of the country, you’d have been very unlucky to lose over the long run, even counting the big price falls of the early 1990s and, more recently, the collapse in values following the 2008 financial crisis.

Whether the next decade will see the spectacular gains of the first years of the century is impossible to say. But homes should continue to be a good investment and at the very least keep up with rising prices over time.

However, although your home is the essential roof over your head, never see it as a conventional investment, no matter how appealing any price rise may be. Buying and selling costs a fortune – legal fees, estate agent charges, removal vans, stamp duty – as well as taking up time and requiring saintly patience. You don’t need to own shares or bonds or hedge funds. But you do need somewhere to come home to.

Someone with a standard mortgage and with £100,000 outstanding at 6 per cent pays £60 a year, or £5 a month, in interest for each £1,000 borrowed. On the £100,000, that works out to £6,000 a year or £500 a month.

Now suppose that the homebuyer pays back £1,000. The new interest amount is £5,940 a year or £495 a month.

Compare the £60 a year saved with what the £1,000 would have earned in a bank or building society. The £1,000 could have earned as little as £1 at 0.10 per cent. And even at a much more generous 3 per cent, it would only make £30 – half the savings from mortgage repayment.

‘But you’ve forgotten income tax on the savings interest,’ you rightly say.

Ah, but the money you save by diverting cash to your mortgage account is tax-free. It must be grossed up (have the tax added back in) to give a fair contrast. Basic-rate taxpayers must earn the equivalent of 7.5 per cent from a normal investment to do as well. And 40 per cent taxpayers need a super-safe 10 per cent investment return from their cash to do as well.

Now where else can you find a 7.5 per cent a year guaranteed return, let alone a guaranteed 10 per cent a year? Nowhere.

Reducing your loan makes sense if your mortgage rate has fallen to a tiny percentage and you now have more spare cash each month than you previously allowed for. After you make a payment to cut the outstanding loan, you reduce this year’s interest as well as that for every single year in the future until you redeem the mortgage. If interest rates go up, you’ll save even more. But if they stay low, you’ll keep on having extra and be able to afford to pay down your mortgage even more.

Some flexible or bank-account-linked mortgages let you borrow back overpayments so you can have your cake of lower payments with the knowledge that you can still eat it later if you need to. Alternatively, you can remortgage to a new home loan to raise money from your property if you need it. This sounds very attractive in bank account publicity, but dipping into the value of your home should only be a route when other solutions to your financial difficulties have failed.

Setting Up a Rainy-Day Fund

Before investing for the longer term, you need to set up your own personal emergency (or rainy-day) fund for contingencies that you can – and, more importantly, can’t – imagine but couldn’t pay for out of your purse or wallet. The fund should contain enough money to pay for events such as a sudden trip abroad if you have close family in distant lands, any domestic problem that insurance wouldn’t cover, a major repair to a car over and above an insurance settlement or a substantial vet’s bill not covered by insurance.

Here are some additional snippets from experience for you to keep in mind:

✔ Don’t put your emergency-fund money in an account that offers a higher rate of interest in return for restricted access, such as not being able to get hold of your money for five years. The problems and penalties associated with getting your cash on short notice outweigh any extra-earning advantages.

✔ An emergency cash reserve serves as reassurance so you can more easily ride out investment bad times such as a fall in the value of shares.

✔ Monitor your potential emergency cash needs on a regular basis. They can shrink but are more likely to expand.

✔ Know that you may not be able to access some investments in an emergency. Don’t be put in a position where you’re forced to sell.

✔ Know that your credit card can be a temporary lifeline, giving you breathing space to reorganise longer-term investments when necessary. The key word here is ‘temporary’ – maybe up to three or four months. Using plastic for long-term borrowing is a certain road to financial ruin.