Part One
40 Ways to Find £2,000
MAKE
BEST USE OF THE CASH
YOU HAVE
1 Get Interest on
Your Bank Account
One of the
simplest actions you can take to build on the cash you already have is to
open an interest-bearing current account with your bank or building society
to replace your ordinary current account.
You may
have already done this. But many people don't realise they have a choice –
or how easy it is to do. Perhaps it is also because, understandably, not all
banks are keen to publicise this facility. They make more profits if they
have free use of your cash.
Suppose
you have a low average of £100 in your bank account, not earning any
interest. At an interest rate of, say, 5 per cent gross a year, you would
earn an extra £5 before tax by the end of the year.
This may
seem a trivial sum, hardly worth the bother. But many people have much larger
average balances and pass up the opportunity to earn several hundred pounds
a year in interest. Then there are two further points for you to consider
– the rate of interest you earn and the effect of compounding
that interest.
2
Take Advantage of the Miracle of Compound
Interest
Suppose that you were to put £100 into an account earning 5 per cent
per year, not just this year, but every year for, say, the next 25 years.
Assume that the interest was compounded. How much would your savings be worth
then?
The answer
may surprise you. First of all, you would have accumulated contributions of
£2,500 (£100 per year for 25 years); and secondly, you would have
accumulated the interest that those contributions would have earned.
But that's
not all. You would also have the interest on all that accumulating
interest.
As a result,
after 25 years your investment of £2,500 would have more than doubled
to over £5,000. Without compound interest, your total investment would
have accumulated
to only £4,125.
Now, suppose
you were to set aside £1,000 per year, earning interest at 5 per cent
per year. At the end of 25 years, you would have accumulated over £50,000.
And of
course, you end up with much more if you begin to compound your savings
at a rate that is higher than 5 per cent. If you could earn an average
return of 10 per cent per year, then your annual savings would have grown,
at the end of 25 years, into a nest-egg of more than £108,000.
And if
you could boost your return to 18 per cent – something that is well within
your reach using the knowledge you will gain from SPI –
then your savings would grow into a small fortune approaching some £350,000.
How just
one pound
a year grows
The table
below shows how just one pound a year grows at various interest rates compounded
over 5 to 35 years. Note how the rate at which your money grows accelerates
as time goes by – see how the really big gains come towards the end.
Imagine
what the total would be if you were investing not just one pound a year
but many hundreds or thousands! And if the interest is compounded more frequently
than once a year, your savings will grow even faster.
Investing
One Pound a Year, Interest Compounded Annually
| Years |
| Rate |
5 |
10 |
15 |
20 |
25 |
30 |
35 |
|
| 4% |
5.63 |
12.49 |
20.82 |
30.97 |
43.31 |
58.33 |
76.60 |
| 6% |
6.00 |
13.97 |
24.67 |
38.99 |
58.16 |
83.80 |
118.12 |
| 8% |
6.34 |
15.65 |
29.32 |
49.42 |
78.95 |
122.35 |
186.10 |
| 10% |
6.72 |
17.53 |
34.95 |
63.00 |
108.18 |
180.94 |
298.13 |
| 14% |
7.54 |
22.04 |
49.98 |
103.77 |
207.33 |
406.74 |
790.67 |
| 16% |
7.98 |
24.73 |
59.93 |
133.84 |
289.09 |
615.16 |
1300.03 |
3
Shop Around for the Best Available Interest
Rates
In addition to your bank current account, you probably
have other accounts with banks or building societies which pay you interest.
Look now at the big differences you can make by gaining even small increases
in the rate at which your money grows.
It's not
just the quoted or nominal rate that counts. The key percentage to look at
is the Annual Equivalent Rate (AER). This is the rate you actually earn if
you're investing. If you're borrowing, the effective rate is known as the
APR or Annual Percentage Rate.
The reason
there's a difference is this – interest is often added to your account
more frequently than once a year. It could be added half-yearly, quarterly,
monthly, weekly or even daily.
If your
bank pays interest compounded half-yearly, the interest earned in the first
half of the year would itself earn interest in the second half. At a nominal
rate of 5 per cent you would receive an effective rate of 5.06 per cent.
The more
frequently interest is compounded, the higher the effective rate.
And remember,
this principle works for borrowers as well as lenders. So if you take out
a loan at a nominal rate of 10 per cent compounded half-yearly, you'll actually
pay 10.25 per cent.
Now look
at the significant differences more frequent compounding makes.
What compounding
really pays:
| Nominal
rate, compounded annually
% |
Compounded
half-yearly
% |
Compounded
monthly
% |
|
|
| 4.00 |
4.04 |
4.07 |
| 5.00 |
5.06 |
5.12 |
| 6.00 |
6.09 |
6.17 |
| 7.00 |
7.12 |
7.23 |
| 8.00 |
8.16 |
8.30 |
| 9.00 |
9.20 |
9.38 |
| 10.00 |
10.25 |
10.47 |
| 11.00 |
11.30 |
11.57 |
| 12.00 |
12.36 |
12.68 |
| 13.00 |
13.42 |
13.80 |
| 14.00 |
14.49 |
14.93 |
| 15.00 |
15.56 |
16.08 |
Conclusion:
Be prepared to move your cash to a higher-earning account. Check the
interest rates you're earning on all your bank and building society accounts
as well as any investments with National Savings & Investments you may
have. Do this regularly – but check whether you would have to pay a
penalty for early withdrawal before you transfer to a new account. It might
not be worthwhile moving it if the difference is small and you don't plan
to leave your savings there very long anyway.
4
Get
a Free Overdraft on Your Bank Account
The best
way to use your bank account is not just to have an interest-bearing account,
but to manage your bank balance so that you don't accidentally go in the red
and pay charges on each transaction as well as interest and other charges
on the unauthorised overdraft.
Banks now
offer you many choices of account.
Some automatically authorise an overdraft up to a given amount – if
you do overdraw, you pay interest on the overdraft, but no charges on your
transactions. One example of this is called a revolving credit account.
You make a regular monthly payment and can overdraw up to 25 or 30 times
that payment. This kind of account is often a poor choice as overdraft interest
rates are relatively high and the interest on credit balances is usually
low or even non-existent.
Instead
go for an account which will allow you to overdraw slightly, say up to £100,
without making any charges for transactions or interest. This will cover
most cases of occasional oversight.
Conclusion:
If you think you're likely to overdraw, use your credit card or building
society instant access account to cover you until your bank balance recovers.
Unauthorised overdrafts cost an arm and a leg. Even authorised overdrafts
can be expensive for small sums over short periods – you'll often be
charged a monthly fee as well as interest.
5
Use Your Cash to Bargain
When
you're buying a car or expensive household goods for example, you can often
negotiate a discount by offering to pay cash. Phone around and find out where
you can get the highest discount.
The credit
card companies have been barred by the Competition Commission from requiring
the retailer to impose a uniform charge for both credit cards and cash, so
you can negotiate a discount for cash if the retailer accepts card payments.
As the credit card companies usually charge retailers between 2.5 and 5 per
cent, you can ask for this as a minimum.
With cars,
you'll find that distributors usually
offer the best discounts. You can expect a further discount if it's a straightforward
purchase, without a trade-in. Even if you haven't the cash you need to buy
a new car, compare the savings you could make by borrowing from your bank
and negotiating a discount on your purchase. There's more on bank loans
later.
Conclusion:
Cash
can be a powerful negotiating tool. Make sure you use it whenever you can.
6
Regular Saving Pays Dividends
There are
several advantages in making a commitment to regular saving.
-
It
provides a discipline. You're less likely to spend money on things you
don't really need.
-
Over
time, your capital builds up dramatically. You've seen how compounded
interest accelerates the rate of growth.
-
There's
another principle – pound cost averaging – which allows you
to make further gains.
Pound cost
averaging works like this. If you invest a fixed sum each month in a security,
perhaps directly in a share or indirectly in a unit or investment trust, you
won't be buying the same number of shares each month. This is because the
share or unit price changes – so when the price is low you'll buy more
for the same amount, and when the price rises you'll buy fewer.
The result
is that the average cost for each share or unit is always lower than the average
price over the period. Here's an example of how it works:
| Month |
Share
price (pence) |
Amount
invested (£) |
Number
of shares bought |
|
| 1 |
200 |
50 |
25 |
| 2 |
100 |
50 |
50 |
| 3 |
250 |
50 |
20 |
| Total |
550 |
150 |
95 |
The average
price of the share over the three month period is 183.3p (550p ÷ 3).
But the average price paid is only 157.9p (£150 ÷ 95) per share.
The more the share price fluctuates and the longer you invest, the more you
benefit from this principle. A steady downward slide, though, would not give
you any benefit – you'd just be buying more and more of a wasting asset.
Beware of allowing yourself to carry on buying a loser.
Conclusion:
Pound cost averaging is a good
way to get into the market in uncertain times. You carry on investing even
when things look rough – just when most other investors are selling up,
often at a loss. By committing yourself to a regular monthly investment you're
giving yourself the chance of building up a substantial sum. If you reinvest
the interest you earn, or the dividends in the case of shares or unit trusts,
you'll benefit further from the powerful effect of compounding.
7
How a Cash Flow Forecast and Net Worth Analysis Can Help You Manage Your Money
Banks
offer you budget or revolving credit accounts to even out the peaks and troughs
of regular bills but they charge you a fee for this service and interest rates
are often higher than on a simple overdraft. There's no reason why you can't
create your own system to organise your account.
One simple
way is to add up all your bills – including
your mortgage, council tax, electricity, telephone and so on. Do this for
the next twelve month period, adding an amount to cover price rises, if appropriate.
Pay one twelfth of this annual sum into an interest-bearing current account
each month. Use it to pay the bills by standing order or direct debit, if
possible – and especially if it gives you a discount – or by cheque.
If you've got
big bills early on, you'll need a float in order not to overdraw.
Another way
is to do a cash flow forecast month by month, preferably
for a year ahead.
If
your income is considerably higher than your expenses for
the coming period, you can plan how to use this surplus
to advantage by investing it profitably. But it's more likely
you'll find a shortfall at certain times, with adequate
cover at others. This may be because you have several bills
arriving together. You may find you can rearrange the payment
dates to suit you. This is often possible with credit cards
and fuel bills.
You may wish to take this assessment of your financial position
a step further.
This
is your financial position at a point in time – rather
like a company's balance sheet. It is the value of all your
assets – the things you own – less your liabilities,
the money you owe.
Some of your
liabilities, or expenses, are fixed – you can't do anything to change
them. Insurance, mortgage costs and council tax come into this category. Other
expenses are variable – they change according to actions you take. It's
here that your scope for savings lies.
Use the form
to analyse your figures. Compare your liquid assets – the ones which
can fairly easily be converted into cash – with your short-term debt.
Consider taking action to reduce your debt if the ratio is below 2:1 (less
than two pounds of cover for each pound of debt).
Second, look
at your debt : equity ratio. The younger you are, the more you can afford
to be in debt. As you near retirement, it's safer to reduce your total liabilities
down to no more than one tenth of your net worth.
Conclusion:
Knowing where you stand at a given moment is the key to successful financial
management. It allows you to take avoiding action so as to save bank or interest
charges and to highlight the proportion of your income you can afford to invest,
before it gets frittered away.
8
Keep Your Capital Actively Employed
Look
again at the "net worth" form. You
can see that there are many places apart from a bank or building society to
keep your liquid assets. It's best to avoid keeping too much of your capital
in a fixed interest account. The reason is that, after you've deducted the
value your money loses because of inflation, there's usually little if any
interest left to give you "real" growth. And if you spend the interest, your
capital invested loses value as time goes on even faster.
Work out
how much you really need to keep in an instant access account for unforeseen
expenses or perhaps for large purchases and holidays. Remember that you can
usually use your credit card for loans to cover you in an emergency. So pare
the sum you need to a minimum.
Consider
a slightly less liquid form of investment
for any surplus you have which will give you an increase in real wealth. For
example, as you'll learn in SPI, investments in good quality
shares – including investment trusts – have far outpaced inflation
over most 10 year periods over the last 8 decades. The chart
shows you how the All-Share index has outstripped the average building
society deposit rate as well as the retail price index over the long term.
9
Use
an ISA or a PEP for Your Most Profitable Growth Shares
The government
offers special tax breaks to encourage people to invest in the stockmarket.
Taking advantage of these tax breaks may dramatically improve the total return
on your savings.
Personal Equity
Plans (PEPs) were superseded by Individual Savings Accounts (ISAs) in April
1999, with lower annual investment limits. But you continue to benefit from
the tax breaks on any Peps that you owned at that date until at least 2004,
as you will on any shares you hold in an ISA.
The advantage
of ISAs and Peps is that the capital growth on the investments in them accumulates
entirely tax free, and until 2004 dividends are tax free too. When you cash
them in there is no tax to pay either. The life of Peps has been extended
until at least 2004. ISAs have a guaranteed life until at least 2009.
ISAs have
lower overall contribution limits than Peps, but you may still invest £7,000
each year until 2005-06.
ISAs and
Peps are particularly suitable for sheltering high income investments from tax,
especially if you are a higher rate taxpayer.
If you regularly
make sufficient capital gains on your shares to push you into paying capital
gains tax, you stand to benefit most by using an ISA or PEP for the shares
where you expect the biggest gains. This will maximise
your tax-free returns.
As you'll
learn in SPI, ISAs and Peps aren't investments in their own right
– just a potentially tax-efficient way of holding other investments. So
they're only as good as the shares, units or whatever you may put into them.
It's also
important to look carefully at the charges levied by an ISA or a PEP manager
before you invest. It could turn out that the tax saved is more than outweighed
by the charges – particularly if you're a basic rate taxpayer.
But in many
cases you can avoid substantial tax bills on dividends or capital gains.
10
Regular Saving via an ISA
You've just
looked at the tax advantages
of ISAs and Peps, and how if you're an investor with a large portfolio of
shares they may be the best home for your growth shares. If you're not a holder
of a large portfolio but still a taxpayer with either a lump sum or a regular
amount out of income to invest, consider an alternative use of Individual
Savings Accounts.
Both unit
trust and investment trust companies
offer savings schemes, for either lump sums or monthly payments. With investment
trusts, charges are nearly always low by comparison with other investments
in securities. With an ISA, you have the added advantage of tax-free income
and capital gains.
ISAs are
best regarded as a medium to long-term investment to give you more chance
to build on the tax-free growth. But there's nothing guaranteed about an ISA.
It's only as good as the shares within it. By using a unit or investment trust
you're spreading the risks – as they both invest in a wide variety of
shares themselves you benefit from their diversity.
Conclusion:
Consider an ISA if you're planning to invest in a unit or investment trust
– particularly via a savings scheme.
The advantage
to you over the standard unit trust or investment trust savings scheme is
that both dividends and capital gains on investments
in the scheme are currently tax free. In the standard scheme they are not.
But remember
to check the charges first – don't get a tax break only to pay it back
to the managers in charges.
11
Look Around for a Lower Cost Stockbroker
You may be
an experienced investor and want to make your own share buying and selling
decisions. Or you may have bought some privatisation issues which you want
to sell as cheaply as possible.
Either way,
look for an "execution only" service. This won't be cheaper in every case
than an advisory service from a stockbroker, but you may make big savings
if you shop around.
For example,
minimum charges on small bargains – say £1,000 – can be as
low as £15 or even lower on both selling and buying. Many brokers charge
a minimum of £25-£30. So you could save at least £10 on each
deal. Some of the best deals can be found on the internet.
Apart from
charges don't forget that the price you pay when you buy (the "offer" price)
is about 5 per cent higher than the price you would get if you were selling
at that time (the "bid" price). This bid-offer spread eats into any gains
your shares have made.
Watch out,
too, for extra costs. Some brokers charge you joining fees or annual administration
fees, for example. Stamp duty is also payable when you buy.
Conclusion:
If you are an experienced investor and confident about your investment
decisions, then using an execution only service is likely to be the cheapest
way for you to build up a diversified portfolio or to shed small holdings
of shares you no longer want to keep.
|
REFS is
a mine of invaluable information for the private investor.
