A Good Formula: Saving + Investing = Financial Independence!
If you have had a look at the “Investment Resources” section or you’ve ever seen the inflation-adjusted returns on the S&P 500 since 1950, you know the benefits to being a long term investor. Provided that you re-invested dividends and income, $1 invested in 1950 and held until this point in 2019 would be worth $52 in today’s money. For the FTSE 100 £1 would be worth about £34 after inflation. That is the true power and effect of long term compound growth.
What about the Savings side of the equation?
That is a hugely important part of financial management and it is the engine behind investing. After all the old adage isn’t far from the truth: you have to have money to make money.
Years of austerity and poor wage growth have made the Savings situation very challenging for UK households. According to the TUC household debt in 2018 ticked up to £428bn, which is at an all-time high. That’s £15,385 for every household and matches the Bank of England’s own analysis of the rise in consumer credit and debt since 2016. Unsecured debt is now 30.4% of household income, meaning households are increasingly turning to borrowing to get by.
The Frugal Investors approach is to address savings by focusing on things that households do have control over. That means looking at key areas of expenditure and thinking: how can I do this more effectively or efficiently? How can I make my money stretch further on an already limited budget?
Reduce Any and All Bank Debt, Credit Card Balances or Loans
I remember growing up in a household saddled with credit card and bank debt and it was stressful. There were times towards the end of the month where there simply wasn’t enough money left over to pay for food and it would come down to my lawn mowing job or baby-sitting in the neighbourhood that ended up helping the family to get by until the next pay check. The second I got paid, the car was ready, to get off to the supermarket to buy some food. It’s the sort of experience that truly teaches you the value of money!
What I learned is that a positive mind-set and an approach to tackle the challenge step-by-step is a key component of solving the problem. If you have £8500 in credit card debt the very figure itself is daunting. The average APR on a credit card has ticked up to 20.01%. That works out to £1701 per year in interest. These are very real problems: as I write this, on a train back from London Kings Cross, I can hear a conversation in the seat next to me about over-spending for a kid’s birthday party and it is getting quite heated! Saving and reducing debt is crucial before you even consider investing. Even when you’ve paid down your debt, you’ve got to keep a firm hand on the Saving tiller and start to save more than you spend. Then eventually save a lot more (30-50% of your net after tax income).
Savings Opportunities Are Everywhere!
As a specialist in process improvement I get paid, more or less full time, to dream up ways to reduce expenditure and increase efficiency or productivity in businesses. I love this job!
One of the key challenges isn’t being the smartest, or coming up with really clever solutions. In order to make true progress you have to challenge your own thinking: what is out there that you simply have never thought of? Why hasn’t this worked before, and what can I do differently? Get underneath the root cause of the problem and systematically fix those core root causes.
Reduce Pension Fees
Let’s take pensions – there’s a big one. Likely the biggest savings account you’ll have! Try this on for size: the average pension pot in the U.K. at age 55 is £42.6k. The average fee charged on those pensions is 1.85% per year. That’s like me reaching into your proverbial pocket and taking £788.10 per year from you. Imagine having a standing order for that on your current account – I’d be raking off £65.68 per month, every month, and the amount would grow and grow as you deposit more money every year.
Read here for how to reduce that cost down to 0.23% and save £690 per year just on costs. You would pay only £97.98 in fees. I have a major bug bear with fees because they hide in the background and can be very pernicious towards your long term returns.
Smarter Not Harder – Retire 17 Years Earlier
Want to challenge your thinking even further? Combine all of your pensions into one account and self-manage them. All it would take is about 10 minutes a month to do once it is all setup. You could make an extra 1.22% by effectively reducing the fees that a whole raft of financiers, accountants and consultants make in the industry managing your pension funds. At the end of the day pensions, on average, under-perform the market by a decent margin:
|Calendar year||% Pension fund growth||% Change FTSE All-Share|
Source: Moneyfacts UK Personal Pension Trends Treasury Report/Lipper Reports
That’s why companies like Legal & General and Aviva make a good profit margin and pay healthy dividends. There are very few ‘inputs’ into managing your pension because a lot of investing is now automated, i.e., when they set the strategy for your ‘ABC Investment Company Pension Fund’ they use automation and technology to manage and re-balance hundreds of thousands of accounts at the same time.
What would lowering your pension fees save you between now and retirement? The answer: A WHOLE LOT. According to advice firm Profile Financial, if you are 55 and you have a £42.6k pension pot, paying 1.85% in fees you may need to work until you are 80 to afford a comfortable retirement. Yes 80 – Eight-Zero. If you managed to reduce the fees to a much healthier 0.23% (which we advise on how to do here at Frugal Investors) that would mean retiring at 63. That’s 17 years earlier!
Define and Measure Your Goal
How much do you need to retire? Have a look here to figure out your target income and work backwards in order to achieve that goal. The twenty-five rule helps: for a simple answer, multiply your target income by 25 to get the pension pot or savings you will require to give you that income.
Make Saving Fun
I come from a wonderful family with the usual dreams of consumerism and materialism. To be honest my mind-set has completely changed and I know that this doesn’t happen overnight: I think my wife has had a hugely positive impact on improving my spending habits and the way that I save money. The other component is that, frankly, I enjoy saving money. It’s now become fun because my life is focused on family, work, reading and enjoying my time on Earth!
When I had a Ford Fiesta I managed to average 58 MPG off that little diesel gem. But I remember days when I drove 80 MPH on the motorway and rushed around to get to and from work. That drops my efficiency to about 48-50 MPG. That means I am losing 17% of a tank of diesel at that rate. And considering I filled up weekly, that would cost me an extra £8.33 per week. That adds up to £433 per year. Not to mention the risk of speeding tickets and fines, or a collision.
Instead of thinking about what new things I can buy, I do a lot more reading. Since 2014 the number of books I have read per year has grown considerably:
|Full Year (Jan-Dec)||Books Read|
|2019*||20* (on track by 31 Dec)|
Have a look at the Savings posts below. I endeavor to go into detail about areas of household finances where improvements can be made, and once you’ve generated a saving, how to immediately invest those savings to pay down debt or accrue investments that will compound growth over many years.
If you have ideas, suggestions or comments for material that you would like to see please access the ‘Contact’ section to get in touch.
 TUC January 2019 [https://www.tuc.org.uk/news/unsecured-debt-hits-new-peak-£15400-household-–-new-tuc-analysis]