The other day a friend asked me about his work pension and the investments that made up the pension. It was great to see he was being proactive and seeking advice, but before I gave him my thoughts on the matter I wanted to make sure he had the right financial foundation.
Why? Because preparation is everything. Whilst I believe investing is for everyone, not everyone puts in the right amount of preparation to address every facet of their financial lives before taking a plunge into the market. Lack of preparation is often the source of the horror stories that make it seem like investing is overly complex or excessively risky.
Before you start investing you need the right mind-set and the right financial foundation. This preparation begins with most central part of any money-management system:
The Current Account
A Current account (checking account in America and other countries) is used for day to day spending. The fundamentals are simple: your incomes goes into the account; your expenses come out, either through a debit card, cheques, cash or bank transfer (paying off credit cards and bills). The first goal is to make sure that each month your income is above your expenses. A budget should help with this. But if you are really going to grow your pennies successfully and consistently there are a number of things you can do with your current account to help you achieve your goals.
Note: if you have a business it’s important you have a seperate business account. The importance of business savings include separating funds from personal expenses for budgeting, accounting, and psychological reasons to help prevent you getting in a financial mess.
Fee or No Fee
Some current accounts come with a monthly fee offering ‘packaged’ benefits. These offers can be useful like insurance or a higher ‘free’ overdraft limit but take 5 minutes right now to consider if you really are getting enough value out of the ‘product’ to justify the monthly fee. Fee-based current accounts are highly profitable for banks because most people do not use all the features that they are paying for month in, month out. That said, the fees that business accounts have are often very worth it given the benefits and preferential treatment you can get.
In the UK direct debits are one of the most common ways to pay regular bills (they are like a US Automated Clearing House –not to be confused with direct deposit because for direct debits it is the vender that initiates the transfer after you give it permission). It’s useful for irregular amounts like varying utility or credit-card bills and vendors often give you considerable discounts for paying this way as they have the added security of knowing they will get paid each billing cycle. Giving control to a company to take money out of your account may seem odd but thanks to the British direct debit guarantee the consumer is 100% covered should any mistake occur.
Like all regular financial commitments though, you should review them as much as possible to ensure that you are still getting the same amount of value out of them. Personally I’ve avoided as many direct debits as possible (I only have 1!) prefering to make my spending conscious and my saving automatic, rather than the other way round: the most common way.
Ultimately if you are making necessary regular payments, paying by direct debit can save you a considerable amount (particularly for utilities) but make sure you review them from time to time and if you are overpaying for things you no longer value then be proactive and channel those pennies into savings.
Standing orders can be used to pay regular fixed payments and in the UK you can specify them to run indefinitely or for a fixed amount of time. For example I pay my rent by standing order because it is a consistent amount every month and it means I don’t have to worry about mailing a cheque or making a manual transfer to my landlord each month.
One of the most powerful things you can do however is set up a standing order TO YOURSELF. You can do it in two clicks with online banking or by filling out a form in your local branch. It doesn’t have to be much if you’re just starting to save but rather than waiting until the end of the month and saving anything that’s left, set up a standing order to automatically transfer something, anything, from your current account to a savings account at the start of each month And don’t worry, if you get in any trouble you can cancel the standing order at anytime. You are in control.
‘Paying yourself first’ is one of the most important things you can do to begin building up your pennies, without any effort after you have set up the initial standing order.
The final element of the current account that we’ll review today is the Overdraft facility. Overdrafts are an extension of your account balance, essentially a flexible loan that allows you to spend more than the total of your account balance. Almost all of my friends have overdrafts as they are a staple feature of student and graduate bank-accounts. Student overdrafts are nearly always interest-free meaning that you can use up to a typical £2500 at no cost for the duration of your time at university.
The problem comes when the interest-free overdraft is reduced, as happens after graduation. In my own case my interest-free overdraft facility grew from £1500 to £2000 upon graduation, then a year later reduced to £1000, then £500. Of course the bank was still willing to keep my overdraft facility at £2000 but anything above the ever-decreasing threshold was charged with interest. Thankfully I always remained below the threshold but most students find themselves in their overdraft and then can’t pay it off in time before the interest-free rate disappears. They are financially captive: paying for money that was given to them for free but then the terms changed. If you took the bait of ‘free money’ then your first priority should be setting yourself free.
The most important thing to remember about overdrafts is that it is not your money. On an intellectual level this is obvious and simple but banks know that psychologically we find it hard to grasp, particularly when our bank statements include the overdraft facility when they say how much we have available to spend.
Whilst it is possible to profit from an interest-free part of an overdraft by putting the money in an interest-bering savings account (I did this), generally the returns are not big enough to warrant the physiological effect of being in your overdraft. The best piece of advice is to get out of your overdraft and then ignore that it ever existed. Do not consider it a part of an emergency fund or treat it as part of your savings account. If you’re truly wishing to grow your pennies concentrate on other things and stay away from the mind-games that an over-draft facility can play on you.
A Managed Bank Account
Another possible option to help you with managing your finances could be a managed bank account. Essentially two accounts in one: one for your essential bills, Direct Debits and standing orders, and another where all your disposable income is placed for you to spend as you wish, knowing that your important bills have been accounted for. Also, since managed bank accounts are a kind of basic bank account, there is no overdraft available, so you aren’t tempted to spend money you haven’t got.
There are also other options to consider if you are interested in commercial banking.
Get your current account doing the work
A current account may seem like the most basic tool in finance but when optimised through reduced direct debits, plenty of standing orders to yourself and ignoring any overdraft facility, it can provide a strong foundation before undertaking any plan to grow your pennies. An optimised current account also allowing you to be more confident when you move onto more fun things –like saving and investing for the things in life that matter to you. Have a look at you current account today and make the next step to get it working for your future self.