The other day a friend was asking me about investments and his work pension. Understandably I was excited, not only because he was being proactive and seeking out my advice but also that I was given the opportunity to talk about the best way to invest and what to look out for. I love this kind of stuff and it was why I set up Magical Penny.
Yet almost two months in and I have yet to move onto the subject here.
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.
For the first few weeks of this blog we have been exploring the mind-set needed and the importance of simply making a start if you are to successfully grow your pennies. I’ve been writing about the ‘Why’. It’s now time to get specific with ‘How’. And where better than to start than the most central part of any money-management system:
The Current Account
The humble Current account (checking account in the US) 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. All good so far. 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:
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.
Direct Debits
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
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.
Overdrafts
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 (see Magical Penny posts on Debt).
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. Have a look at an example of this type of account here.
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.
Further reading:
Carnival of Personal Finance #249
Who’s Awesomest? Pirates Vs Ninjas Vs Nuns Vs Robots Vs Real Estate Agents Vs Zombies
Magical Penny was selected as part of the winning team, the Ninjas, so a big thank you to Kyle @amateurassetallocator for hosting.
Also worth a read is the below link to a thought-provoking piece by Monevator explains why ‘state of mind’ is so important if you are to grow your pennies and earn more:
{ 5 comments… read them below or add one }
Hi Adam! Thanks for the reference!! I’m glad you’ve started getting on to the ‘how’.
I totally agree with paying off the overdraft. Even now, it’s a real struggle to keep that balance above the interest free line. So far, I have only dipped below a couple of times, but I hate it whenever I do. I always try to pay it off as soon as possible, so I don’t have to pay too much interest!
I am currently trying to sort my finances, and part of that includes paying off my overdraft, and switching back to using my pre university bank account (which thankfully I kept open). This has no Overdraft facility, so I will know exactly what I can spend every month, and don’t have to worry about exceeding the limit.
Now, I could say that I know what I can spend every month and still have an overdraft, but I think most people in a similar position would agree when I say that while it is there and available to use, it is really hard not to use it! Say I’ve got an overdraft, I’ve reached my spending limit for the month, but I see that CD or item of clothing that I’ve always wanted. I have the option to dip into my overdraft, so I will! No overdraft, no option! It’ll have to wait until next month.
Overdrafts are getting worse.
The Halifax, one of the credit crunches victims, now charges 50p per day of ‘normal’ overdraft and £1.50 for going over your overdraft limit – and this is in what used to be the cheapest fee-free account.
The Halifax, now part of Lloyds banking group is in a poor state so obviously charges more; however it is my belief that where these desperate banks go now less desperate banks will head later.
Can you imagine whether it be a fiver for that CD or five hundred for that emergency you’d be charged the same, and charged quite highly (50p per day is £182.5 per year irrespective of whether you have a £100 overdraft or a £1000 overdraft)
Current Accounts, like banking are becoming stricter, the future is in the black so stay out of the red as long as possible
I agree with Rightly Knightly, Once you go black you never go back…
Great article Adam! I agree with you on not setting up too many direct debits. Whilst I do not have direct debits set up, I tend to pay my bills online or electronically. I did not know about discounts though, so I will be looking into that!
Thanks the other Adam, great comment as usual
I’m glad you’re working on a plan that should work for you. I quite like having my overdraft available, even though I never intend to use it and know that it is not my money really. By resisting the temptation I also feel empowered. But you’re right that for some the temptation is too great.
@Rightly Knightly -scary stuff! I don’t really follow overdraft fees so thanks for the info!
@Sam. I’m keeping this comment….it’s a family-friendly blog but its cryptic enough to stay…and it made me smile because the financial message is empowering -once you have been in control of your finances you really don’t want to be controlled by debt.
@Kate -thanks for the encouragement Kate! I’m glad I could let you know about discounts -I’ve mostly seen them apply to utility bills e.g. you can get the cheapest gas and electricity tariffs if you agree to pay by direct debit -worth an investigation given the savings that can be made.
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