Your Home is Not an Investment

by Magical Penny on April 14, 2010

…to be more specific, you shouldn’t consider your primary residence, the house you live in, as part of your long-term wealth and investments. This article will explain why:

For many of us in our 20s and 30s buying a house is a big goal that’s either staring us in the face or coming up on the horizon. A house is likely to be the biggest purchase we will make in our lives and it’s a likely trigger for beginning to think about saving money and growing pennies.

However, whilst saving for a house deposit is an admirable goal it shouldn’t stop you from begin investing for even longer-term savings goals like retirement. It’s not OK to just be saving for a house. Here’s why saving for a house isn’t enough:

Renting from the bank

You may be tempted to rush into buying a home because ‘it’s an investment’ and you want to avoid ‘throwing money away in rent’ (phrases I’ve heard my friends and people online say all the time). Yet paying for a roof over your head is largely unavoidable: even if you own your own home: in the early years of a mortgage only a fraction of the monthly payment is going towards to the ‘principle’ (the money you owe on the house). Most of your money is going towards the interest your mortgage provider is charging you each month. You are essentially renting so the amount of money you’re contributing to any ‘long term’ investment like a house is very small. You should therefore be making provisions for more meaningful long term investment plans while you are still young.

A lifestyle investment

Most people consider a house to be an investment: certainly it is worth a certain value in the market-place and tends to increase in value over time. However, assuming it’s the house you are living in, then it’s value is limited because you need a place to live: It offers you shelter and depending on the size and quality of its features it also provides you with a certain lifestyle. Rather than an ‘real’ investment it is what I call a ‘lifestyle investment’. As explained when exploring lifestyle inflation, with any lifestyle investment it comes the ‘norm’ for you. Regardless of any appreciation of house prices you are unlikely to want to down-trade in house due to lifestyle inflation so the relative investment return for your house is 0%!

Real investing is about reducing today’s lifestyle to put your money to work for a secure financial future tomorrow. Pouring money into your primary residence may give you a secure place to live in the future but this alone will not help you grow your pennies long-term. You need other investments in place as you commit to your future today and the sooner you start, the better.

Playing with leverage

Leverage in financial terms is taking advantage of movements in value using extra money. For example if you were playing roulette and only had a £1 but had a strong feeling that the ball was about to land on red, you could leverage your prediction by asking me if you borrow £9 to put on Red. If the ball did land on Red you could return my £9 to me and you could keep your winnings: the £1 from your own bet and the £9 winnings from my money! You just made an extra £9 even though you only had £1.

Leverage is what makes property so appealing. You may only have £10k but if you then borrow £90k on a mortgage you can ‘afford’ a £100k house. If that house then goes up 10% in a year and you decide to sell you’ll have a £10k profit –add that to your original £10k and you’ve doubled your money!

However leverage can work the other way. If the ball had landed on Black in the roulette example you would owe me my £9 even though you only had £1 to bet with and you’ve lost that too! With houses if the value goes down even a small amount you can find yourself ‘upside down’ –owning more money that you ever put into the house. You would be trapped in the house until you could sell it and pay off the rest of the mortgage that the house sale couldn’t cover. If you needed to sell and house prices dropped 10% in that year you’d be in trouble: trying to pay off an extra £10k debt can wreak habit with your mission to grow your pennies!

Poor flexibility

For those of us in our 20s who have not settled into our careers or a particular location, a house, (or rather the leveraging mortgage) is not an investment but rather it’s a dangerous liability (debt) that’s not worth the trouble: that is until you have saved a big enough house deposit to not worry about being ‘upside-down’ should you need to move after your house has lost value.
Houses are also one of the most expensive and inflexible ‘investments’ as anyone who has tried to sell a house will be able to tell you! Unlike other investments like shares that can be sold in batches and almost instantaneously on the open market if you need to sell quickly, a house is pretty hard to sell brick by brick!

Buy and Invest!

Ultimately anyone who is actively working towards saving for a home is doing a great job as they must certainly have a great mind-set and vision for what they want in their future. This is great and they get the Magical Penny Thumbs Up!

However, buying a home is not automatically a good move, especially if it comes at the expense of being prepared to save separately for the long-term. Inflating your lifestyle by buying a home can be a great move at improving your quality of life but don’t think that investing in a home is simply enough to secure a comfortable financial life in the future.

Thankfully you don’t have to choose between saving for the long term and for a home (or dutifully paying on a mortgage). You can do both –even if you can only afford a small amount to channel into long term savings, the likely returns will help your pennies grow over the long-term and will prepare you for another one of the biggest purchase you’ll ever likely to make: buying your financial freedom!

What do you think?

This article refers to the problems with considering your primary residence as an investment. The subject of investing in property as a investment asset class (as discussed in some brilliant and recent comments) is a different issue and will be covered here on Magical Penny soon.

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Why You Should Be Investing

by Magical Penny on April 12, 2010

Saving money in a ISA is great at helping you counter-act inflation as you to keep more of your interest, but Cash ISAs are not going to help you grow your pennies over the long term. For that you need to be investing.

no time like the presentYou may be in your 20s and money’s tight, or in your 30s and 40s and have lots of financial commitments. Regardless of your situation, you should be investing (and not just the minimum in a company pension scheme if you’re lucky enough to have one).

If you’re not already investing and don’t start soon you could miss out of tens if not hundreds of thousands of pounds over the course of a lifetime.

If you’re reading this in your 20s I’m especially excited you’re here reading this because time is on your side.

Investing is daunting

Unfortunately, unlike in America where it appears stock market investing is ‘sexy’ and cool’, us Brits are traditionally a bit more reserved about investing in stocks and shares.

Talking with my friends about the subject most think investing is something that only rich people do;  that it’s complicated and risky; or it’s something they’ll get around to but it’s too hard right now.

There’re wrong though.

They should be investing something now, even when other financial priorities seem more pressing. Even if it’s a deliberate decision that may be right for them, I doubt they fully appreciate the true cost of  their priorities. I undertand their reservations though so let me elaborate with 4 reasons why you should be making steps to grow your pennies and begin investing.

1. Long Term Return

When you buy shares you are buying tiny pieces of companies: Companies sell part of their organisation as shares to investors to gain more funds to grow and develop. Investors buy these shares with the hope that the business is profitable and pays out company profits back to them. These payments to shareholders are known as dividends. As well as the dividend money, investors also hope the shares they have bought go up in value as demand for company shares grows, assuming the company is profitable and has strong future potential.

Of course there are good and bad companies but collectively over the long term history has shows that the returns (increase in value over the course of a set time period) from businesses have consistently outperformed most other asset classes (an investment term for types of things you can invest your hard-earned pennies in: i.e gold, cash, shares, or even commodities like sugar). The difference in returns between shares and say, a Cash ISA, may seem small over the course of a year but longer term the difference becomes thousands of pounds.

Why Investing is Important

Whilst the rate of return is not important when it comes to cash savings (click here for the article) the return of an long term investment is important as it determines when you can retire or reach any other goal that requires plenty of pennies. Ultimately it is  investing in shares that gives you one of the best chances to enjoy the best return over the long term. And arguably the long term investment return is more important than in the past as people are living longer than ever:

Will you be able to afford 20-30 years of not working when you retire?

Even if you saved double the amount in a Cash ISA compared with someone who invested their savings in shares, you are unlikely to end up with anywhere near the amount you are likely to achieve by investing in stocks and shares. There’s only so much you can save so investment returns have the potential to help considerably.

cautionImportant Note: Investing in shares is more ‘risky’ than cash because the value may fluctuate over time but with the right strategies and investing philosophy it doesn’t have to feel or be anything like gambling with your future. This is an article in itself and will be addressed in another post.

2. Time on your side

It’s not only about the asset class but the time you give your pennies to grow. The difference between investing now and investing later is huge. Ramit Sethi gives a good example in his book: I Will Teach You to be Rich: No Guilt, No Excuses – Just a 6-week Programme That Works (which, as my favourite personal finance book you should buy by the way),  when he tells the story of  Smart Sally and Dumb Dan:

“Smart Sally starts saving at 25, by putting money into a low- cost investment account. She decides to do that until she’s 35, then she stops. So she invests for 10 years. Dumb Dan doesn’t get around to it until he’s 35. He invests for 30 years, until he’s 65. And when they both retire, because of compound interest … (Smart Sally) has about £100,000 more.”

In this story Sally saves less and ends up with more simply because she started earlier. This is possible because the interest she earned early on began earning interest too. Magical pennies indeed!

3. Information Super-Highway

The internet’s great isn’t it?! Getting started in investing has never been easier than today. The preconception that investing is only for the rich may have been true a few years ago but now the barriers to investing are much lower than at any other time and anyone with an internet connection has a chance to learn. My parents would have had to visit a broker with a large cheque if they had wanted to do what I’m doing when they were my age. Instead, you can now automate small amounts directly into investments around the world with a few clicks of a mouse if you know what you’re doing.

That said, in my journey to learn about investing I found lots of mis-information and confusing things on the internet but that’s fixed now because Magical Penny is here!

In all seriousness there are some great resources online that I’ll be reviewing in up-coming posts. In the mean time, do some internet searches yourself and let me know in the comments if you come across any great finds.

4. Thinking Beyond Today

Finally, the best reason to invest is that it encourages you to think beyond today. It’s too easy to only be concerned with what’s right in front of you in life, rather than having goals on the horizon. By saving long-term you really do get a sense of empowerment that you are taking control and can reach some ambitious goals.

Magical Penny is only just beginning to talk about investing but is there anything you’d like to know or have questions about that you want answering right away? Leave me a message in the comments 🙂

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A Chance Encounter -How I Became Interested in Personal Finance

by Magical Penny on April 9, 2010

Magical Penny has set the ground-work for growing your pennies: covering debt, saving and focus, amongst other topics. Starting on Monday Magical Penny will begin Investing 101 but to finish the week I thought it would be worth sharing how a chance encounter with the subject led me to first begin growing my pennies.

One thing that fascinated me as a history student was discovering how so much of our history was dictated by chance: particularly how different the world could have been if a seemingly insignificant event hadn’t occurred.

Chance, of course, continues to play a huge part in all of our lives: perhaps for you it was a chance meeting that lead to a life-long relationship. Or a job advert catching your eye whilst flicking through a paper leading to your eventual career.  For me, one chance thing that I hope will change my life, and yours by reading this,  was my discovery of the world of personal finance.

A Whole New World

Many people think that personal finance is not relevant to them: perhaps they think personal finance is about either being a miser living on a few pennies a day or a hot-shot speculator gambling everything you’ve got in the markets. Both views are based partly on reality but  there is a middle-ground. For me, personal finance blogs opened my eyes to this middle ground and were great resources for demystifying personal finance (Reading stuffy investment prospectuses and finance books came much later!)

Using credit cardsMoney Money Money

The personal finance blogosphere to the uninitiated might at first seem filled to bursting with self-indulgent rants by people obsessed with growing their net worth. New readers might ask “Haven’t people got better things to do than sit counting their money?”. But there’s much more to it than that: personal finance blogs have exploded online and their value is through offering new perspectives and insight about everyday problems and goals.

There certainly are some characters writing personal finance blogs and I’ve certainly read my share of extreme stories detailing astronomical debts or outlandish stock market gains. The best and most successful blogs however are written by people who, after wracking up huge credit card debts, experience a money epiphany of religious intensity, before turning their life around (The Simple Dollar , Get Rich Slowly and Five Pence Piece come to mind)

As a student reading such stories in modest student accommodation in England, without a credit card or a stock market account, and not knowing anyone personally who actually had such a thing, I found these accounts of crazy spending and financial reconciliation utterly fascinating.

Naturally I compared their stories to my limited experiences. I didn’t have a story to tell. I had never been particularly reckless with money: I saved semi-regularly and never exceeded my interest-free overdraft at university. I had not ever found myself in a ‘make or break’ position that most personal finance bloggers profess to have been in. But one idea did stick with me as I read through the dramas of ‘financial armageddon’:  the power of now: these faceless formerly financially irresponsible American 30 somethings were telling me that if I started on a meaningful financial journey early I could reap the rewards in the future, particularly as I was only just entering my 20s. The faceless 30 something Americans had spoken. And I listened.

And I had the best thing going for me: youth.

I had never seriously thought about personal finance or investing until that chance encounter on a personal finance blog and whilst I doubt I would have found myself in mountains of debt, I’m glad to have discovered the subject when I did. It was arguably the perfect time: as a young adult preparing to enter the working world. The chance discovery of personal finance blogs raised my consciousness and made me determined not to drift financially in these early years when financial habits are only just beginning to form.

First You Make the Habit, Then the Habit Makes You

Saving money is one of those things that everyone knows they should be doing but for many, is something that they never get around to. Or perhaps they do but only when *something* happens, perhaps a significant life event that makes them think about what they want their future to look like and they realise they need to make meaningful steps to get there. For me it wasn’t a specific event but rather it was seeing a graph (yes I know how cool that makes me sound) showing how over time your savings can grow much faster than your contributions if you put your pennies to work.

First Steps

So personal finance reading helped me appreciate the power of time. But it’s doing something with that knowledge that ultimately will have an impact.  When it came to learning about investing the resources on the Internet were helpful to an extent but then came the hard part: Most of the advice on investing was very US-centric so I had to adapt the strategies to what was available in the UK. Thankfully over the next 3-4 years I found the best ways to grow my pennies with the resources and services available in the UK. I finally had a story to tell! Magical Penny was born.

So much of history is determined by chance: perhaps you stumbled on this post today by chance, like I did on a similar post 4 years ago.  If so don’t miss out as Magical Penny begins detailing how to invest your money, starting next Monday.

Make your own history by starting to save today because those history lessons didn’t just teach me about chance:  Alas you can’t just hope your way to financial success. History taught me that it’s not chance but rather it is planning and focus that has the biggest impact of all.

Have you ever come across something completely by chance that led you down a completely different path in life? Let me know in the comments!


In Other News

Magical Penny is proud to launch a new facebook campaign: Aleksandr the Meerkat for Prime Minister!

The Facebook fan page points to a Magical Penny information page, inspired by the UK elections announced for 6th May 2010, to encourage you to take financial responsibility and put it in your own hands-why rely on politicians when you can be proactive yourself to get money in your pocket today?

<If you are in the market for renewing car insurance or home insurance then using a price comparison site to get a number of quotes can save you substantial sums.

As well as encouraging you to get a quote, (Magical Penny is all about you being proactive with your finances), you will also be supporting Magical Penny as I will get a few pennies for every completed quote so thank you in advance.

You don’t even have to take out the insurance itself. Just get a quote using the links on this info page.

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Do You Have Too Much Cash?

by Magical Penny on April 7, 2010

It’s important to work towards have plenty of pennies saved. Doing so will give you options and give even your most ambitious dreams a chance to develop. Even if you haven’t been reading Magical Penny from the start, you know this!

But it can be hard in two ways:

  1. It can be hard working out how to live on less than your income and putting money away consistently in a savings account. Budgets and goals can help immensely but eventually you simply have to learn how to do it like second nature.
  2. Once you have built up your savings a bit, it can be hard making sure you don’t spend them again! Even when you feel first-hand how empowering it is to have pennies saved for emergencies and opportunities, you may come close to justifying spending all your savings away. I have!

However, like anything that you do deliberately over time, you’ll get better at it. Better at putting money away; better at staying focused; better at achieving savings goals. You may not think it but you could soon start developing a new problem: Having too much cash!

Cash is King?

As your pennies grow slowly over time you may find yourself, in a surprisingly short period of time, with several thousands sitting in a savings account –preferably an ISA if you’re in the UK.  After working so hard to save and keeping those savings untouched it’s only natural to want to see a return on your money. But even if you’re monitoring the interest rates and making ISA transfers every so often, the interest rate on your savings account ultimately is not that important, because cash is cash : a safe, liquid  (immediately accessable) low return investment. That’s why you should be saving cash: for your short and medium term needs!

A Good Problem to Have?

When you’re first begin growing your pennies, building up cash reserves is the best thing you can do. But if you want to grow your pennies long term, cash will not grow in value: even with interest your hard-earned money will largely lose value to inflation: Having too much cash may seem like a good problem to have but it’s really not.

It Can Happen to Anyone!

Many people may find themselves with this problem if they religiously take advantage of the cash ISA limits each year. It might seem like a good idea at first but if you’re not making a return on your money and you’re not spending it either, then huge potential growth is missed. Current ISA rules recognise that cash is not the best vehicle for long-term saving: You can only save half the total yearly allowance in cash: the rest must be in other assets like stocks and shares. You can also easily transfer any cash in an ISA to stocks and shares (although not back to cash again).

Is Cash Over-Loved?

I was prompted to write about the tyranny of cash after reading the findings of the recent study by Clydesdale and Yorkshire Banks  75% of respondents were in favour of a change to the ISA rules to allow savers to invest up to the full ISA allowance in cash alone. If this happened it would allow savers in the UK to save over £10,000 in cash every year instead of the current allowance of £5100 tax free cash saving.

Read the full article here.

Whilst raising tax-free saving limits would be great in itself I think the findings of the study demonstrate that many people are intimidated by other asset classes like stocks and shares – ignorant of the huge potential of other asset classes to grow in value while cash reserves stagnate with every passing day. Cash still has its place: it’s great for its flexibility but leaving it in its current form, rather than investing it in other asset classes can be the difference, over 40 years,  between having a few thousand pounds and having millions.

We’re Only Just Beginning!

If you’re reading this and you’re in your 20s and 30s it’s unlikely you have the  problem of too much cash at this point in your lives. Keep at it. So whilst it is possible to have too much cash when saving long-term, it doesn’t hurt to save as much as you can first before putting it to work!

And Magical Penny is here to show you how to do exactly that: now that we’ve been through the basics we’ll begin moving towards the subject of investing and the opportunities available in the stock market –allowing you to put your pennies to work.

As the survey showed, for many, stocks and shares are intimidating but hopefully in the coming weeks you’ll begin to understand that rather than representing too much risk, asset classes other than cash offer a huge opportunity to grow your pennies over the long-term.

I’m pleased to have you along for the ride. 🙂

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Open a Cash ISA regardless of interest rate

by Magical Penny on April 5, 2010

It’s ISA season in the UK. Firstly Magical Penny told you to avoid the frenzy, Secondly  we detailed why you should open a Cash ISA. Today we’re hammering the message home with why you should stick with ISAs despite the low interest rates available.

ISAs stop your money being rained on by tax

ISAs are great savings accounts because all the interest is tax-free –acting as an umbrella from the rain of tax on your money. You don’t have to give any earnings from interest to the government (unlike any other account where your bank automatically deducts the government’s cut before you see it). But what should you do when the interest rates on ISAs are much lower than can be found in other types of savings accounts like now?

The controversy

Banks advertise when they have a market-leading interest rate on one of their accounts. Why? Because a market-leading rate can bring in a flood of new money, which they then can invest in the hope of an additional return for themselves. As ISAs have grown in popularity they have become highly profitable for banks who offer low rates on ISAs as they know there will still be demand for ISA accounts due to their favourable tax status. They don’t need to give their ISAs a competitive interest rate so they can keep more money in their own pockets. Although this practice is not ideal I think opposing ISAs for their lower interest rates misses the point: Is it still worth having an ISA? Yes. And here’s 3 reasons why:

1. All good interest rates are temporary

When you look for different places for your money you may well come across a number of seemingly ‘killer-deals’: perhaps a regular saver account that promises 5% or more, or a term deposit offering double the interest rate of a normal savings account. Whilst these can be appealing in the short-term, such accounts never remain competitive for more than a few months. Most financial providers offer these market-leading rates to attract new business and then notch the interest rate down in the hope that inertia on the part of the customer will keep them there, in a sub-optimal account (As Rob mentioned in the comments). Rather than rate-chase it makes sense to get your money into the ISA system and then search for good deals rather than keep it in a taxed account which most likely will not be a ‘killer-deal’ for long.

2. Terms and Conditions Apply

Another thing to look out for on financial accounts offering great interest rates is the number of terms and conditions attached. Financial providers add limitations and conditions to protect themselves from making a loss on you as a customer. Examples could be forcing you to tie your money for a certain amount of time, limiting the number of withdrawals, or requiring you to increase your balance each and every month. Sometimes these terms and conditions are worth it and you can get some amazing returns but make sure you are in a strong enough financial position to keep your end of the bargain.

In 2008 I managed to get 10% on my money, risk-free, using a regular saver account. But if I hadn’t had a strong financial cushion this could have gone very wrong as for months at a time I had several thousand pounds ‘locked up’-unavailable if I had needed it. It was a fun and profitable experiment but on reflection it’s not something I would recommend unless you have a huge ’emergency fund’ and if you have so much cash about then it’s likely another asset class would be better anyway (more on this in later posts)

In most cases, the increase in interest rate isn’t worth the trouble: for example you may have a promotional current account that offers an amazing credit interest but as it’s a current account you’ll be tempted to spend it, or perhaps a fixed deposit might promise a great return but it won’t be there if you need it. You would better off getting your money into an instant access ISA: think  about why are you saving in cash in the first place: for flexibility, safety and security. You don’t want conditions tying you down for the sake of a couple of percentage points.

3. Tax Benefits are forever…

…Well, maybe not if the government changes the rules but for now the tax benefits on ISAs are unmatched. Not only do you get to shield your money from tax this year, but growth is shielded in all subsequent years. It might not immediately seem intuitive to be paying into ISAs that offer lower interest rates than other accounts, but over the course of a few years getting your money under the ISA umbrella is the best thing to do. For medium term goals that take a number of years of saving, like if you’re saving for a house, then it makes sense to ‘future proof’ your savings from tax.

That’s not all

Once your pennies are under the umbrella of an ISA, protected from the rain of tax, you continue to have options. That’s right, the fun continues! You can transfer to better performing accounts within the ISA framework and even transfer your ISA funds into a Stocks and Shares ISA –the bigger and better cousin of the humble cash ISA…but that’s a discussion for another day!

Happy New Tax Year everyone.

Further reading

  • If you can’t get enough reading about ISAs perhaps you’ll enjoy a new UK finance blog discovery of mine @ShrewdCookie

Magical Penny was featured in Carnival of Personal Finance #251. Thanks MBH. So many quality articles worth reading.

If you’re new to Magical Penny be sure to read all the articles on Saving.

Sign up to the free newsletter and you can follow the blog on Twitter and Facebook too

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Opening an ISA in 2010

by Magical Penny on April 2, 2010

When it comes to savings your money there’s lots of choices. Instant Access Accounts, Term Deposits, ISAs… Magical Penny is reviewing each one over the next few weeks to help you find the best way to grow your pennies.

We’ve already outlined the magic of an instant access savings account: it’s easy to set up and acts as an important separator from your current (checking) account, whilst still being accessible for when you need it. In practical terms an instant access savings account is perfect for saving for irregular expenses: like insurance premiums that come around once a year, or for saving for your summer holiday in a few months time. But what about other savings goals?

“ISA ISA BABY”

Once you have managed to save a few months of expenses in an instant access savings account, your next goal (if you’re in the UK) should be to open an ISA (Individual Savings Account). At the moment it’s ISA crazy in the UK and if I’m honest, I’m loving it: ISAs are great and here’s why:

Interest Free Savings

For all other types of savings accounts you don’t get to keep all of the interest that you earn on your pennies. For example if you allowed £100 to grow in a 5% savings account, you would have earned £5 after a year. But you’ll only get to see £4 (assuming tax is at 20%). It might not seem much but as your savings grow the difference between taxed and non-taxed accounts grows substantially.

In the UK we have a great opportunity to save tax-free for anything we want. Compare this to in America where tax free savings are limited to retirement (Roth IRAs) and education (Education Savings Accounts) and have strict terms, conditions, limits and penalties. Put in this context, ISAs are amazing especially as we already pay tax on our earnings so it makes sense to take advantage of avoiding tax on our savings.

More Tax-Free Savings than Ever Before

Starting from next week (April 6th 2010) you will be able to save up to £5100 in cash over the next year. This is the highest amount ever since ISAs were introduced in the UK in 1997. Considering that all interest earned this year and for all subsequent years will be tax-free it’s one of the best risk-free things you can do with your money.

Important Considerations

Enough with the cheer-leading. Whilst ISAs are awesome, there are a few things to consider:

Avoid taking money out where possible

You cannot replace any money you take out of ISA over the course of a year as the £5100 allowance is measured by how much you put in. For example, if you put £5100 in an ISA next week then take out £3000 next month, you cannot then put that money back in the account as you have already used the full yearly allowance. You’ll have to wait until April 2011 and open a new ISA to make any future tax-free savings.

To use another example if you put £1000 in then take £500 out to go on holiday, you can only put another £4100 in the account over the rest of the year, leaving you with a maximum account value of £4600. It’s still a lot of money but by taking money out you have prevented yourself from taking full advantage of the tax-free saving threshold.

For this reason ISAs are perfect for medium term goals like savings for a car or a house deposit, rather than short-term savings goals –because for medium term goals you should not be planning to repeatedly dip into your savings for holidays and irregular expenses. For those of us in our 20s we are unlikely to be able to manage to save enough to reach the threshold but every little bit counts!

Bait and Switch

As Tax-free saving is such an appealing idea ISA products are big business in the UK. Almost every bank and UK building society (similar to credit unions in the US) offers an ISA, and every year there’s plenty of head-line grabbing interest rates. However, the interest rates advertised may not be what they seem. You may see a headline rate of a 3% ISA  but this most likely will consist of a low interest rate (say 0.5%) and a bonus rate (making up the remaining 2.5%). Such ‘bonus’ tactics give some ISAs an edge in the savings account ranking tables but can leave you with a very low rate of return once the bonus period ends (after 12 months is typical). It’s great for banks because the headline rate attracts lots of pennies but then, after a year or so, they get essentially free use of your money as the interest rate drops to close to 0% and most people leave the money alone. Despite these tactics ISAs are still worth it given the favourable tax-free growth that you can enjoy year after year but you must not forget to  ‘tranfer’…

Don’t forget to transfer

tax umbrellaGiven that most ISA providers drop the interest rate on the account after a year it makes sense to transfer your ISA funds to a better performing account after a year. You can do this with a transfer form once you’ve found a better ISA provider that accepts ‘transfers’.

You can transfer your ISA money as many times as you want: this works because an ISA isn’t a savings account itself, it’s simply a ‘tax wrapper’ or ‘umbrella’ over a savings account that stops your pennies from being rained on by tax.

As understanding the transfer process is such an important step when it comes to ISAs Magical Penny will be walking you through this process in the coming weeks (I’m doing it myself shortly!).

In the mean-time, do not manually transfer funds to a new ISA by taking your ISA money out of old account and depositing it into a new one –doing so will result in losing your ISA allowance: remember, the allowance is measured by the amount of money going into an ISA over the course of the year. The transfer has to be done internally by the ISA providers themselves. It’s a simple process but most people forget about it, and end up having multiple ISAs with different providers who are paying close to 0% in interest.

I hope this post has made ISA rules a little clearer for you and that you take advantage of ISAs in the new tax year.

Have a great Easter everyone and repeat after me: “ISA ISA BABY!”

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Scared of the ISA Frenzy?

by Magical Penny on March 31, 2010

It’s ISA time in the UK and it would seem that every financial services provider is going all-out to make sure that everyone is taking advantage of their ISA before the new financial year begins next week. But is it really worth all the fuss?

In short, an ISA is an ‘Individual Savings Account’ in the UK that allows you to save for anything, tax free. The best way that I’ve heard an ISA described is as an umbrella that stops your savings from being rained on by tax. And within your ISA umbrella you can cover both cash and Stocks and Shares from being rained on.

For the 2009/10 tax year ending this week there is a total savings limit of £7,200, up to £3,600 of which can be in cash and the rest, up to £7,200 total (including cash), can be in stocks and shares. For American readers ISAs work very similar to Roth IRAs (tax-free post-tax savings) but us Brits are not limited to saving only for retirement –we can use it for anything!

With such a great opportunity to shield your savings from tax it’s understandably a very popular way to save and one that Magical Penny will be exploring fully in the coming days. But not today.

Last Minute Saving

Yesterday I had an amazing opportunity of working with one of the UK’s leading financial service providers (a rare treat for a personal finance blogger!) and I heard first-hand the number of people rushing to take advantage of the 0910 ISA allowance before the new tax year begins next week. The time-sensitive nature of the calls coming in really hit home to me the fact that so many people rarely consider financial decisions until the last minute: when the deadline is beating down on them:

  • Many leave depositing savings into an ISA until the last few weeks of the financial year.
  • Many leave saving for a house deposit until they begin thinking about buying a house that very year.
  • Many leave retirement planning until they are in their 40s and 50s, having previously thought they had plenty of time.

Don’t get me wrong: I understand the thrill of doing things at the last minute. I’m even writing this post in the early hours! But when it comes to growing your pennies: ‘last minute’ is definitely not the way to go. Make a promise to yourself to do something today to grow your pennies and remember slow and steady wins the race: Save something every month, regardless of what’s going on. When you’re just starting you don’t need to worry about ISA deadlines and interest rates on your savings. Just start.

Making sure as much of your savings are shielded from being rained on by tax is a worthy goal but it is much more important that you are saving as much as you can in the first place so you are not left scrambling around trying to find as much money as possible when deadlines start coming up.

Avoid the fuss and simply save what you can in any account. There’s plenty of time to find the right accounts once you are in the savings habit.  If you’re not quite ready then set your savings goals in motion and bring on the new tax year!

Magical Penny does recommend you use your ISA allowance but recommends gradually filling it throughout the year rather than being in a rush to ‘use it or lose it’ -it gives you a chance to find the best rates and makes the process of saving less stressful and more easily automatic.

In other news:

If you don’t already know Magical Penny has launched a free prize draw! Read the 2nd Magical Penny Newsletter here for details and subscribe for a chance to win a great personal finance book!

Magical Penny was featured in Carnival of Personal Finance #250. Thanks Mike @4 Pillars

Follow Magical Penny on Twitter!

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Instant Access Saving Accounts

by Magical Penny on March 26, 2010

One of the most powerful concepts in personal finance is of ‘paying yourself first’.

It means making a commitment to yourself that regardless of personal circumstance you decide that every day you are working not only to buy things that you need today, like food and shelter, but that you are working to pay for your future too. In its most simple form it means you give yourself money before you give your earnings to anyone else.

One of the best ways to optimise your current account is to make this concept a reality by automatically transferring money by standing order every pay-day to another account, separate from your every-day spending account. To separate these savings you’ll need a savings account:

Instant Access Savings Account

There’s lots of different savings accounts available to choose from. ISAs, regular savers, fixed deposit, building society accounts (the UK equivalent of US credit unions) and instant access accounts. But don’t fall for decision paralysis when looking for the ‘best savings account’ –your first point of call should be the bank you have your current account with. Simply open an instant access ‘standard’ savings account with them. Here’s why:

It’s the easiest to set up

If you do not have a savings account at all, you should get one. Today. Opening up a savings account with your current bank is quick and easy, considering that the bank already has all your details on-file. You’ll also be able to easily get a standing order set up to feed the maximum amount you can afford into the savings account each and every month.

A layer of separation

The purpose of this savings account is not to earn interest on your savings –this will come later – but to provide a barrier between your pennies to spend now, and the pennies to spend at a later date. It might seem like a trivial barrier but it’s not. I’m reminded of a friend of mine who recently received a sizable inheritance. By his own admission he has quite a lot of debt yet as a result of the inheritance he found himself one day with thousands of pounds deposited into his current account.

Despite intentions to pay off his debt, the inheritance money stayed in his current account for several weeks. You can guess what happened to some of that money!

Whilst sizable inheritances and a strong income can help with growing your pennies, most money management is a psychological game. Take control by separating as much of your money as possible from your day-to-day spending account.

It is still accessible

Having a savings account with the same bank as your current account allows you to instantly transfer money from your current account to your savings account, and back again if you need it. When you first start developing a savings habit you are not going to be perfect. You will underestimate your spending and may need to dip into your newly accumulated savings. Having it readily accessible will give you the confidence to save as much as you dare, whilst also being comforted by the fact that if you really need to dip into your savings then you can, and quickly. When you are first beginning to save speed of access is important as other kinds of savings accounts either penalise you for withdrawing funds or have a delay between when you request your money and when you receive it.

Overall, a standard instant access savings account isn’t going to win any awards for good interest rates but setting one up is perfect for getting into the habit of saving. Instant access savings accounts are perfect for short-term goals when you expect to need the money soon but want the psychological advantage of keeping your savings away from your current account which for most of us has a nasty tendency to disappear to zero each month.

Other News

Magical Penny has launched a free prize draw! Read the 2nd Magical Penny Newsletter here for details and subscribe for a chance to win a great personal finance book!

Next week Magical Penny will outline other savings accounts that are perfect for those of us who are out of our overdrafts and already have some emergency savings in an instant access savings account.

Have a great weekend. I certainly will as I’m learning to water-ski!

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Commit to your future today

by Magical Penny on March 22, 2010

should I save for retirement?

What do you hope your life will be like at age 65?

Productive days working on what you love? Sun, sea and sand in exotic locales?

Lazy mornings at home with your family? Busy days sightseeing on the Inca Trail?

We all have different visions of what we want our lives to be like when we’re older. And we’re living in unprecedented times where many of us are likely to have a long, healthy and productive old age. But having a vision will only get you some of the way –making a commitment to yourself to grow your pennies will certainly help you pursue your vision.

The Power of Today

When it comes to saving for the long term (traditionally know as retirement), many people have a fixed idea of when they will start:

“I’ve always said to myself that I’ll start at 25”

“I’ll sort something out in my 30s”

“I should be rich by my 40s so don’t need to worry it now”

Even if you have good reasons for when you intend to begin your long term savings, the only correct answer is: “I need to start now”. There will always be other financial pressures in your life and you may not be earning much right now but you should still consider the benefits of savings.

One of the many amazing things about being in our 20s and 30s is the impact we can have by saving hardly anything at all. We may not be earning much compared with our older counterparts but any pennies we do manage to save will have so much more time to grow. This isn’t to say that you can’t still enjoy the journey through life spending your hard-earned pennies but to keep in mind that anything you put away for the long term is worthwhile. We have the power. And that power is time.

What if I don’t want to retire?

Around the blogosphere there’s been a recent trend of writers proclaiming that they don’t want to retire. For example Adam at ManVsDebt recently wrote that he’s not planning on retiring but rather he’s:

“focusing intensely on devoting energy to aligning my work, my passion, and my purpose”.

With the new information economy and digital revolution, more and more people are finding fulfilling work creating value in new digital intellectual mediums. As this kind of value can be created without the need for physical labour, it’s the kind of work that could continue well past the traditional age of retirement.

Likewise those of us who have found fulfilling work don’t want to retire: We have hopes that we can continue doing what we love for as long as possible. Sitting around waiting to die is not an option! It is said that doing what you love means never having to work for the rest of your life. Perhaps it also means you never really retire. And that’s the plan for an increasing few.

Ultimately though, you can’t rely on such plans: The world changes too fast. Health scares and accidents; industry changes; and the waning of passions cannot be predicted and could be devastating on your quality of life if you have not made any long-term provisions when these things occur.  Having pennies saved is an important level of security even if you do not intend on an idle retirement.

And if everything does go to plan, having a few extra pennies in your bank account certainly won’t hurt as you explore the Inca trails!

Recommended reads:

http://www.obliviousinvestor.com/dont-retire/

http://www.providentplan.com/95/rethinking-retirement/

In other news, Lee is back writing at Five Pence Piece, another rare UK based personal finance blog. If you enjoy Magical Penny I’m sure you’ll like Five Pence Piece too!

Have you started long-term saving? Or are there just too many other things going on in your life at the moment? If you have started already, what did you find helpful in getting you to start on the Thermals of Wealth?

Coming soon: Specifics on the best saving vehicles for each penny-growing goal.

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The 3 Pronged Approach to Financial Goal Setting

by Magical Penny on March 19, 2010

Over the last week Magical Penny has been exploring the concept of focus when it comes to growing your pennies. Previous posts have explored this subject in the context of short, medium and long term goals. But should you be working on all 3 types of goal at the same time?

A case for single-minded focus:

If you have lots of debt and are reading this site you’ve most likely had an ‘a-ha’ moment, a lightening flash of clarity, where you realise that your debt level is unsustainable and you need to make drastic changes. Whilst I have never been in that position myself, many bloggers have, and many turn to Dave Ramsey’s baby steps.

The baby steps are 7 steps towards financial independence and the creator, being a proponent of the power of focus,  insists that you only take one step at a time.

The Baby Steps

#1 $1000 emergency fund

By first saving about £655 you can cover small emergencies without turning to more debt

#2 The Debt snowball

You begin paying off your debt with intense focus with minimum payments on all of the debts apart from the smallest debt, which you attack with every penny you have. Once paid off the first and smallest debt you keep your focus by working towards paying off the next smallest debt until all debt is eliminated (for other debt strategy’s click here)

#3 Three-six months of expenses

Once all the debt is gone you then save for a bigger emergencies like losing a job or needing a new car.

#4 Retirement savings at 15%

Only once you are debt free and have a strong emergency fund do you begin saving for retirement, and then only 15% of your income

#5 College-saving

With hugely expensive university fees to pay Dave encourages parents to save for their children’s higher education next. Now that the UK is following the US model of tuition fees, a new generation of British parents should consider putting money away to cover this too. If you’re in America consider saving in a 529 College Savings Plan. UK readers can stick to ISAs -more infomation to follow shortly.

#6 Pay off the house

Dave evangelises being totally debt free including your house as soon as possible. Before you do any other saving or investing (with the retirement baby step as the exception) he shouts on his radio show to pay off your house saying that the garden grass beneath your feet will feel much better once your house is truly your own.

#7 Invest and grow wealthy

Once you’re walked up all the baby steps there’s nothing left but invest some of your money and give lots of it away!

Many people love Dave Ramsey and his ‘Baby steps’ because they provide an easy-to-understand structure.  As you are not meant to skip any of the steps it also helps with financial focus too. However, I feel it’s too restrictive and, perhaps controversially, believe that by focusing on more than 1 goal you can make more progress.

Magical Penny’s 3 pronged approach: the powerful way to keep you financial goals on track and grounded

UK electric plug

Firstly to address the problem with Dave Ramsey’s single focus ‘Baby steps’:

Beans and Rice, Rice and Beans

Even with intense focus, paying off debt can take a long time. Would you feel comfortable only having £650 to your name while you paid off your debt?

For some being uncomfortable helps them focus on getting out of debt –perhaps by getting an extra job or cutting their lifestyle back, way back to “rice and beans, beans and rice”. However, I’d rather be in a position of financial strength with more emergency savings before tackling my debt. For me knowing I had pennies in the bank would help me focus on eliminate the debt. That said, this is mere speculation as I have never had consumer debt. If you have, I’d love to hear your thoughts on Dave’s approach.

Multi-Focus No No

Dave’s plan requires focusing on one goal at a time but personally I would find it disheartening not to be able to save for a few different goals simultaneously. For me beginning a savings fund for a medium term goal makes what I am saving towards closer to reality, helping me to focus my spending and saving better than if I were only saving for one thing at a time.

By diffusing my savings goals it does take longer to reach each goal but in most cases I’m happy to wait. The wait helps me to evaluate my larger scale purchases and also adds another hurdle to avoid lifestyle inflation. To give a real example, I could currently afford to buy a car when I eventually pass my driving test (don’t ask!) but this would mean I would empty my ‘house deposit’ fund. Psychologically this fund is important to me so I’d rather save up for a car separately than have to start my ‘house deposit fund’ from scratch, even though buying a house is at least 5 years away in my mind.

Waiting for Long term

The power of compounding returns is mind-blowing so I have reservations about any plan that puts off saving for the long-term. Whilst Dave is right to encourage people to get out of debt, I feel that not all debt is equal (particularly UK student loans) so with the exception of higher interest-rate debt, you should consider starting your long-term savings as soon as possible. Time goes by quickly and there will always be something stopping you from saving for the long-term if you don’t make the commitment to put some pennies away for your future.

UK plug socket

The Magical Penny approach: Save Save Save

Ultimately when it comes to creating your own budget I encourage you to consider the Magical Penny 3 Pronged Approach of working towards short, medium and long-term goals at the same time.

It might seem like a lot of saving and it won’t always be easy but doing so can have a powerful effect on your life. Just be sure not to have too many sub-goals or you risk spreading your attention too thinly. If this happens and you find yourself feeling overwhelmed, lacking focus or simply becoming impatient, then perhaps a single focus approach is best for you! The main thing is that you have a plan –the surest way to be successful at growing your pennies, regardless of the time horizon.

What do you think works best?

Recommended Reading

5 Pracitical tips for Saving money. JD Roth, author of ‘Your Money, the Missing Manual’ and Get Rich Slowly touches on this very subject in a recent interview @Oreillyanswers

Not Personal finance related but I enjoyed reading about how to keep track of what you learn. Bottom line: Keep learning and refreshing your brain  @Freestylemind.

Have a great weekend and thanks for stopping by. If you haven’t already, be sure to sign up for the Magical Penny free newsletter, follow Magical Penny on Twitter and Facebook, or simply make my day by sending me an email!

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