This doesn’t look like it is going to be much of a year. The US may be moving into recession, as may the UK. House prices are falling and are set to keep doing so. Credit conditions are tightening. This is the kind of environment that puts everyone at risk – from hairdressers hit by consumers cutting back on spending to one-time City hotshots finding banks don’t need as many employees in bear markets as they do in bull markets. Anyone in any doubt need only glance across the Atlantic. There, according to Challenger Gray & Christmas, more than 150,000 jobs were cut in the financial services sector in 2007. That’s 24,000 more than went in the aftermath of the dotcom crash in 2001. My point? That this year it is vitally important to get your finances properly sorted out. Here’s how.
1. Spend less
Start the year by filling in a budget planner. Unless it tells you you’re rich enough not to have to change your lifestyle even if you lose your job, figure out how to make it look better. This means acknowledging the difference between the things you need and those you want, and buying fewer of the latter.
It also means ensuring you’re paying as little as possible for all your utilities (check via comparison sites such as Moneysupermarket.com); for petrol; for your big ticket items; and for your housing (cheap mortgage deals are getting thin on the ground, so if your current deal is coming to an end start looking now).
Next, it means cutting all the unnecessary insurance you’ve been bamboozled into buying, which eats away at your income every month. Take mobile-phone insurance. It is much too expensive at £8-£10 a month, given a new handset costs as little as £20. Do you really expect your phone to be stolen every two months? Probably not, but that’s how often it would have to happen to make it worth buying insurance.
Sure, these insurance polices are also supposed to cover calls made when the phone is stolen, but they won’t pay out if the phone vanishes as a result of being left unattended, and otherwise will only pay out if the loss is reported within 24 hours. This makes it tough to claim. If the phone was stolen and you noticed, you’d report it right away, so there would be no call costs involved. If you didn’t notice, you might well not notice for another 24 hours. You get the picture – it’s a waste of money.
And while £10 a month might not seem a big deal, once you add on all the other largely useless products you might have (ID theft insurance, payment-protection insurance, etc) and the ones you are overpaying for (car insurance quotes can differ by 100% plus), you could find yourself a couple of hundred pounds out of pocket every month.
2. Sort out your debt
It is obvious that being in debt isn’t desirable, but this is particularly the case today given how much harder it already is to get access to cheap loans. So shift all your debt on to the cheapest credit card or personal loan you can and pay it down as fast as you can. And even if you have no debt bar a mortgage, pay that down too.
Why? Look at it like this, says James Dickens of financial planning company Grierson Dickens Limited. “If your mortgage rate is 6% and you are a 40% taxpayer, you would need to get a gross guaranteed return of 10% on your investments to make them more efficient than using your money to repay your mortgage. That’s 10% every year before even considering product and advice charges.”
Given that the typical actively managed investment fund has an annual charge of 1.5% per annum and initial charges of anything up to 5.5%, the idea of not investing anything until you have repaid all your debt suddenly makes very good sense.
“Imagine,” says Dickens, “an investment opportunity advertising a guaranteed return of 10% every year!” You’d jump at the chance. So why not use the one you have staring you in the face? All you have to do is increase your mortgage payments as much as you can every month and that 10% is yours. Couldn’t be simpler.
3. Save more and save better
That said, most people will need to be saving some cash too. Everyone should have six months’ worth of living money salted away on deposit just in case. But where? The usual answer is wherever you can get the highest rate on it, but this year things aren’t so simple. The credit crunch is far from over and that means some of the banks operating in the UK should be considered to be at some risk.
Yet our deposits are only guaranteed up to £35,000. Keep any more than that in a bank that goes bust and you’ll lose the excess. Don’t expect to get the £35,000 back in a hurry, or any interest on it while you don’t have it, either – this is a Government-guaranteed scheme, after all.
So which UK banks are the safest? One way to judge this, says MoneyWeek and Model Investor writer James Ferguson is to look at the price of their credit default swaps (CDSs). These are a good proxy for the price each bank is having to pay for insurance on the funds they need to borrow to keep going. On this measure, the riskiest banks (ie, the ones the credit markets are most worried about) are the Icelandic and the Irish banks, including Anglo Irish and Landsbank (which runs the very high interest IceSave account in the UK).
For the record, says James, “I would not be happy having my savings in any of these institutions’ accounts, however much interest they are paying.” The banks that look the least risky on this measure include HSBC and Lloyds.
See the end of this article for a full list of the banks with the worst CDS ratings.
4. Think carefully before you buy a house
It has long been clear that the UK property market has been a bubble looking for a pin, but still, few people realise quite how much money they are wasting by buying instead of renting in a falling market. One example sent in this week by a reader from Wales makes the point very clearly.
The house in question, an ‘executive’ four-bedroom house with views over fields to the rear and close proximity to several excellent schools, is both for sale and for rent. The sale price is £315,000 (at least 12 times the local average wage). A repayment mortgage on this amount would come to around £2,000 a month and even an interest-only mortgage to around £1,500.
Yet you can rent this very same house for £750 a month (offering its current owner a pathetic gross yield of under 3%). Better still, as a tenant you won’t have to pay for its upkeep, nor will you have to care about the fact that it is falling in value every single day.
5. Get a Sipp
If you have access to a company pension scheme, take it. Payments are taken direct from your income and if the scheme includes an employer contribution, and most do, this has to fall into the rare category of ‘no-brainer’ investments, says James Dickens. “Not to join such a scheme is surely madness since it means effectively turning down extra pay (not to mention the tax breaks associated with pensions).”
If you don’t have access to a company scheme, you’re still going to need a pension, so make sure you have your own and, if you want it to be flexible and cheap, make sure it is a self-invested personal pension (Sipp).
Sipps are just tax wrappers – you buy the wrapper from a provider and put your money into it. Then the Revenue tops up your fund by basic tax relief (higher-rate taxpayers claim the rest back in their tax return) and you use it to buy whatever funds or shares you want to own.
Buy the wrapper from the likes of Hargreaves Lansdown or Killik & Co and you can run your fund for very little: they charge you only basic trading fees for shares and heavily discount the initial and annual fees on funds.
Investing for your old age like this works: it’s cheap, it gives you access to every asset class you can think of (you can even buy property funds if you really must) and, best of all, it’s tax-efficient.
Worst CDS ratings
(5 year spread)
1. Kaupthing 315.8
2. Banca Italease 239.3
3. Glitnir Banki 230.8
4. Lansbanki 167.5
5. Anglo Irish Bank 122.0
6. HBOS 75.3
7. Bank of Ireland 72.7
8. Allied Irish Banks 71.7
9. RBS 62.8
10. Fortis 62.7
11. Santander 59.3
12. Barclays 58.7
13. UniCredito 56.7
14. ABN Amro 56.3
15. Dexia 56.0
16. Banca Monte 55.5
17. BBVSM 55.0
18. Abbey National 53.8
19. Dresdner 53.5
Source: Bloomberg