Monday Finance:  Are You Saving Enough?

How much should you be saving? It’s an important question and not without relevance for those working on a 5YP. Put simply, a 5YP without adequate financing will either not get very far or get you into debt.  Neither destination is a place you want to go.

So back to the question of how much is enough. The answer, of course, is as much as you can afford.  But that simply shifts the question to how much can I afford?  There are at least two schools of thought on this question.

The first is to make an accurate budget and whatever is not required to live on is what you save. What you do with what you save is up to you.

Piggy bank savingsJohn Wesley, an 18th century Anglican priest and one of the founders of the worldwide Methodist movement, is an unlikely financial advisor. He is credited with the following mantra:

Earn all you can.

Save all you can.

Give all you can.

He apparently lived by his own mantra. So it is claimed that when he earned £30 a year he lived on £28 and gave away £2 per year. Towards the end of his life he earned closer to £100 per year and he still lived on £28 but gave away £72.

The upside of this approach is that if you live frugally you could save a great deal.  However, the downside is that if you aren’t very frugal you won’t save very much at all.  Indeed if you are reading this, my guess is that you are more likely to have the opposite problem.

The second approach seeks to address that issue by setting a minimum amount that you should expect to save each year. The best suggestion I have found is to seek to save a minimum of 10% of your gross income each year. NB: this is not 10% of your take home pay but rather 10% of the total before tax, National Insurance and pension deductions.

keep-calm-and-do-charityIn addition, the virtuous might choose to give away an equivalent amount each year. This leaves you with a maximum of 80% of your earnings to live on. It is worth saying that the point of saving is not so that it can be spent on your 5YP. Rather, your 5YP expense needs to be fit into that 80%.

The advantage of this approach is that it means that you aim to save at least a minimum amount each year.  For example, if you earn the average wage in Britain, i.e. £26,500, then you should be aiming to save a minimum of £2,650 each year, around £221 per month.

If you are managing to save more than 10% then you are doing pretty well.  If you are saving less than this then you may have some work to do. The obvious disadvantage of this approach is that it works better for those who earn more and less well for those who earn little.

Those who earn less than the average wage, or whose financial responsibilities take up most of their pay cheque, might think the aim of saving 10% of their gross income a pipe dream. In contrast, those earning £50K per year may scoff at the idea that they only need save 5K per year to be on target.

isas_1891322b
Image: The Telegraph

Whatever your preferred savings targets there is one key thing you need to know.  Savings targets are meaningless if you don’t actually hit them.

I used to put aside, religiously, a few hundred pounds per month into my savings account each month. Equally religiously, I would take most of it back out some months later for important or unanticipated expenses.  The net result was that at the end of the year I had little more savings built up than at the beginning of the year.

This is why it is better to set annual savings targets rather than monthly ones.  You haven’t hit your target until you get to the end of the year and you actually have saved the amount you set out to save. You then need to repeat this each year.

Image: The Telegraph
Image: The Telegraph

With the new tax year beginning yesterday (6th April) if you haven’t already done so you might want to look into a cash ISA which allows you to save without paying any tax on your interest earned up to £5,940.  From 1 July this is scheduled to rise to £15,000.  You may never have to pay tax on interest earned again.

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