Sorting Out Your Finances For Dummies, 2nd Edition

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Introduction

W elcome to the second edition of Sorting Out Your Finances For Dummies. If you’re struggling to clear your debts and build up your savings and investments for the future, you need some sensible tips to help you realise your goals. This book provides all the help you need to enable you to get your debt under control – and start saving for the future.

About This Book

Although these pages are overflowing with useful advice and information, I present it in a light, easy-to-access format. This book helps you decide where your priorities lie when it comes to your finances. I cover debt and how to clear it, and give tips on finding the best savings account so that when you’ve got some cash you can ensure it works as hard as possible for you. I offer some hints on picking the best investments for building up a nest egg or for a specific outlay, such as buying a car or paying for a holiday. Just as important, this book helps you maintain your sense of humour – as well as your sanity – as you deal with financial challenges.

Conventions Used in This Book

To help you navigate through this book, I’ve set up a few conventions:

Italic is used for emphasis and to highlight new words or terms that are defined.

Boldfaced text is used to indicate the action part of numbered steps.

Monofont is used for Web addresses.

What You’re Not to Read

I’ve written this book so that you can:

Find information easily and

Easily understand what you find.

And although I’m sure you want to pore over every last word between the two yellow covers, I actually make it easy for you to identify ‘skippable’ material. This is the stuff that, although interesting and related to the topic at hand, isn’t essential for you to know.

Text in sidebars. The sidebars are the shaded boxes that appear here and there. They share personal stories and observations, but aren’t necessary reading.

Anything with a Technical Stuff Icon attached. This information is interesting but not critical to your understanding of sorting out your finances.

The stuff on the copyright page. No kidding. There’s nothing here of interest unless you are inexplicably enamoured by legal language and reprint information.

Foolish Assumptions

In this book, I make some general assumptions about who you are:

You want to tackle your finances but you don’t know the first place to start. You’re wondering whether – just maybe – it might be possible to get out of debt once and for all. Perhaps your friends are no longer talking about overdrafts and credit cards but are saving for a deposit for their first home, a new car, or to start a family. You may be worried about being left behind or are simply embarrassed by your spending habits and are ready for things to change.

You hope to get information on how to start saving for the future – you want to know the pros and cons of pensions, or buying property, or toying with the stock market – or all three.

You want easy-to-understand information that explains what you need to know about your finances, but you’ve got better things to do (like sleeping, participating in your favourite leisure activity, or even relaxing on holiday) than become an expert on annuities and derivatives. In other words, you want to get it right while you retain control over your life.

How This Book Is Organised

Sorting Out Your Finances For Dummies is organised into five parts. The chapters within each part cover specific topic areas in more detail. So you can easily and quickly scan a topic that interests you, or troubleshoot the source of your latest major headache!

Part I: Organising Your Finances

The chapters in this part help you take stock of your financial goals. This part helps you figure out whether you need to use an independent financial adviser to help you organise your finances and, if this is the case, how to select one who’s qualified and suitable for the task. I cover making sure you’ve got the best current account for your needs. This part also includes everything you need to know on insurance, so that you, your family, and your belongings are covered in case the unexpected happens.

Part II: Dealing with Debt

There’s not much point starting to save and build up your investments until you’ve cleared expensive debts, such as unauthorised overdrafts, credit cards with high rates of interest, and uncompetitive personal loans. In this part, I give you the lowdown on debt and how to get out of it. I guide you through all you need to know about choosing the cheapest overdraft, the special deals providers offer on credit cards, and how to shop around for the most competitive personal loan. I also highlight the dangers of store cards and loan sharks so that you don’t get into further difficulty.

Part III: Building Up Savings and Investments

This part takes you from putting aside a little cash to tide you over in an emergency to building up serious investments for the future. I look at tax-free savings and investments, and why you’d be mad not to take advantage of these. I cover understanding risk and how to ensure you don’t take on more than you’re entirely comfortable with. And if you fancy the thrill of investing in shares, I include plenty of tips to get you started. I also address choosing a mortgage and making sure you can raise enough cash to get on the property ladder.

Part IV: Taking Care of the Future

With a decreasing amount of state help available in retirement, you need to start investing as soon as you can afford to do so to ensure you have a comfortable retirement. In this part, I look at the various options available – from occupational and personal pensions, to property or other investment products, such as individual savings accounts. I also include guidelines on coping financially in retirement and ensuring your money stretches as far as possible.

Part V: The Part of Tens

Here, in a concise and lively set of condensed chapters, are tips to make the difference between a prosperous future and one where you struggle. In these chapters, I give you tips on getting out of debt, coping with events life may throw at you, and the golden rules of sorting out your finances.

Icons Used in This Book

Scattered throughout the book are icons to guide you along your way and highlight some of the suggestions, solutions, and cautions of sorting out your finances.

Keep your sights on the target for important advice and critical insights into the best practices in saving, investing, and clearing debt.

Remember these important nuggets of information and you’ll stand a better chance of achieving your aims.

This icon highlights the landmines that you need to steer clear of.

Prepare for brain strain when you read these bits – and impress your friends with what you know.

This icon highlights the real-life anecdotes from years of experience and mistakes, made by myself and friends, when tackling our finances. While we should learn from our own mistakes, it’s even better to learn from others’ – and I share some of them with you here.

Where to Go from Here

This book is organised so that you can go wherever you want to find complete information. Want to know what information is on your credit file? Head to Chapter 6. If you’re interested in writing your will, go to Chapter 15. You can use the table of contents to find broad categories of information, or use the index to look up more specific things.

If you’re not sure where you want to go, you may want to start with Part I. It gives you all the basic information you need to get started in establishing your financial goals and points to places in the book and beyond where you can find more detailed information.

Part I

Organising Your Finances

In this part . . .

Before you sort out your debts and investments, you need to get the basics in order. In this part, I guide you through the process of establishing your financial goals and how an independent financial adviser can help you reach them. I include hints on choosing an adviser and the qualifications to look for.

I also give you tips on choosing the best current account for your circumstances, and making sure you’ve got enough insurance in place to guard against the unknown.

If you’re thinking about getting your finances in order, but are not quite sure where to begin, this is the part for you.

Chapter 1

Exploring the Basics

In This Chapter

Benefiting from getting a grasp on your finances

Looking at your financial picture

Working out how you can get out of debt

Figuring out what you want from your finances

Investing the tax-free way

Understanding the importance of financial advice

C ongratulations! You’ve decided to get to grips with your finances and start building up your savings and investments for the future. Making sure you’re in control of your finances enables you to do what you want – upgrade your car, get on the first step of the property ladder, or start building funds for retirement.

In this chapter I start by giving you the lowdown on working out what your financial goals are and how you can achieve them. I offer advice on clearing your debts before you begin building up your savings and investments, and the importance of seeking independent financial advice. Only when you have the basics under your belt can you ensure your finances work for you – rather than limiting you from doing all the things you want to do.

Looking at the Benefits of Being on Top of Your Finances

Sorting out your money by clearing your debt and building up your savings and investments makes you the master of your financial future, and brings several benefits:

You stop paying expensive fees and charges for being in debt. Debt is pricey, with high rates of interest and often extra fees and charges. If you’re in a lot of debt and pay a significant amount of interest on it, you may find that you simply can’t clear what you owe as all your money goes towards servicing the debt and paying the interest. Clearing your debt removes the debt itself and the cost of financing it.

You get rid of your guilt. Being in debt can be a worry, particularly if your debt has got out of hand and you can’t see any way of escaping the situation. Some people also regard being in debt as a stigma – something to be ashamed of and hidden from friends, family, and colleagues. Any way you look at it, debt is a burden and getting rid of it can be a huge weight off your shoulders.

You feel more confident about the future. With the state providing little financial support in retirement (see Chapter 15 for more on this), you may be concerned about how you’re going to make ends meet. But if you have savings and investments spread across a range of funds, pensions, and property, you can rest easy with regard to the future. You may even be able to look forward to giving up work, rather than dread it.

You open up a range of financial options. If your finances are in order, you can afford to take time off to travel or try a new career. But if you have lots of debt or little in the way of savings, you may not have the option to do what you like. This can make you feel rather resentful.

Pondering Money Matters

To stay on top of your finances, you need to review major investments – such as savings accounts, unit and investment trusts, shares, and your pension – at least once a year, to ensure that you’re still earning the best returns. Getting into the habit of spending a couple of hours a week keeping things ticking over is also a worthwhile idea: Paying bills before they’re late or moving surplus cash from your current account to a high-interest-paying savings account. You should also use this time to plan what you’re going to do next.

When you find the best financial products available, keep a careful eye on them. As soon as they start to look uncompetitive, consider switching to a better deal with a more attractive rate of interest. Don’t become complacent, or you could lose out.

If you aren’t prepared to track your own financial investments, consider using an independent financial adviser (IFA) to do this for you. An IFA can make suggestions as to what you should be investing in and whether you should move out of existing investments. See ‘Using a financial adviser’ later in this chapter for more details.

In the following sections, I look at how you can start getting on top of your finances.

Working out how much money you have

You should know off the top of your head roughly how much your assets are worth, but if you aren’t on top of your finances you may not have a clue. Or if you’re in a lot of debt you may know the depressing answer straight away – nothing.

Many people have lots of savings accounts and investments dotted around with a few pounds in each. The money in such accounts often has been languishing there for years and earning a poor rate of interest. If the interest rate is halfway decent, it’s more likely to be down to luck than careful financial planning.

As a first step to getting a clear view of your finances, make an inventory of what you have: List all your savings and investments so that you can see all your assets at a glance. Don’t forget those windfall (free) shares you got when your building society demutualised (listed on the stock market), those premium bonds granny bought you when you were born, or that odd £20 sitting in a National Savings account. It all adds up.

Don’t forget payments into your pension (if you have one) and equity in your home (you can work this out by subtracting your outstanding mortgage from the market value of your property). These are all assets.

From there, you can assess whether your money is in the best place to earn you the highest returns.

Calculating your debts

If you’re like most people, you have a bit of debt. Or you may have quite a lot of debt, depending on your financial situation and attitude towards credit.

Debt isn’t always bad: The low interest rates of the past few years made it possible to pick up cheap personal loans or credit cards charging 0 per cent for an introductory period on new purchases or balance transfers. Making use of cheap money is a smart financial move, so long as you keep up with the payments and avoid expensive fees. And make sure you switch to another 0 per cent deal when the introductory period on your credit card runs out so that you don’t find yourself paying a much higher rate of interest.

On the other hand, you never get out of debt if you ignore bills and credit card statements for fear of what you might find within the envelope. It may not make for pretty reading, but facing up to your debts is the first step to getting rid of them. A bit of short-term pain now leads to stronger finances in the longer term. Bite the bullet and open the envelope.

Before you can attack your debts – getting rid of the most expensive ones and chipping away at the rest – you need to make a list of exactly what you owe.

Compile and arrange a list so that your most expensive – rather than your greatest – debt is at the top. For example, you may owe £150,000 on your mortgage and £2,000 on a store card, but paying off the store card is more of a priority because you pay a lot higher interest on it. While you may be paying around 5 to 6 per cent interest on your mortgage, you might be paying six or seven times this much on the store card. Clearing the store card debt in the short term, and the mortgage debt in the longer term, therefore makes sense. (Go to Chapter 8 for more on store cards and Chapter 14 for the lowdown on mortgages.)

Clearing Your Debt – and Starting to Save

When you know how much debt you’ve got and what savings you have, use the latter to clear the former. This is particularly worthwhile if your savings are languishing in uncompetitive accounts while your debt is expensive.

If you don’t have enough surplus savings to make much of an impact on your debt, at least shift store and credit card balances onto cheaper plastic. This reduces the interest you pay: Instead of paying back just the interest each month, you can chip away at the outstanding debt as well.

Having some savings set aside is always reassuring, but if you’ve got expensive debt it doesn’t make much sense to have money just sitting in an account. Use the savings to clear some of the expensive, short-term debt, as you generally pay more interest on the debt than you earn on your savings. Only after you clear your expensive short-term debts should you start building up savings for an emergency or rainy day. (The chapters in Part II give tips for clearing your debt.)

After you clear your debt, your next step is to start your emergency fund – for if the boiler packs up, for example – which is vital to your financial health. Having an emergency fund prevents you from slipping into expensive debt in the first place.

Make sure your emergency savings are easily accessible. There’s no point choosing an account where you have to give 90 days’ notice before you can get your money – it defeats the whole object. The amount you save should be the equivalent of three to six months’ worth of outgoings: The exact amount you need depends on what you’re personally comfortable with and how much you spend each month. If you’re the main breadwinner, you may need more cash than someone with a wealthy partner with a good income. Chapter 9 has more on saving for a rainy day.

Establishing Your Financial Goals

Deciding how you should proceed is impossible until you know what you’re saving or investing for. Thus, you need to decide what you want before you begin.

When you’ve got your emergency savings covered, you can be more adventurous with your money. However, before you get carried away, remember that how you invest depends on what you want the money for and when you want it:

If you’re investing for the short term – less than five years – to pay for a holiday or new car, for example, some form of high-interest savings account is your best bet, rather than stocks and shares, which can go down in value as well as up. If you need to raise a set amount of cash in the short term you can’t afford to take risks. Instead, opt for low-risk investments so that you end up with enough cash to enable you to achieve your goals.

If you want to raise a sum of money for use in 10 or 15 years’ time or more, you need to invest for the long term. You may want to raise cash to pay for your children’s school fees or cash to put towards your pension. You can afford to take on more risk if you don’t need the money for a few years. The idea is that you have longer to ride out the ups and downs of the stock market.

Riskier investments should generate greater returns in the long run, but make sure that you don’t need to get your hands on the cash in the short term and that you aren’t investing cash you can’t afford to lose.

Assessing how much risk you’re happy with

A crucial factor to finding the right investments to suit you is how much risk you’re willing to take on.

You can afford to take on more risk the longer you can allow your money to stay invested. As you near retirement, or need to get hold of your cash, you should switch to less risky investments so you have less chance of losing your money.

Planning for retirement

One of the main reasons people invest is to ensure they have enough income in retirement. You can’t rely on the state to provide a generous enough pension – you have to make your own provision.

A pension is one way of generating retirement income, but not the only one. Diversifying and spreading your risk across a broad range of investments is always a sensible idea.

Pensions come with excellent tax breaks (see Chapter 15 for details) but they are inflexible. If you tie up all your spare cash in a pension, and need some money in an emergency before you reach retirement age, you may not be able to get hold of it.

A sensible approach is to combine pensions with property, individual savings accounts (ISAs), and other investments to build a broad portfolio of products to provide you with an income in retirement. That way you won’t put all your eggs in one basket but will expose yourself to a diverse range of products.

Taking Advantage of the Tax Breaks on Saving and Investing

Never look a gift horse in the mouth, particularly when it comes to savings and investments. You have to pay enough tax to the Government without paying more than you need to. You can save tax on your investment returns – completely legitimately – by opting for tax-free products.

If you don’t pay income tax as a general rule, you don’t have to pay tax on your savings. Ensure your savings account provider knows this by filling out form IR85 – available from your bank or building society, or HM Revenue & Customs ().

If you do pay tax, opt for tax-free investments where possible, such as individual savings accounts (ISAs). These enable you to invest in cash or equities up to a maximum of £7,200 each tax year (6 April to 5 April the following year).

Other tax-free investments, such as those offered by National Savings and Investments, are available. But the rates on these aren’t always the most competitive (Chapter 10 has more on these) so don’t be blinded by the tax-free benefits.

Choosing an investment simply because returns are tax free isn’t wise, and may not suit your attitude to risk or your investment aims, or fit in with the other products in your portfolio. Consider each investment as part of the wider picture and you minimise your chances of opting for the wrong product.

Using a Financial Adviser

One of the easiest ways to choose the right investments for you is to use an independent financial adviser (IFA). I advise opting for one who is totally independent and can recommend you any product on the market, rather than a salesperson who is restricted to a limited range of investment products.

You don’t always need a financial adviser. If you opt for simple products, such as a savings account, credit card, or personal loan, you should be able to choose one yourself. Do your research beforehand and opt for a product only if you understand exactly how much that product is going to cost you in the long term.

If you’re an experienced investor, you may not need advice either. But most people could always use a bit of advice, so paying a bit of cash to ensure you get the best investment may be worthwhile, and could save you money in the long run. (Go to Chapter 2 for more on choosing an IFA.)