The Miracle Of Compound Returns
The first step towards wealth is sorting out your finances, and the first step towards sorting out your finances is understanding the miracle of compound returns. Basically, this is about interest, and how earning a slightly higher rate of interest can make a massive difference to the amount of money you end up with in the long run. How does it work, you ask? Like this:
- You earn some interest
- Next year, you earn interest on that interest
- The year after, you earn interest on the interest on the interest
- The year after that... and so on...
With compound returns, interest earned is put into the pot, rather than set aside, which means the pot keeps getting bigger. The bigger the pot of money, the more interest the money earns... and the more interest that gets put back in. Over the long term, this can really add up!
Compound returns are driven by two factors: rate and time.
Rate
More than anything else, interest rates determine how quickly and how much your savings grow. The higher the rate at which you invest, the more - and the faster - your savings will grow, which is why you should make every effort to get the highest possible rate. How much does one percent point really matter? You tell us:
| Investment value at these interest rates | ||||
|---|---|---|---|---|
| 1% | 3% | 5% | 7.5% | |
| Age 20 | 0 | 0 | 0 | 0 |
| Age 30 | £12,626 | £14,009 | £15,598 | £17,904 |
| Age 40 | £26,578 | £32,912 | £41,275 | £55,719 |
| Age 50 | £41,998 | £58,419 | £83,573 | £135,587 |
| Age 60 | £59,038 | £92,837 | £153,238 | £304,272 |
Even small differences in the rate of return have a huge impact on the amount of interest earned in later years. The two percent points between the 3% account and the 5% account yield a difference of over £60,000 after thirty years of saving - that's over £30,000 a percent point! Kind of makes it worth it to shop around for the right account, doesn't it?
Time
Another major factor in the growth of an investment is time - how long your investment appreciates interest. As a rule, the longer your investment sits around and gathers interest, the better:
| Age started saving | |||||
|---|---|---|---|---|---|
| 20 | 30 | 35 | 40 | ||
| Value of savings at different ages | 30 | £15,598 | £0 | £0 | £0 |
| 35 | £27,188 | £6,962 | £0 | £0 | |
| 40 | £41,275 | £15,598 | £6,962 | £0 | |
| 50 | £83,573 | £41,275 | £27,188 | £15,598 | |
| 60 | £153,238 | £83,573 | £58,812 | £41,275 | |
What you should learn from this table: the sooner you start investing, the better. What you shouldn't learn from this table: "I'm forty-five years old and I haven't invested a penny! I won't even bother - it's too late!" No, no, NO. While obviously it is better to start early, late-blooming savers still get some time in the sun, we promise. All we're saying is... well, get a move on!
How much should I save?
The short answer: as much as possible. We've used a figure of £100 for our examples, but don't be put off if you can't afford to save as much. Small sums soon build into bigger ones and you can increase the amount you save each year. The trick, as we've said, is to start saving early and invest steadily in order to get the miracle of compound interest working for you.
A final note on smart saving
Locked-in savings vehicles like bonds and term deposits tend to offer the best interest rates. If you're willing to sacrifice temporary access in exchange for a top rate of return, consider locking your money up for a spell to give it a serious chance to grow.
Get Control Of Your Money
Getting control of your money is about spending less than you earn and using the difference to fund savings and investments to get the miracle of compound interest working for you.
You should aim to spend less than you earn each and every month. If you already do this, you're well on your way to gaining control of your money - you just need to get the money you're not spending to start earning interest. Do this by paying yourself first: set up a direct debit into a savings account just after pay day and put that money to work right away so you don't get tempted to spend it elsewhere.
If you don't spend less than you earn, don't worry. Most of us need a little help getting control of our money. In fact, those of us who barely make it from one pay day to the next need to start with basics: budgeting.
Budgeting - the key to a healthy bank balance
Budgeting is neither as scary nor onerous as it sounds. To start, make a list of your regular bills and how much they cost you each month. This should give you a good idea of your main areas of expenditure. If you're not sure where your money's going, keep a spending diary: for one month, make a note of everything you spend, even if it's 40p for a chocolate bar. At the end of the month, tot it all up to see how much you spend and where you spend it.
Once you know your outgoings, it's time to start trimming them. Often there's no need to cut back on the things you enjoy, but rather to get better value for money for the stuff you have to get anyway. If you're spending far in excess of your income, you will need to take more drastic steps, but for most of people, a trim should do it.
Trimming the fat - the same products for less money
Start trimming your outgoings by reducing one major bill each month, prioritising the bills you pay on a regular basis, as with these, one phone call could lead to sustained savings. Most people can save hundreds of pounds, if not more, just by making a couple of switches. You shouldn't have to look too hard, either...
- Financial products
Changing your mortgage, savings account or credit card is often one of the easiest ways to generate some surplus cash. - Energy
One of the biggest expenses most of us have, after rent or a mortgage, is energy bills. You can usually get a better deal by switching energy providers - just shop around online. - Getting around
If you're a driver, you can probably save a packet on car insurance by switching to a cheaper provider - just compare online. Women drivers and drivers with clean records can stand to save the most here. Comparing online will also yield savings on journeys by rail and coach. - Getting away
Fancy a break? However and wherever you're making tracks, you can save at least the price of a meal by shopping around before you buy. With dozens of online resources dedicated to finding the cheapest fare, accommodation, excursions, and breaks, there's just no excuse for paying too much for your holiday fun.
A final note on getting control of your money
Getting control and keeping control are different things, and there's no guarantee you won't fall off the straight and narrow at least once. When this happens, just take stock of why you fell - so you can learn from your tumble - and calmly and proudly climb back on the horse.
Learn The Rules Of The Money Game
Banks and other financial companies are often portrayed as big, ugly beasts that have no interest other than ripping people off. This may be partially true, but don't forget that in comparison you are small, nimble, and perfectly formed. All you need is a little insight into the nature of the beast. Learn what to look for and what to watch out for to ensure you trust your money to only the most respectful of financial partners.
Fair and friendly financial behaviour
- Flexibility
Avoid any loan products that impinge on your financial freedom by tying you in for any amount of time with early repayment charges. The only exceptions to the flexibility rule are products like bonds, which offer you a higher-than-usual rate of return in exchange for locking your money in for a set time. - Low-cost
With financial products, less money for the bank means more money in your pocket. The best way to find the lowest-cost products is to shop around online, but beware of hidden costs: a better rate could end up costing you more if it includes high charges or - heaven forbid! - commission.
Keep an eye out
- Best buys
Banks often reserve their best deals for new customers, so the deal that got you in the door may fade over time. Banks expect you to put up with this - don't. Keep tabs on your money and move it elsewhere if you can get a better deal.
Stop, turn, and run as fast as you can in the opposite direction
- Complexities
If you don't understand how a financial product works, don't touch it. - Bundles
If a company tries to sell you a combination of products in one go, chances are most of the add-ons are overpriced, unnecessary, and only serve to make them money. Don’t bother! - Cross-sells
Many companies grab you with a winning product and then try to sell you a load of tat. Few banks excel across the board; if you need a new product, be prepared to shop around. - Commission
Salespeople often recommend a product because they earn more commission on it. Whenever someone tries to sell you a particular financial product, ask what's in it for them. - Scams
From dubious emails asking for your bank details, to endowments, to pyramid schemes, the cliché stands: if it sounds too be good to be true, it probably is.
Dump Your Debts
These days, being in debt is almost considered normal. The average UK adult has non-mortgage debts of several thousand pounds, and pays interest rates well in excess of 10% on what they owe. While the miracle of compound returns can be a fantastic thing when you're saving, it works in reverse when you're borrowing, which explains why debts often spiral out of control.
Credit cards are a major culprit here. While it's useful for borrowing money, if your card has a high interest rate and you can't afford to pay off much each month, then the credit card company is getting the benefit of compound returns - and who wants that?
Savings vs. debt: the knockout round
A common mistake for well-meaning but misguided savers is to carry debt on the credit card while accumulating savings in the building society. Unless you have a 0% card, these are good intentions, but bad maths: with savings earning, say, 5%, but debts costing 15%, there's a shortfall of 10%. It makes far better sense to use the savings to pay off the debt and start again from scratch with savings that are earning real returns.
Beware the lifelong debt!
It's impossible to overemphasise dangers of debt. Even small, seemingly harmless debts can quickly grow out of control. Take a credit card debt of £1,500. If you're charged 1.5% a month and only ever pay the minimum monthly requirement of 2% of your outstanding balance, this bill will take an astounding 37 years to clear, and at the cost of thousands of pounds of interest!
If you have non-mortgage debts, paying them off should be your top priority. Only once this is done can you really start building up your finances for the future.
Don't panic if your debts are large. The Fool has plenty of advice, and you probably have more rights than you realise if lenders are knocking at your door and your finances are causing you sleepless nights.
Make It Home Sweet Home
Sooner or later, most of us buy a home, which means sooner or later, most of us need a mortgage. As far as borrowing goes, mortgages are considered acceptable debt: mortgage providers are prepared to lend people money at a reasonable rate, and it is usually a far cheaper way of borrowing than almost any other form of debt, because it is secured against a property.
As with all financial products, the one thing we cannot stress enough is the importance of shopping around for the best possible mortgage for your needs.
Repayment mortgages vs. interest-only mortgages
With mortgages, you must pay off the interest on the loan each month, but as for the loan itself, you have a few choices:
- With a repayment mortgage you can pay off the loan gradually: part of the cash you pay each month covers interest on the loan, and the rest pays off a portion of the capital sum you borrowed.
- With an interest-only mortgage, you will have the amount you borrowed outstanding for the whole term, as you only pay off the interest each month - the challenge with this type of mortgage is that at the end of the term you'll need a lump sum to pay off the capital.
Different types of interest rates
Once you decide whether you're going with a repayment mortgage or an interest-only mortgage, the next step is to look at the kind of mortgage you want, which is all about interest rate. Differentiating by the way interest is calculated, the most popular mortgages tend to be variable rate, fixed rate, discount and tracker, capped rate, and offset mortgages:
- Variable rate mortgages are up to your bank or mortgage provider. They set a rate on their own, usually heavily influenced by the Bank of England's base rate, and raise, lower, or freeze this rate as they choose.
- Fixed rate mortgages are fixed for a set time, so you know exactly what to expect. It's a smirk of satisfaction for you if your lender's variable rate rises above your fixed rate, but if it falls, your mortgage provider is laughing all the way to the bank.
- Discount mortgages offer a percentage discount off the lender’s standard variable rate, which means your monthly payments move up and down with the lender's normal variable rate, but you enjoy a discount over a set time. The trick with these is getting a discount mortgage that doesn't lock you in after the discount ends, as you'll want to remortgage as soon as it does.
- Tracker mortgages follow the interest rate of an independent body, usually the base rate set by the Bank of England: when the base rate changes, the tracker mortgage changes automatically. Interest rates on tracker mortgages are usually set at the base rate plus or minus anything between 0.5% and 2%.
- Capped rate mortgages ensure there is a ceiling to the interest rate you will pay over a given period of time. As with fixed rate mortgages, if your lender's variable rate rises above the capped rate, you benefit, but unlike as with fixed rate mortgages, if it falls below the capped rate, you pay what everyone else pays. The downside of capped rate mortgages is that they tend to have higher interest rates than fixed rate mortgages - the price of enjoying a fixed upper limit on your mortgage payments.
- Offset mortgages allow you to contribute your savings towards your mortgage, without losing access to the funds themselves. The more you have in your savings account, the less interest you have to pay on your mortgage, which helps you repay your mortgage faster and more cheaply. Offset mortgages tend to be best for people with volatile incomes or significant savings.
Buying to let
Buying to let is a popular investment option, but from a mortgage perspective, being a landlord requires a bit more planning than your average homeowning situation. If you need a loan to fund the purchase, you will need a buy to let mortgage. These are designed to give more favourable and flexible terms, with the main difference being that most lenders won't just take your salary into account, but will include potential rental income from the property when assessing loan eligibility.
Foolish tips for mortgage holders
Whatever your mortgage, remortgage! Most lenders reserve their best deals for new customers, which means you can often get a better deal by remortgaging every few years. While remortgaging can take some time, with rates for new mortgages up to two percentage points lower than the typical standard variable rate, remortgaging could save you hundreds of pounds a year.
Overpay your mortgage each month. If you can do it without penalty, overpaying even £50 a month could save you thousands of pounds in interest in the long term and take years off the term of your mortgage, bringing forward the day when you own your home outright.
A final note on mortgages
Be a savvy mortgage shopper! Look at the Annual Percentage Rate (APR - also known as the overall cost for comparison), how often interest is calculated (daily is better than monthly and monthly is better than annually), how long any early repayment charges will keep you locked in for, and if you can overpay without incurring penalties.
Retire When You Want To
The key to a happy retirement is having enough money to make the golden years count.The alternatives are grim either way: working long past the age at which you'd have liked to retire, or subsisting entirely on a diet of Value Baked Beans for the last thirty years of your existence.
The current pensions crisis has come about because people are living longer than in the past but not saving more to compensate. With many of the best company pension schemes shut to new members, or even closing down entirely, and the State Pension predicted to fall in value over the long term, the responsibility has now shifted to us to provide for our own retirement.
What's a Fool to do? Start saving early, and defer tax by starting a personal pension or joining a company plan. With compound interest at work, investments made when you're young can become much more valuable when you're older. Putting aside even a small amount can make all the difference in the world, 30 or 40 or even 50 years down the line, and you can always increase the amount you invest in manageable steps.
Start a personal pension
Personal pension plans are a way for people who don't have access to an occupational pension scheme to defer tax as they save for retirement. Your pension payments usually go into an investment fund, although you can also get Self Invested Personal Pensions (SIPPs) where you get much more control over how your pension fund is invested.
You receive tax relief on the payments you make: for basic rate taxpayers, the Government pays £25 into your pension for every £100 you put in, and for higher rate taxpayers there is an additional £25 of tax relief for every £100 you pay in. On retirement you can take out up to 25% of your pension as a tax-free lump sum, and the rest is basically used to provide you with a taxable income throughout your retirement.
Stakeholder pensions are personal pensions with a few unique features. Firstly, they must meet certain standards set out by the Government. They're penalty-free and they usually cost less than personal pensions if you’re putting in small amounts.
SIPPs, or self-invested personal pensions, are another personal pension option. With a SIPP, you pick the investments yourself, from stocks and shares to income trusts and business properties, and wrap them in the benefits of a pension. For the most part, SIPPs are subject to the same rules and benefits as other pensions, including tax breaks, limits on contributions, and the 25% restriction on the tax-free lump sum.
Join a company scheme
If you have a company pension scheme, it nearly always makes sense to join it, especially when you don't have to make contributions. With your employer putting money in on your behalf, not joining a company scheme is, effectively, refusing free money - and who would do that? Even if you have to contribute to your company pension, opting out is still turning down free money: less than half of the money you ultimately get through a company pension plan actually comes from your pay - most of it comes from your employer and through tax breaks.
If you don't have access to a company pension scheme, don't worry. You will need to save a little bit more, but it's manageable. It makes the most sense to save in a tax-efficient way – usually a personal pension or an ISA (more on these in Step Eight). Note that while you can put more into a pension than you can an ISA, a pension is not as flexible when the time comes to actually get at your money.
A final note on saving for your retirement
Your pension should form the foundation of your retirement savings plan. Build on it with a range of other savings and investment vehicles, from ISAs to funds and shares.
Invest! Seriously, It's Simple
What would you do if we said you were missing out on an investing strategy that, in the long run, has produced returns that far outweigh those offered by a building society? One that outperforms cash in a deposit account or bonds? Well, meet the stock market.
Internet bubble and credit crunch included, over the last 90 years or so, the UK stock market has returned an average annual rate of around 11%, outperforming bonds and cash in a deposit account by around 5% to 6% a year. Although recent falls have shaken many people’s belief in shares they also do pretty well over shorter periods too. For example, over period of five years, the returns from shares have historically beaten cash around 80% of the time. Over ten years, this rises to about 90%, and for twenty-year periods, it's 98%. With odds like that, investing for the long term remains one of best ways of building your wealth.
Investing in the stock market can be financially savvy, simple, and inexpensive.
Investing in the stock market: funds vs. shares
You can invest in the stock market by buying shares in an individual company, or by investing in a fund, which consists of a variety of shares in different companies – sort of like a basket of shares. With shares, as the value of the share itself (a publicly-traded company) goes up or down, the value of your investment does the same. With funds, the value of your investment is tied to the value of the fund, which is reflective of the value of the shares the fund is comprised of. It follows that one share's movement has a smaller impact on the fund as a whole, and thus on you, than it would if you had all your money tied up in that share alone. You do pay a price for the relative stability of funds, and that's the fund management fee – all funds have these.
Perhaps the biggest challenge with the stock market is knowing what to buy, when to buy it and when to sell it. This is where our two stock picking newsletters can help.Dividend Edge is focused on picking high yielding shares, while Champion Shares PRO leans towards digging out bargains about smaller companies. Both are 'real-money portfolios' meaning we have invested a portion of the Fool's cash to demonstrate how each strategy works in practice.
Introducing the index tracker
Individual shares and funds not to your tastes? The index tracker might be your best investment option. An index tracker is a fund that copies one of the main stock market indices (like the FTSE 100, for example) so that by buying into a tracker, you can buy the overall market without having to pick individual shares. The FTSE 100 contains the hundred largest companies on the UK market, with each company weighted according to its market value. This means movements in large, usually more stable companies like BP, GlaxoSmithKline and Vodafone affect the FTSE 100 index much more than smaller companies.
Index trackers charge less than other funds. A good index tracker will cost you 0.5% a year in charges whereas a managed fund, where a fund manager chooses shares for you, will set you back around 1.5% a year, plus an initial charge of 5% for investing your money in the first place.
Our share dealing service
If you’re interested in investing then you’ll want a low-cost share dealing service to keep your trading costs down. This is where The Motley Fool’s Share Dealing service can help. You can buy and sell for just £10 or set up a regular purchase plan for £1.50.
Further reading on investing
As a rule, the longer you invest for, the greater the chance that you'll do well. Investing for the short term, which we would describe as less than five years, is certainly risky. But when you're investing for your retirement you can afford to be a bit more patient.
Keep The Taxman At Bay
Pretty much all the money your earn is subject to some degree of taxation, but you can protect some of it from income tax, Capital Gains Tax (CGT), and inheritance tax. The easiest way to prevent all of your money from falling into the taxman's clutches? Wrap it up in an ISA, pensions, and trusts.
The Individual Savings Account (ISA)
The simplest way to protect your money from income tax and CGT is to hold your savings and investments in an Individual Savings Account, or ISA. An ISA is essentially a tax-proof wrapper for your money: as long as it's tucked inside an ISA, you won't have to pay tax on any income or gains you make from your money.
There are limits to how much you can put in an ISA in each tax year. For the 2011/12 tax year (tax years run from April 6 to April 5) you have a maximum ISA allowance of £10,680. You can invest all of this allowance in shares or funds but only up to £5,340 in cash. So for example, you could put in £5,340 in cash and £5,340 in shares, or you could put the whole £10,680 in shares. The Government has said it plans to raise the ISA limit each year, in line with inflation.
The Motley Fool offers a shares ISA through our Share Dealing service.
ISAs can seem a little complicated and the government tends to tweak the rules for them on a regular basis. They’re well worth investigating though. Many people who have invested in them each and every year since 1999 have built up portfolios worth in excess of £100,000 that are totally protected from the taxman.
If you have an index tracker, you should consider putting it in an ISA. It's a tax-savvy move that won't cost you anything extra, and it could significantly boost your returns in the long run.
Pensions
We talked about pensions in step six, when we looked at retiring. If your employer offers an occupational pension scheme, you're best to take part - as we demonstrated earlier, the contributions your employer will make to your pension fund amount to free money. If you don't have the option of an occupational scheme, you can start a personal pension, a stakeholder pension, or even a self-invested personal pension (SIPP).
All pensions offer relief from income tax, but they work slightly differently than ISAs: if you're a basic-rate taxpayer and you put £200 a month into a pension, the Government will give you tax relief on this amount, boosting your investment to £250 a month. Higher-rate taxpayers are able to claim more tax back - in this example they would be able to claim a further £50 a month back from the taxman via their tax return.
Money within your pension is free to grow without being taxed. However, once you begin to draw your pension, the money you draw from it - your income - is then taxed at that point, although you will be able to withdraw up to 25% of your pension as a tax-free lump sum, if you want to.
Inheritance tax: the taxman's last hurrah
Inheritance tax is the last tax you will ever have to pay, although technically your estate pays it as by the time inheritance tax is to be paid in your name, you will no longer be with us. Here's how it works: your estate is valued at the time of your death, and a certain amount is tax exempt. The balance is then taxed at 40%. Your estate is the aggregate of all property owned as well as any significant transfers of wealth made within seven years of death.
A number of exemptions arise with inheritance tax, including transfers between spouses, gifts to charities, annual gifts, gifts in consideration of marriage, and a lifetime gift. The most effective, but most complex, way to avoid inheritance tax is through the use of trusts - and for this we strongly encourage you to seek the guidance of a solicitor or financial advisor.
A final note on tax and your money
With a little time and effort, ISAs, pensions, and even trusts can save you from paying a fortune in tax. Just remember, the more money you put in and the longer you keep it there, the greater your potential tax savings will be.
Make Your Child A Millionaire
One of the best things you can do for your kids is to show them how money works: how to make money, how to manage it, and how to make it work for them. The best way to do this is to invest for them while they are young, slowly building a solid financial foundation for them to stand on. A lot of people are quick to dismiss this as indulgent behaviour guaranteed to turn out spoilt-rotten sponges, but we urge you to think a little more broadly.
Making your child a millionaireis about ensuring your child is able to enter adulthood without serious financial worries, and with the advantages money can buy, and the kind of financial sense - instilled in them by you - that ensures a healthy relationship with their pennies and pounds for a long time to come. Granted, with inflation and without guaranteed rates of growth, you may not reach a million pounds by the time your children become adults. No matter - by then, they'll be finance-savvy savers and investors themselves, building on the foundation you began.
How to invest for your children
Stock market, stock market, stock market! The long-term return on investment in the UK stock market has been around 11% per annum since 1918. Take a look at what might happen if you invest just £25 each month on your child's behalf, and what might happen if you leave it up to them to start on their own:
| Child's age | Invest £25pm until 21 then stop | Start investing £100pm from age 21 |
|---|---|---|
| 0-21 | £24,064 | £ 0 |
| 21-60 | £1,409,189 | £696,991 |
| Total invested: | £6,300 | £46,800 |
If you put £25 a month into a tracker fund until your child's twenty-first, and the historical return had been achieved, it would then be worth about £24,064. If you hand the fund over and it continues to accrue compound interest, then by the time they reach 60, a total outlay of £6,300 would be worth around £1.4m. However, if you invest £100 a month from age 21 to 60, you’d only end up with half this amount, despite having invested considerably more.
For simplicity, we’ve ignored the impact of tax, charges and inflation here, all of which would take a hefty chunk from these sums. But, even allowing for these, the basic message remains the same and that is the earlier you invest, the easier it is to build a significant pot of wealth.
To help parents prepare for their children's futures, Child Trust Funds were launched for babies born after 31 August 2002. The Government added money at birth and at age 7 and anyone could add a further £1,200 a year and all this money is completely protected from the taxman. Unfortunately, this scheme is now being phased out and won’t apply to children born after December 2010. Existing Child Trust Funds will continue until the child turns 18.
The easiest way to teach your children about finance is to get them involved.Investing money on their behalf is a great place to start, but that's just the beginning. Teach them how money invested sensibly will grow, and how, when the growth is added in, that will also start to grow. Show them how to save by opening a savings account for them, and get them to pay the money in themselves. You could even introduce the idea of buying shares in individual companies.
Protect Your Wealth
Once you've got your finances in order, you need to ensure they stay that way. Life can throw any number of unexpected oddities at you, and the value of financial security in the event that a "what-if" actually happens cannot be overstated. It's dull, it's depressing, it often feels like spending good money on nothing at all, but it's also the only thing protecting you when fate gets nasty: it's insurance.
Protect your income
What happens if I'm hurt or ill and cannot work? To protect yourself and your family against financial hardships brought about by accident, sickness, and unemployment, you're best to invest in income protection insurance, also known as Accident, Sickness, and Unemployment (ASU) cover.
As with all financial products, with ASU cover, you're urged to shop around carefully! Buy it from your mortgage lender and you will typically be charged £5 to £8 per £100 of cover per month for a policy that pays up to twelve monthly benefits during the course of a single claim. Shopping around could reduce this to £3. Also don't forget that on many policies you can't start to claim until you have been without a salary for at least three months (although it does get backdated).
A word of caution: Payment Protection Insurance (PPI), an insurance policy to reduce everyday risks, sounds ideal, but unsavoury industry practices mean that PPI is far less attractive than it should be. If you are considering PPI, try contacting an insurance broker, as most stand-alone policies easily undercut mortgage lenders' premiums. You may find that Income Protection (IP) insurance is worthwhile alternative to PPI.
Protect your mortgage
If you've got a mortgage, you know the warning: your home is at risk of repossession if you are unable to make your mortgage payments (or those on any loan secured against your home). The best way to protect your home and mortgage just in case the unexpected happens is with Mortgage Payment Protection Insurance (MPPI), best bought from a stand-alone lender as opposed to your mortgage broker.
Protect your savings
Thanks to inflation, not all saved money is safe money. Let’s say inflation is running at roughly 2% a year, which means every year, the same things cost 2% more. This means money put in a savings account with 2% interest would actually only be keeping up to the rate of inflation – in effect, not growing.
In fact, if you're a basic-rate taxpayer (paying 20% savings tax), you need to earn 2.5% a year just to keep pace with inflation. Higher-rate taxpayers would need to earn 3.3% a year. To beat inflation, you need to ensure your savings are in an environment with a growth rate strong enough to make a difference over not just over a year, but over the course of five, ten, or twenty years. The best place we can think of? The stock market, of course!
Protect your family
We've looked at everything else that can go wrong, now let's turn our tragic gaze to the big one: death, and what happens to the people you leave behind.
Your ability to earn money is your most valuable possession. If there are people in your life who depend on you financially, you cannot afford not to have some form of life insurance. Here's how it works, in brief: you pay your life insurance broker a monthly premium, and if you die during the life of your policy, your broker gives your dependents an agreed sum of money.
When you buy life insurance, you'll need to consider both the length and the size of the policy. Though the amount of cover you need will vary according to your dependents, at bare minimum you need cover enough to pay off your mortgage and other debts and replace at least some of your income. Realistically, cover of ten times your gross income (your salary before deductions) should leave your dependents debt-free and with a decent standard of living. In terms of policy length, it makes sense to cover yourself until your normal retirement age, usually 60 or 65.
An alternative to life insurance: Family Income Benefit (FIB). If you want to provide your partner or dependants with an income if you die before collecting your pension, FIB is a far cheaper alternative to life insurance. Whereas life insurance gives your family a lump sum, FIB pays them a tax-free income for a defined period. Buying FIB instead of a lump-sum policy could halve your monthly premiums.
A final note on wealth protection
Hopping back aboard the Grim Thought Express, even the savviest of insurance policies won't protect your family from all kinds of hardship if you haven't left your affairs in order. If you have possessions, family, insurance, or even just a parting comment, you absolutely MUST write a will and keep it current.
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