Independent expert Harvey Jones answers a reader's query about saving for their future
“What is the best way to save for my future?”
There’s no single answer to your question unfortunately. Saving for your future is a very personal decision. Your choices depend on personal circumstances such as your age, why you are saving, and the time frame in which you’re saving.
Setting money aside for a specific purpose, such as buying a new car, is very different from saving for your retirement in 20 or 30 years’ time. So let’s look at your options by posing some different scenarios.
You should steer clear of stocks and shares, because although historically they have been likely to perform better than cash investments over long periods (five years or longer), they are not recommended as a short-term investment. If markets fall in that time, you could end up with less money than you started with.
You therefore need to play it safe, by leaving your money on deposit. To maximise your returns, shop around for a market-leading savings rate.
Some banks offer a slightly higher return if you can lock a lump sum away for a while, until you need it. Be warned, though, most fixed-rate bonds have hefty penalties for early withdrawal, and you should never tie up money you may need to get your hands on during the term of the bond.
If you’re a taxpayer, make full use of your annual cash ISA allowance. You can save up to £5,640 in a cash ISA this financial year (up from £5,340 last year), and take all the interest free of income tax. Every little bit helps.
Enjoy your big day!
If you’re willing to take an element of risk, you could put some of your money into stocks and shares. You shouldn’t invest all of your money this way though – there is never any guarantee that stock markets will be higher than they are today.
You could start with a low-risk tracker fund that follows the fortunes of the UK FTSE 100 or FTSE All-Share. As with the previous scenario, most of your investments should be in cash.
One option is to save a lump sum in a fixed-rate savings bond for four or five years. These currently pay up to around five per cent. This looks good now, but bear in mind that when interest rates start to rise – as they must at some point – it may look less attractive and you will still be locked in for several years.
As always when saving, avoid putting all your eggs in one basket. Depending how much you have available to save, you could divide your money between a fixed-rate bond and instant access accounts.
Again, if you’re a taxpayer, make full use of your cash ISA allowance (£5,640). The tax savings over several years could run into hundreds of pounds, greatly boosting your return.
You should consider putting money into a personal pension.
The main attraction of a pension is that you earn tax relief on your contributions. This is at 20 per cent, 40 per cent or 50 per cent, depending on your tax band.
At retirement, everybody can take 25 per cent of their pension as a tax-free cash lump sum. When you convert the remainder into an income, then you pay income tax.
If you are working, check whether your employer has a company pension scheme. Many contribute between three per cent and five per cent of your salary, so if you don’t sign up, you are effectively turning down free money. You may have to match this with contributions from your own pocket, but it’s still a great way to save.
From October 2012, millions of employees will be enrolled on a company pension for the first time, when the new Government-backed auto-enrolment scheme forces employers to set up pension schemes for anybody paying enough to earn tax (the threshold has just increased to £8,105 a year). You contribute four per cent of salary yourself, your employer pays three per cent and the Government adds one per cent tax relief. So, for every £100 you pay into the pension, you get another £100. The scheme isn’t compulsory for you to join, but you should seriously consider it. As well as putting money into a pension, anyone investing for 10 years or more should consider putting money into the stock market. This is because stocks and shares typically outperform cash over the long term, but with plenty of volatility in between. Over such a long period, you have plenty of time to overcome any short-term volatility.
This is also when ISAs come into their own. You can invest this year’s full £10,680 ISA allowance in stocks and shares and take your profits free of income tax and capital gains tax.
Pensions offer tax relief when you pay money in, stocks and shares ISAs when you take it out. A combination of the two is probably the ideal way to save for the long term.
Don’t put all your money into stocks and shares – build a balanced portfolio that also includes cash, bonds and possibly even property, to even out the risk. You might need to take independent financial advice, to assess your attitude to risk and find the right investments for you.
However long you are saving for, always leave the equivalent of three to six months’ salary in an instant access savings account, so you can get your hands on it in an emergency.
- If you have a general financial query or dilemma unrelated to a specific financial services provider, email Harvey at asktheexpert@virginmoney.com.
- Harvey regrets that he cannot answer your questions individually. These are his personal views and not those of Virgin Money. Nothing in the article constitutes legal, financial or other professional advice.
- If you have a specific financial concern, you should always seek your own professional financial advice.
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