We all want to save and invest more. While inflation has come down and the economic outlook has improved, some are still feeling the pinch and it may feel like you’re losing control rather than taking control.
There are steps we can all take to get us back on financial track though. Here, we’ll show you some of the actions you can take, such as creating a budget that works for you, making the most of opportunities to boost your savings and paying down high-interest debt. This is the first of our three steps towards long-term financial success.
1. Create a budget that works for you
An effective budget is one you can stick to and helps you to see where you’re spending money. List all your essential monthly costs; everything from your mortgage, food and utility bills to your council tax, home/car insurance and childcare. This helps to identify where you can save money, even if it’s only a small amount like cancelling a subscription that you don’t really need.
Once you know your day-to-day needs, you can see whether to focus on controlling your spending, or whether you have capacity to achieve other financial goals. This might include setting up emergency or contingency funds, for example, or thinking about any unmet insurance or investment goals.
2. Make the most of your employer’s pension contributions
More than a third of UK employees work for an organisation that offers more than the minimum 3% contribution1 to their workplace pensions, with a third of UK employers matching their employees’ contributions in full2, up to a certain limit. Even though extra employer contributions are effectively free money, many people fail to make the most of them.
By taking full advantage of employer matching, you can make a big difference to your long-term finances, effectively doubling your pot in some scenarios.
Our chart below shows three scenarios where an employer pays an unconditional 8% of the employee’s salary into a pension (meaning it is paid irrespective of whether the employee makes a contribution) and will also match any further contributions from the employee. In the first scenario, the employer pays 8% but the employee doesn’t make any contributions, so there is no matching. The second and third scenarios show the employee contributing 2% of salary and 4% of salary respectively, which are in both cases, matched by the employer.
The figures assume annual investment returns of 6% and an employee salary of £40,000 (which increases by 3% each year). No allowances have been made for investment platform fees and taxes.
Employer matching pays off
Source: Vanguard calculations. This hypothetical scenario is for illustration purposes only and doesn’t represent a particular investment or its expected returns. Assumes annual returns of 6% per annum, while monthly returns are assumed to be the geometric averages of these values. Input figures are based on an annual starting salary of £40,000 increasing at 3% per year, over a period of 30 years.
As you can see, an employee gets a pension two times larger when they contribute an additional 4% of their salary compared to contributing nothing at all. A relatively modest additional contribution of 2% of salary results in a pension worth 50% more than under the smallest contributions. Next time you get a pay rise, you may want to consider diverting some of it to your pension!
3. Get to grips with your debt
Managing debt should also be a top priority. To begin with, you may want to focus on how you can meet the minimum payments on your debts. This will help to ensure that you don’t rack up any unnecessary charges and improve your credit score. You can often set up a direct debt to automate this process for you.
Try to tackle debts with the highest interest rate first. The power of compounding – where interest is added to a loan, the loan balance builds and the provider charges you interest on your interest – can work against you over time, with debt snowballing and becoming ever larger.
It rarely makes sense to invest before you pay down high-cost credit card debt. The chart below shows what we expect global shares and bond markets to return each year for the next decade and compares that to a typical annual interest rate on a credit card. As you can see, the credit card rate is much higher!
Beware high credit costs! You’ll face more in interest costs than you can hope to make investing
Source: Vanguard calculations. Comparison between the median 10-year Vanguard Capital Markets Model (VCMM) projected annualised investment return distributions, with common consumer debt interest rates (Annual Percentage Yield APY). Credit card at 22.2% is a hypothetical example and is not meant to reflect a true cost of lending.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Distribution of return outcomes (in GBP) from the VCMM are derived from 10,000 simulations for each modelled asset class as at November 2023.
Having taken care of higher-interest debts, you can then decide whether to pay off lower-interest debts such as overpayments on your mortgage. You may be able to take advantage of tax incentives when investing or achieve a better return than from paying down debt. However, some people simply have an aversion to debt and want to pay it off quickly.
In the next piece in our series, we’ll be looking at how to prepare for the unexpected.
Things to consider to help you take control of your finances
1. Create a budget that works for you
2. Make the most of your employer’s pension contributions
a. Find out the details of how much your employer will pay in
b. Make room in your budget to contribute to your pension
3. Get to grips with your debt
a. Find out the minimum payments on all your debts
b. Set up payment reminders or consider automating the minimum payment on your debts
c. Rank the interest rates of all your debts
d. Allocate money towards paying down high-cost debt
e. Take advantage of one-time windfalls such as tax refunds and bonuses to pay down high-interest debt
1 Since April 2019, UK employers have had to pay a minimum of 3% of an employee’s salary above £10,000 into a workplace pension scheme. The employee pays 4%, with an additional 1% coming from the government as tax relief, giving a total contribution of 8%.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include US and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, US money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
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The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
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