As we embark on a new year, the economic outlook has improved but many are still feeling the pinch and may be anxious about their finances1.
In a challenging environment, it can be easy to feel overwhelmed by your financial situation and unsure how to balance your short- and long-term goals. However, a series of simple, rational steps may help you to feel more in control and improve your sense of financial wellbeing.
Vanguard’s three-step framework can help you to take control of your money, prepare for the unexpected and make progress toward your long-term goals.
What is financial wellbeing?
Financial wellbeing, also known as financial wellness or financial resilience, is a way of assessing you or your family’s financial situation. It is the ability to meet your current and near-term financial obligations as well as being on track to meet your future goals.
It is about more than just money; it is about having financial confidence and feeling in control, which can improve your overall sense of satisfaction.
We know that everyone’s circumstances are different but, just like maintaining a healthy lifestyle, there are core principles that anyone can follow if they want to nurture a better relationship with their finances. So here are our three steps you may wish to consider to help achieve financial wellbeing.
Step 1: Take control of your finances
It may seem obvious but it’s very important to understand your day-to-day spending because how you manage your finances will affect your ability to save and invest. Setting a budget can help in this regard.
When you subtract all your outgoings from your salary, you’ll be left with your disposable income. Many people will be able to save some of this income, but others may need to control their spending first. You may wish to consider going through your bank statements and cancelling any unnecessary direct debits or subscriptions if you need to cut back.
As well as creating a budget that works for you, it’s also important to take advantage of the opportunities to kick-start your long-term savings habits.
Since April 2019, for example, UK employers have had to pay a minimum of 3% of an employee’s salary into their workplace pension scheme. The employee pays an additional 5%, including tax relief2, giving a total of 8%.
However, some employers will match the employee’s contributions if they want – and can afford – to pay in more each month. This is essentially ‘free money’ from the employer and therefore one of the best ways to give your investing a head start.
Alongside creating a budget and taking advantage of workplace pension schemes, paying down high-interest debt is usually a top priority for most households, so budgeting to meet at least the minimum repayments of your household debt is something important to think about. This will help you assess how much of your disposable monthly income you can then save or invest.
For more on taking control of your finances, read our article.
Step 2: Prepare for the unexpected
Uncertainty in life is a given, so it pays to be prepared in case of unexpected expenses, but also in case you suddenly fall ill or lose your job. You should think about maintaining an emergency fund in your instant-access account that is enough to cover one-off expenses such as replacing your boiler. You should also think about how much you might need should you or your partner suffer an income shock, from being made redundant, for example. Three to six months’ worth of income is a good starting point.
It’s also important to make sure your paperwork is up to date. This includes making a will and looking at what power of attorney means should you be unable to take important decisions.
For more on preparing for the unexpected, read our article.
Step 3: Make progress towards your long-term goals
Once you have a solid monthly budget in place and emergency funds, you can start to think about putting your money to good use. For people with a long investment horizon (usually beyond five years), the earlier you start investing the better, because it’s time in the market that counts more than market timing. By increasing your contributions by a few pounds each year, the benefit from compounding will be even greater, over the longer term. Compounding is where you earn a return on your original investment as well as on the returns on that investment.
Where possible, investors should consider taking advantage of the tax breaks available to them, particularly individual savings accounts (ISAs) and self-invested personal pensions (SIPPs). Don’t wait until the end of the tax year to take advantage either. Our research shows that those who invest at the start of the tax year can end up with investment balances twice as large as those who do so at the end of the tax year3.
For more on taking advantage of the available tax breaks, read our article.
1 According to data released by the Office for National Statistics in February 2023, wellbeing was worse for those adults struggling to afford their bills. How are financial pressures affecting people in Great Britain, Office for National Statistics, 22 February 2023.
2 Your employer takes your pension contribution from your pay after deducting tax (and National Insurance contributions). Your pension scheme provider then claims the tax back from the government at the basic rate of 20%, which is added to your pension.
3 Vanguard calculations. Assumes two investors putting the same amount into an account, one at the start of the tax year and one at the end, with the investment period running for 25 years. Investment returns are the same in both instances, with an annual compound growth rate of 5.5%.
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