Making a couple of good financial decisions early can make the goals of owning your own home and having a decent retirement fund feasible
Want to have a comfortable financial future? Don’t want to be broke and still renting when you’re 68? Don’t despair – the power is in your hands.
Last week, we showed how it has always been difficult to buy a house, and it is no different for the current generation than it was for their parents. But making a couple of good financial decisions in your twenties and early thirties can make the long-term financial goals of owning your own home and having a decent retirement fund feasible.
You may argue that you simply can’t afford to save anything, but you’ll only be half right. Ask anyone struggling to trade up, or even buy their first property, with three small children and exorbitant childcare fees and retirement lurching ever closer; you may never have as much disposable income as you do in your twenties/thirties (shocking but true). So make the most of it.
1: Save, save… and save some more
Call it an emergency or a rainy day fund; call it your “holiday” account, or savings for a house. Whatever you call it doesn’t matter, just open that savings account. Having substantial savings behind you doesn’t just offer you comfort, it also gives you options.
If you’re looking to change career, buy a house, or just take some time out of the workforce, having a little nest egg you can rely will help you fund that life decision.
“I don’t believe people in their twenties do enough of it,” says Jonathan Sheehan of Compass Private Wealth, his belief being that you should redirect 20-25 per cent of your net earnings into savings.
As a recent survey from Standard Life showed, of about 1,000 people surveyed, 44 per cent said that they should have started earlier and saved more for their future.
It might hurt at first, but once you are used to it, you won’t notice the difference. Apply the principle of “pay yourself first”. This means that you don’t put whatever you have left over each month into a savings account. Instead, set up a direct debit and put the money into your savings account first.
And every time you get a pay rise, or money back after a budget change, increase the amount you save. As financial adviser Eoin McGee, of Prosperous Financial Planning, notes, your lifestyle will expand to fill the amount of money you’re willing to spend – so don’t let it expand.
If you start saving €100 a month when you’re 23, by the time you’re 40 you’ll have a nest egg of €22,226 to fall back on – and that’s only based on an annual return of 1 per cent and no change to the amount you save. Wait until you’re 30 to start and you’ll only have €12,614 built up.
Compounding, whereby the interest you earn on your savings in turn generates more interest, can have a dramatic impact on your savings.
You can also potentially take on more risk and chase better returns. If you start saving just €1,200 a year, for example, or €100 per month, at the age of 25, by the time you’re 65 you’ll have a nice little nest egg built up of €185,700 if you can obtain – and sustain – a return of 6 per cent a year.
But if you leave it until you’re 35 to open this savings account, you’ll only end up with a nest egg of €94,800. Think about it; if you start 10 years early you’ll double your money. And that’s not some crazy promise from an investment adviser, that’s just simple maths.
If you’re thinking of buying a house at some point in the future, your twenties is a good time to – pardon the pun – lay the foundations. “A bank or lender will always look more favourably on a borrower showing early discipline of saving,” says Sheehan.
McGee warns that if you’re serious about buying a property, you need to start saving early,unless you’re going to be the recipient of a gift from family.
“If you don’t start saving at 21, you’re not buying a house in your twenties in Dublin,” says McGee.
Recent figures from the Central Bank showed that it takes an average earner about four years to save for a deposit of about €47,000 in Dublin, while those outside the capital will reach their goal in about 18 months in other urban areas such as Cork and Galway, or as little as seven months in rural areas in Connacht.
McGee, however, doesn’t buy the figures; he thinks it will actually take much longer. “The average person in Dublin wanting to buy the average house will have to save for nine years in order to achieve enough of a deposit to buy a house,” he says. “It’s a big problem.”
And don’t be tempted to blow all your savings on a deposit. Remember to keep something back for your rainy day fund.
“People tend to spend all their money on deposit, and borrow a few quid to buy the couch, but it leaves them completely wiped out afterwards,” says McGee.
2: Start thinking about retirement
It’s hard to think about how your life will be in 30 or 40 years’ time; but the problem is that if you don’t think about it all, it may well be penurious. Ask your parents, who may well be facing into retirement with less relish than they may once have done – and less relish than their own parents once did – given the move away from defined benefit to defined contribution schemes, where the onus is on the individual rather than the company to provide for their retirement.
But as with saving, if you start early enough, “compounding” can also work magic on your savings for retirement. And don’t say you can’t afford it; most people can afford to save something, however small.
Consider the example of someone starting to save. If you’re aged 30 and you give up a daily latte at a cost of, let’s say, €3.50, you will save more than €1,200 a year.
If you were to put this money into a pension fund, and benefit from higher rate tax relief on it, you would have a pension fund of about €250,000 in retirement – just from this little latte alone. If you waited until you were 40, however, to forgo this daily treat, your fund would be worth much less, at about €121,000. Now might be time to swap to those Nespresso – or Lidl – capsules.
Sometimes you might be sitting on substantial pension benefits without even realising. Does your employer, for example, offer to match what you put into your pension, up to certain limit?
“It’s incredible, the number of clients who come in and say they were offered a pension but they never really looked at it, or they’ll say ‘But I have to contribute to get their contribution’. It just doesn’t make sense,” says McGee.
3: Don’t take on too much debt
A fancy car (or indeed any car); a trip around the world (or just to Belfast); shopping in New York (or Kildare Village); glamping at the Electric Picnic (or even camping in Clare), the temptations to spend on experiences may be many while you still have youth on your side. But the key is not to get into debt while doing so.
“People often find themselves in their late twenties with a whole pile of debt and they didn’t really realise what they were getting into. So they spend their thirties getting themselves out of that debt rather than putting money into a pension,” says McGee.
Debt costs, and if you’re paying interest on loans, it means you’re spending money that could be going towards your savings or your retirement.
“Certain types of debt are a lot more expensive than others. I’d completely discourage anyone from taking on unnecessary credit card debt,” advises Sheehan. For instance, if you rack up a debt of €5,000 on AIB’s “Be” credit card at an interest rate of 16.8 per cent, paying back 3 per cent or €150 a month, it will you take you four years to repay the loan – years when you could have been saving this €150 a month. And the total cost of that €5,000 will in fact be €6,782. That’s an additional €1,782 that you could have put towards a deposit on a house.
But while credit card debt is expensive, it doesn’t mean that you shouldn’t have a credit card – you should just use it if you can pay it back in full each month. Otherwise, it should be used only in an emergency.
“Have a friendly credit union or credit card to hand, something you can go to in case of an emergency,” advises McGee. “Make sure you have a credit facility open to you somewhere.”
In this respect, McGee recommends joining a credit union, taking out a small loan and paying it back, so you’ll have a good credit history if a problem arises and you need access to money in a hurry.
4: Create a budget … and live within your means
McGee bemoans the ease with which we can spend our money today; contactless payments, one-click purchases on Amazon, the imminent arrival of the likes of Apple Pay.
“I think what people aren’t doing enough of, is to analyse their income and expenditure,” says Sheehan. “It is so unbelievably powerful to see where your money is going.”
Millennials should be more proficient than most at using a budgeting app to itemise their spending. Once that’s done, you can break it down into three categories:
1) What you have to pay – ESB bill, rent;
2) “Essential” spending – that is, what’s essential to you, be that Sky Sports, the gym or highlights in your hair every two months;
3) discretionary spending.
It’s in the third category where you can probably apply the most swingeing of cuts.
Once it’s done, Sheehan recommends you revisit it every three-six months.
5: Wise up
In an ideal world, people would learn to manage their money before they had any – in school.
“I actually think this is where we really fail people,” says McGee, who suggests that there should be a module in transition year teaching young people about personal finance. It means that the first financial transaction many people will make in Ireland is likely to be borrowing money – be it for a holiday, student fees or a car.
“The first motivating thing is to borrow money for something,” says McGee.
In Australia on the other hand, compulsory pensions mean that, once people enter the workforce, they’re saving for their retirement without even realising it, so their first engagement is to save money rather than borrow. It can lead to a different mindset.
But your twenties can be a good time to play catch up, and start understanding all those terms that are so important but can confuse people: APR; AVC; LTV; LTI; CGT. It’s also important to consider what you’re losing in your pay check each month – and how you might be able to claim back some of it via tax reliefs such as those available on health insurance; medical costs and renting out a room in your house. So watch the budget, read the paper and listen to trusted family and friends.
Your twenties can also be a good time to start investing. McGee suggests an “averaging in” approach, whereby you allocate a certain amount each month to an investment fund. It can be a much less riskier approach than putting all your money into the market in one go, as you’re buying at different prices each month which means your portfolio has a better chance of smoothing out the ups and downs of equity prices.