Less stress, more cash: how to build a financial cushion even if you’re on a tight budget.
If you reach for your credit card whenever an unexpected expense comes up, you’re in good company. According to a poll by the Money Advice Service, 40% of working adults have less than £100 saved up. Meanwhile, those same Brits are, on average, £2,000 in debt.
Shocking, right? But hardly surprising. Credit is convenient, and you don’t pay actual money until later.
But, convenience aside, you shouldn’t have to borrow money in an emergency. Even on a tight budget, you can - and should - start saving money and creating a financial cushion for yourself.
Why should I save regularly?
Firstly, for emergencies. If your car breaks down, or your dog gets ill, you’ll need a good chunk of money up front.
If you pay for everything on credit, your debts can quickly spiral out of control. Besides, living hand to mouth is stressful. You’ll sleep much easier knowing there’s money to fall back on if something comes up.
Secondly, for yourself. Whether you want to take a well-deserved holiday, put down a deposit on a new home or build up a retirement pot, putting money aside is how you’ll get there. If you can save £50 a month for 30 years, you’ll end up with a nest egg of £25,000 — even with an average interest rate of 2%.
How do I start saving?
Saving money is a habit. You need to do it regularly for it to stick. This doesn’t require a ton of effort — you can easily set things up so some of your money is saved automatically every month.
Step 1: Open a savings account
Keeping your savings separate discourages you from dipping in. Plus, most savings accounts pay interest, so you’ll earn money by simply keeping money in the account.
Opening a savings account should be fairly straightforward. The vast majority of banks offer a range of them; and you can usually apply online. It’s also worth looking into current accounts, as they might offer better interest rates.
Step 2: Decide how much you want to save
This all boils down to your personal preference and financial circumstances. Some people say you should save 10% of your earnings, but obviously this isn’t possible for everyone.
At the end of the day, the most important thing is to actually start saving something, even if it’s just £10 a month. You can increase the amount once you’ve built up your habit.
Step 3: Set up a standing order
Once you’ve decided how much to put away each month, set up a standing order. Your money will be transferred automatically, so you won’t be tempted to skip a month or forget about it.
For best results, set the standing order to go out on payday. This is sometimes called ‘paying yourself first’. It helps you start viewing your savings as just another deduction, like your taxes and national insurance.
Once your standing order is set up, you don’t have to do anything.
Where should I save?
Depositing cash in a separate bank account each month is a quick and easy way to start saving. It’s also relatively risk-free, because bank deposits up to £75,000 are protected by the Financial Services Compensation Scheme.
However, bank accounts have downsides too. Interest rates are usually low, or only apply to a relatively small sum. You’ll also have to pay tax on your interest. So, once you’ve racked up a reasonable amount of savings, it makes sense to start looking at alternatives.
Individual Savings Accounts (ISAs)
ISAs are basically savings accounts, but the interest is tax-free. There’s also a limit to how much you can put into an ISA. During the 2016/17 tax year, you can save up to £15,240.
There are two main types of ISA:
- cash ISAs
- stocks and bonds ISAs
As the name suggests, cash ISAs hold your money in cash, just like a traditional savings account.
You can choose between a fixed or variable interest rate. Fixed rates are usually higher. However, your money will be tied up for a set period of time; and you may incur a penalty if you make withdrawals before the term expires.
Stocks and shares ISAs (investment ISAs)
Here, you’re actively investing your money on the stock market. This means you can potentially earn better returns than you would in a cash ISA.
The flipside is that it’s riskier. Your return will depend on how your investment performs. If it doesn’t do well, you may lose your money. It’s also harder to access your money, because it’ll have to be converted back into cash first.
When you buy a bond, you’re lending your money to the issuer for a fixed term. At the end of the term, you’ll get your money back with interest.
Bonds earn higher interest than bank accounts and cash ISAs. They’re also safer than stocks and shares ISAs, because your capital (the initial amount you’ve put up) is guaranteed. That said, you’ll need to invest a minimum amount (usually upwards of £1,000) which will be tied up for the duration of the term. Any interest you earn will also attract tax.
Can I use apps to help me save?
If you need that extra push, there are also apps for that. Apps are a great way to make your saving easy and automatic. Do keep in mind, however, that many of them charge fees.
Here are a few to look out for:
Squirrel Squirrel is like parental control for your bank account. Once you link it to your account, it’ll hold back part of your paycheque for bills and savings. You can create different pots for different savings goals. However, you won’t earn any interest.
PlumC Like Squirrel, Plum connects with your bank account and puts money aside for you. It determines how much to set aside automatically by studying your income, expenses and spending habits. Somewhat creepy, but effective.
While Nutmeg is primarily an investment app, it also offers ISAs. Do bear in mind, though, that it only offers stocks and shares ISAs. These can offer high returns, but they’re also riskier than a bank account, cash ISA or bond.
Always keep a chunk of your savings handy
While it’s all well and good to look out for better returns, you should still keep some savings in a bank account. This will make them readily accessible should you need something extra for a rainy day.
More importantly, don’t put all your eggs in one basket. Dividing your savings amongst different vehicles spreads risk and helps you get the most out of them.