So you have £25,000 saved, what options should you consider?
With interest rates still low, if you’re a saver then what should you do with your hard-earned money?
Suppose you’ve got a lump sum of £25,000 saved, and you’re a homeowner. Assuming you’ve got an emergency reserve of cash put aside and no unsecured debts, there are a few different options for you to make the most of your money.
Pay down your mortgage
It may not be immediately apparent when interest rates are so low, but by paying down your mortgage, you get a guaranteed return.
Even if you’re paying as little as 1.5% interest on your mortgage, by the time you add on the fees and tax you may pay if you invested the money instead that figure could go up to around 3%. You may well be better off paying down and getting the guaranteed long-term return.
With that said, it’s not usually seen as the exciting choice!
Invest in the markets
The average world stock market returns in recent years are around 9% annually. Even after a 1% fee on a tracker fund, if you hold your money in a stocks and shares ISA then you might think it’s obvious what you should do with your money.
But since 2008 we’ve been in a strong bull (or rising) market. While an imminent crash isn’t predicted, the markets do go in cycles.
You should only put your money into the markets if you’re happy to leave it there for at least five years, and preferably seven or more, to ride out the inevitable peaks and troughs.
If the £25,000 represents your only savings, you might want to consider splitting it. If so, I like to use a 40/40/20 rule of thumb: 40% goes towards mortgage overpayments; 40% is invested in the markets; and 20% is for you, for the here and now.
Think of the last 20% as investing in yourself. You could learn new skills or training to earn more money in the future, or you could take a fantastic holiday and much needed break. As long as you don’t take out debt to cover any extra costs, it’s important to enjoy the here and now as well as plan ahead.
If you’re not a homeowner or have already paid off your mortgage, then you could choose to simply invest 80% of your lump sum instead.
How to invest?
There are various wrappers available – ways to hold shares – when you’re investing. Which one is right for you?
- If you don’t need or want to access your money until you reach retirement age (currently 55 years old), then you should normally use a pension to invest.
- If you want your money sooner, consider an ISA, which is very tax-efficient but has a £20,000 annual cap that you can put in.
- If you’re saving for a home, look into a LISA, a Lifetime ISA, which can give you a 25% bonus on your money.
If you have more money to invest than your annual ISA limit, you should use a general investment account. This is a wrapper which has no limit on how much you can put in, but any gains you make over the capital gains tax allowance (£12,000 in the current financial year) are taxed when you realise them, usually at 10% or 20% depending on your income tax band.
A financial planner can advise you on moving money from your general investment account to an ISA each year, to make sure you’re maximising your tax-free savings.
Risk vs reward
Investments can offer different returns depending on your tolerance to risk. The more market exposure you have, the greater the potential returns – but the greater the volatility too.
When stock markets crash, they usually go down by around 50% before recovering. If you put your money into a stocks and shares ISA with 100% market exposure and the value of it fell by half, how would you feel?
By controlling your exposure to the markets, you control the risk you’re taking. Different funds offer different market exposure levels, so consider your tolerance for risk carefully.
Investing is about having the right strategy and the right psychology. Time is an investor’s friend, so when you’ve decide on your risk tolerance you should let things take their course and enjoy the ride!