How to make financial independence automatic
Helping clients to make the right choices for regular savings and lump sum investment is one of the key roles of financial planners. Making the wrong choices can cause serious financial detriment and this consequence, together with relative complexity over the choices and difficulty in “self-serving” the answers, are the three key components underpinning most needs for advice.
Self-evidently an understanding of the investor’s attitude to risk, fear of loss and time-based financial goals (along with an understanding of all their financial assets) will substantially underpin the choice of investment fund or funds appropriate for the client. As a result of this understanding an appropriate element of risk reduction will be baked into portfolio construction through the development of an asset allocation strategy.
A desire for tax efficiency will also usually be present, or at least it should be. After all, reducing “tax outflow” will enable financial goals to be more easily reached. Tax efficiency will also allow a little more investment risk to be taken with the resulting possibility of more return. Nothing being guaranteed of course – well, not without cost!
In the quest for tax efficiency for the portfolio selected, pensions and ISAs are the recognised “no-brainers”. Once these are “filled up” though (limits reached) then (leaving aside VCT/EIS for the moment) attention will turn to investment bonds and collectives. The tax implications dependent on the underlying portfolio can be material. The changes to dividend taxation, the taxation of interest and capital gains tax all have a role to play – along with charges and how and when they are deducted of course.
As well as advising on investment portfolio and product wrapper choice, though, it seems that we have a job to do to encourage some people to save a bit more in the first place. According to new figures from the Office for National Statistics (ONS), UK households have responded to a tight squeeze on incomes from rising inflation, taxes and falling wages by saving less than at any time in at least 50 years. It seems that only 1.7% of income was left unspent in the first quarter of 2017. This is the lowest savings ratio since comparable records began in 1963.
The UK consumer trend since Brexit seems to have been to borrow and spend – a powerful but worrying combination. Powerful, as it has caused the economy to continue to grow. But, worrying because, as the savings ratio falls, economists and policymakers are likely to be worried about how much consumer spending can contribute to growth in the months ahead. Apparently, over the past 54 years the savings ratio has averaged 9.2% of disposable income. The trend currently, though, is materially declining. In the first quarter of 2016 the savings ratio was 6.1%, already below the long-term average, and it fell to 3.3% by the fourth quarter of the year.
The ONS said that the fall was mostly caused by a rise in taxes on incomes and wealth, which led to a fall in household disposable incomes that was not matched by a corresponding drop in spending.
Part of the rise in taxes was temporary, the ONS said, resulting from high tax payments in early 2017 on dividends paid a year earlier, but it added that not all of the drop was explained by temporary factors.
They say “the underlying trend is for a continued fall in the savings ratio”.
It seems that the Bank of England had expected the savings ratio to rise in the first quarter of the year. In its May inflation report, it thought the drop at the end of 2016 was due to volatile factors and “the headline saving ratio is expected to have risen slightly in the first quarter of 2017”.
Now it may well be that this “low savings” malaise is less likely to be present in the clients of financial planners with whom the planner has a strong and influential relationship. In which case maybe the planner has a strong role to play in helping the client embed a regular savings habit in their children/grandchildren. To do so can, obviously, have really beneficial effects for individuals’ long-term financial security. Establishing the right habits early in life is undeniably a good thing – but eternally difficult in this day and age.
Giving a young individual the gift of financial discipline founded on an acceptance of deferred gratification is one of the greatest things a financial planner can do to enhance intergenerational financial wellbeing for their clients and, ultimately, for themselves by protecting and expanding their client relationships.
We suggest you pay yourself first, it’s the best financial discipline you can have and to make it easier on yourself, make the saving automatic. Saving the first hour of your working day. So if you’re working an 8-hour day save 1 hour or 12.5% of your gross income.
The best place for most people to save this will be an automatic deduction from your pay into your employers workplace pension, so it’s deducted before you even see it!
Allow the money to compound and grow overtime, so you will have a happy retirement.
Happy saving folks!