Whether you want to make the most of the money you already have or look at ways of reducing what you’re spending — including your tax liability — doing a small amount of research and any necessary follow up could be just the ticket for maintaining, or even improving, your financial health. This week, in the second of two Your Financial Future guides, we look at how to get your savings working for you, the potential payback of investing in your own home, whether it pays to get married, and the importance of having a financial plan.
Let’s say you have a decent amount of cash accumulated in your bank account since the pandemic and, despite price increases, you are in the fortunate position not to have to tap into it for day-to-day expenses. At the same time you are concerned about inflation, and everything you read tells you that cash sitting in a bank account is being eroded in value day after day. What to do? There are a number of directions in which you could send your savings, but you will need to get your priorities straight first.
Nick Charalambous, managing director at Alpha Wealth, is very clear about what should be the first item on your list if you have cash reserves. “Pay off any nonmortgage debt you may have, particularly credit cards,” he says.
Most advisers will tell you precisely the same thing: debt (apart from mortgages) should be the first thing you tackle. After that, says Ralph Benson, cofounder and head of financial advice at Moneycube, the next step for most should be to put some rainy-day savings aside. Next, maximise pension contributions, and then invest. But this list — and the order in which you approach it — won’t be the same for everyone.
“It depends on your situation,” Benson says. “For example, I often tell young doctors they can sort their pension later, given their earnings profile, and saving for a house might be more sensible.”
When it comes to cash in the bank, Paddy McGettigan, director of McGettigan Financial Planning, says it helps to think in terms of purchasing power rather than just an amount.
“Many people look at money on deposit as a ‘balance sheet’ figure,” he says. “So if you have €100 on deposit you think €100 will always be there for you.”
He says thinking in terms of what your money can buy makes what appears to be a safe place seem anything but.
“Current inflation is about 8.7 per cent,” he says. “If that is maintained, money on deposit will have nearly 9 per cent less purchasing power in a year’s time.”
Even going on the average historical rate of 4.3 per cent, as the effects of the inflation accumulate, after a decade the purchasing power of your money will be significantly reduced. This, says McGettigan, makes cash a far riskier proposition than many realise. He contrasts it with equity investments, which might be expected to return, on average, about 8 per cent.
“While in the short term equities are considered risky, if you look at the long term and at purchasing power, they are actually safer,” he says.
A RAINY DAY
Advisers will tell you to keep a certain amount of your cash easily accessible for emergencies. This is even more crucial in uncertain times, notes Benson.
“Essentially, you need enough so that you’re not forced to sell investments at the wrong time to fund unexpected costs,” he says. “And you need enough to pay yourself for a few months in case you need to find a new job. That differs depending on your work; if you’re in the gig economy you’d be wise to keep more spare funds than, say, a public servant.”
Charalambous says how much you should put by depends on various factors such as how secure your job is, whether you have benefits such as sick pay, and whether there are two incomes coming into the household.
As a guide, however, McGettigan recommends putting aside six months’ net income. “Anything more is excessive unless there are specific short-term cash requirements such as a house extension,” he adds.
If you will need cash in the short term for the likes of a refurbishment, you’ll have no option but to keep it accessible in your bank account. However, for more medium-term savings such as, for example, children’s third-level education, Charalambous suggests looking at life assurance savings plans.
In terms of tax relief, paying into a pension is by some way the best deal out there; for those paying the higher rate of income tax, every €100 they pay in only costs them €60.
“That is equivalent to a 66 per cent return on investment,” Charalambous says, “plus your investment gets to grow tax-free.”
Benson recommends taking a look at your December 2021 payslip to see if there is scope to save tax by topping up with a lump sum before the tax deadline at the end of this month.
After that, assuming you can afford it, you could increase your monthly contribution in order to maximise your tax savings. Upping your regular contributions — as opposed to making ad hoc larger top-ups — should reduce your investment risk through what’s termed “euro cost averaging”.
However, depending on your circumstances, there may be better ways to divert your cash than paying into a pension — tax saving or no.
“It depends what you’re saving for,” Benson says. “A pension you can use in a few decades’ time is irrelevant if you’re saving for a house deposit.”
According to Benson, while you shouldn’t eschew investing during a recession — especially one where inflation is so high — there are some considerations to bear in mind. The first is that you will face short-term ups and downs. “You can only call the bottom of a market in hindsight, so make a plan to invest and stick to it over the medium term, rather than checking it daily,” he says.
Meanwhile, he notes, as with pension contributions, drip-feeding a lump sum in over a longer period can be a good way to smooth out the cost at which you invest. “In general, financial markets anticipate future economic conditions, so if you have a strong stomach, investing when the mood is gloomy can be profitable.
“Finally, tempting as it may be to pay a chunk off your mortgage, the general advice is that this be well down your list. “Ensure you are on the lowest rate possible,” Charalambous says, “but given current rates, the other areas make more financial sense at the moment.”