five steps: step 5 invest in the future

This is the final post in an irregular series on the five steps to solid wealth. Step 1 was spending less than you earn, step 2 was paying off consumer debt, step 3 was to grow an emergency savings account, step 4 was to insure yourself adequately and no more. Step 5 is to invest in the future - this is the step that you don't so much complete as begin and continuously work on.

First of all, I should start by saying that investing in the future means sacrificing money and/or time now in order to have an improved life at a later date. The most important way in which you need to invest for the future is to ensure that you are not reliant on the state to provide you with a comfortable old age. It is true that the state is likely to keep you off the streets by way, but there is unlikely to be enough money around to keep you out of poverty by the rest of society's definition. There are tax-advantaged vehicles that can help you out with this aspect.

Other ways of investing in the future could mean investing in your children's future by putting away some money for university fees or helping them with their first house or car. It could also mean investing money and time in your career by studying for additional qualification or moving to a location that will enable you to have a better salary or quality of life.

In any case, investment considered here is predominantly for the medium to long term. Over this time frame your biggest enemy is inflation and your best defence is a high average rate of return. Both of these are factors due to the magic of compounding, which by the rule of 72, means that an inflation rate of 3% will halve the spending power of your money within 24 years, whereas an average rate of return of 3% will double your money within 24 years. Some simple maths should tell you that a rate of return over inflation is needed to make your money grow and a return under inflation will make your money shring in real terms.

One of the worst ways to invest is therefore is by stuffing money under the mattress, the best ways are those investments that typically beat inflation - generally stocks and property. I favour stocks over property because the start up money required is lower and the rate of return has historically been at least as good as property. Whatever you invest in, the key thing is to be consistent and sensible. Keep an eye on your money, learn about ways of investing and eventually you will achieve solid wealth.

unpaid overtime sucks

Last night I saw an excellent comedian. He was the headline act at my local comedy club, and he was so funny, the compere insisted that he come on to do an encore, and the first thing he said when he came back on stage was "I love unpaid overtime". As I write, I am just finishing up some unpaid overtime at work myself.

The concept that time is money is often bandied about and can be used to justify spending money to save a little time. I like the idea, though, that if I invest a little time, I may gain a more money. Not so much in connection with my job, but the unpaid overtime that my finances seem to demand.

The time that I spend in reading about investments, and monitoring my spending, and opening and closing new accounts, feels a lot like overtime, when all my finances really demand is that I pay all the bills. And it certainly doesn't pay at a nice hourly rate and I don't see an obvious return for my time.

As at work though, the hours that I am spending in unpaid overtime should reap their rewards as long as I don't over do it. Spending time at work to get the thing right within the deadline, makes everyone happy and enhances my skills. Spending time ensuring that my finances are running in top condition, should ensure that I have the best possible chance of having a successful and secure future.

i need a strategy

I wrote here that I think that the best way to decide on which type of pension would suit is to have an overall strategy and then find the provider with the cheapest cost. I also wrote earlier that I have set up my ISAs for this new financial year. So what is my investing strategy?

I basically don't have one. I have invested all my funds in FTSE All Share Trackers. Its not going to be pretty if the UK goes into a 40 year depression. Why have I done this? Well, I don't know anything about how to pick actively managed funds, but I am aware that the majority do not beat the FTSE index. And they are expensive. I can pick up a FTSE Tracker for 0.1% annual fee but many managed funds have fees more like at least 1%. Thats ten times as much. So it looks like to me, index funds are the way to go, certainly for now.

I'm lead to believe that I should diversify my portfolio with asset allocation. I have no idea about this. I have a very small pot in three separate locations, two pension funds and one ISA. I need to investigate whether I would meet the minimums for additional funds or investments. But first, I think I need to work out which funds I might want. But fund names are so unobvious. Take one of the top 150 picks from Mark Dampier's Wealth 150 at Hargreaves Landsdown the Standard Life Global Equity Unconstrained Accumulation Units fund. I'm sorry, how many big words do you need to have in your title?

What I think I need is a bit of money invested outside of the UK. But I'm not sure. I've caught financial paralysis. The easiest thing to do would be to do nothing. But that is bound to lose me money. So I'm doing what I think is the second easiest thing, despite my detractors. I'm investing in something that I understand. Hopefully sometime soon, I'll learn enough to make a more informed strategy.

not a money script: investing

Various members of my family have taught me lots of things about finance, mostly spontaneously or by osmosis, which I have since internalised as a set of scripts about money that I follow by default. Nearly all the money scripts that I have are useful and work well (although it never hurts to revisit their logic).

One of the things that my family didn't teach me about was investing. I am under the impression, rightly or wrongly, that they just don't know that much about it. To be fair, when my parents started work they had final salary pension schemes, and I'm sure they would have assumed that I would get one too. Also, if asked, I'm pretty certain that they would say that saving for retirement is a good thing. But that only goes so far, especially when you are confronted with a list of investment funds for your money purchase pension from which you have to choose when you start your first job.

If I ever have the opportunity to influence young minds (heaven forbid) on the subject of finance, then I'll be sure to plug investments. I'd tell them about index funds (I understand them) and also explain about tax advantages and the power of compound returns, and opportunity risks, and the problems with inflation. I'll try to give them an advantage that I didn't enjoy at their age.

the great ISA stampede

As we draw ever closer to 5th April and the end of the tax year, you'll probably be noticing huge numbers of adverts for ISAs. That's right folks, its the great ISA stampede, when all the fund managers take out double page spreads in The Times encouraging you to invest your unused ISA allowance with them. This is fine and dandy, but if you haven't used your allowance for this year, what should you be looking for?

My first suggestion is to ignore the adverts, other than as a reminder that you need to get cracking. Secondly, think about what goals you have for your savings or investments.

If you are trying to save for a house deposit in the next couple of years, or you want to go to New York on a shopping spree before Christmas, you probably want a savings account. The current best buy for a plain vanilla ISA savings account is with Kent Reliance Building Society - as a bonus they are also pretty consistent with their rates.

On the other hand, if you've got money you can tie up for the medium to long term (think five years or more) an investment account will give you a good chance of getting a higher return. I think there are two key things to consider in choosing.

1. How does this account work?
2. How much will it cost me?

I understand how unit trusts work - they basically collect together a bunch of people's money and invest it in a variety of stockmarket shares, bonds or other investments - so I would consider investing in one of those. In particular I understand how index tracker unit trusts pick investments - they try to mimic the pattern of the index so they invest in shares in the companies that make it up. I think this makes them a good choice for a beginner investor, but as long as you research and understand, anything goes.

Investments are generally not free, I would always look for the cheapest way of buying it. With unit trusts, you will generally pay an initial fee and an annual fee. You should be able get the initial fee discounted to 0%. If you chose to invest in a plain vanilla FTSE tracker, you should be able to get an annual fee of 0.5% or lower. Good providers are Hargreaves Landsdown and Fidelity, but there are others. The key thing to remember is that the lower the fees, for the same investment the better.

switching from stakeholder pension to sipp

As I wrote earlier, I have been considering transferring my stakeholder pension to a self-invested personal pension (SIPP).

My basic investing philosophy at the moment is to put all my equity investments in index tracking funds, so currently I have a stakeholder pension invested entirely in a fund tracking the FTSE All Share index. The whole thing has a management charge of 1%, in common with most stakeholder pensions. The minimum regular payment is £1 per month and the minimum lump sum investment is £100.

The SIPP I am considering switching to is offered by Hargreaves Landsdown. Here I would invest in a different fund tracking the FTSE All Share index. This fund has a management charge of 0.25%, the SIPP itself has no fees associated with it and is touted by money saving expert as the cheapest SIPP on the market (unsurprisingly, as its basically free). The minimum regular payment is £50 per month and the minimum lump sum investment is £1000.

After a little discussion and thought, I decided that there wasn’t a good reason to stick with my stakeholder pension so I sent off for the application form. However, on reading the small print, it would appear that to transfer my stakeholder pension into the new SIPP it needs to have a balance of £5,000. I estimate that it currently has a balance of £3,800.

This leaves me with two choices.

1. Continue paying into stakeholder and transfer when it reaches a balance of £5,000
2. Start the new SIPP, leave the stakeholder where it is and transfer when the stakeholder grows to £5000

To decide which is the better option I got out my trusty spreadsheet tool and did some calculations. I know the amount that I am able to contribute each month to a pension so I used that together with an annual rate of return to calculate which would give me the better result. I assumed that the rate of return would be constant for simplicity and used the following formula to (iteratively) estimate the monthly balance of the pensions.

=(prev month balance + payment)*(1+growth)^(1/12)*(1-charge)^(1/12)

This showed that initially, I would be better off if I started the SIPP straight away. However, continuing with the stakeholder and switching once it reaches £5,000 would make me better off within a couple of months of reaching £5,000 and the difference increased as time went on.

I tried varying the rate of return rate and found that if I set the rate of return higher, there was less of a difference, but with a negative rate of return, the difference was exacerbated (and obviously it would take forever to get enough in the stakeholder to tranfer it).

Taking a leaf out of JLP’s blog to act on the maths, I’ve decided to stick with the stakeholder pension until it reaches £5,000 and then switch. Fortunately if the stock market grows overall, that should take me less than a year and even if there is a net decline, I’ll still be over the £5,000 barrier within two years.

comparison of US and UK investment concepts

401(k) / 403(b) ≡ defined contribution (dc) pension
A 401(k) or 403(b) is basically the same as a defined contribution or money purchase pension offered by an employer. In both cases, if you contribute, typically your employer will also contribute – this is typically referred to as an employer match. Also in both cases there is often a restricted list of funds that you can invest your money in. The main differences in the pension rules set by the respective governments are about how much money can be invested free of tax, when you may withdraw the money and what you must do with it afterwards. Any money you put in these products is invested with pre-tax income and taxable when withdrawn.

tax deductible traditional IRA ≡ personal or stakeholder pension

A tax deductible traditional IRA is basically the same as a personal pension (including stakeholder pensions). In both cases you can invest money with a huge range of providers in a wide variety of funds. There are large differences in the rules about how much money may be invested – personal pensions have significantly more generous rules than IRAs – which is probably why IRAs are not as often recommended as stakeholder pensions are. Any money you put in these products is invested with pre-tax income and taxable when withdrawn.

roth IRA ≡ stocks and shares ISA

Roth IRAs and Stocks and Shares ISAs are similar investments but there are significant differences in the rules in each scheme. In each case, money is invested from taxed income and grows and can be withdrawn tax-free. There is a limit to how much money can be invested each year of several thousand pounds/dollars. In both cases you can invest money with a huge range of providers in a wide variety of funds. The major difference between the two schemes is that money may be withdrawn tax-free from an ISA at any time whereas a Roth IRA has restrictions on tax-free withdrawals.

?? ≡ mini cash ISA

There doesn’t seem to be a comparable investment product to a mini cash ISA which are tax-free savings accounts. I believe the most similar investment would be a Roth IRA invested in a money market account.

S&P 500 ≡ FTSE All-Share
These are the same in the sense that they are stock market indices which track the vast majority of company shares in the respective countries.

Securities and Exchanges Commission (SEC) ≡ Financial Services Authority (FSA)
These are the regulatory bodies for investing in the respective countries. There are differences in the exact areas of finance that they cover.

mutual fund ≡ unit trust or open ended investment company (OEIC)
These are open ended entities into which you may invest. In each case they pool the money of all the investors and use it to buy into other investment products such as shares and bonds.