How to manage personal finances and investing

About 2 years ago — 10 min read / Suggest edit on GitHub

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Disclaimer

This is not financial advice. Please consult your financial advisor to associate the risks involved.
I am not a professional advisor, just someone with too much time on their hands on the weekends.

Introduction

🇬🇧 The information found here is primarily focused on UK-based saving and investing but should apply generally also, for some things I will explain further how it relates to the UK specifically.
💰 This is a blog post that will cover the early stages of sorting out your finances, assuming you are starting early on or have not started thinking about saving & investing yet such as:
- Step 1: Budgeting and understanding what you want to achieve
- Step 2: Credit score and credit cards
- Step 3: Understanding tax brackets
- Step 4: Pensions, SIPP and retirement

Step 1 - Budgeting and understanding what you want to achieve

❗️ I highly recommend checking out the UKPersonalFinance flowchart as well as the UKPersonalFinance budgeting guide.

Before you jump too far ahead you have to take some time and think about your income in relation to your expenses, what your goals are and what you really want to achieve.

This can vary quite a lot depending on person to person, so I won’t try to suggest anything too specific.

Once you’ve taken a look at the flowchart you will be able to pinpoint what position you’re in and where your goals should align.

When it comes to budgeting your income, ideally, you will use some sort of budgeting website or spreadsheet to organise your spending.

I prefer a simple way of “pay yourself first” which massively simplifies everything and you don’t need to track everything extensively.

Example:

Savings: 50%
Household/Bills: 20%
Fun: 20%
Food: 5%
Subscriptions / misc: 5%

You can adjust this for yourself, but be wary of lifestyle creep if you are newly coming into a decent salary. Ideally you will not spend more than 30% on rent and save as much as possible until you have a nice emergency fund. From there you can adjust your savings percentage depending on your upcoming savings goals.

This means that when I get paid I move 50% of the income into savings, from there I can mentally set aside the amount I need to pay for bills, and the remaining money is my fun money which I track on my credit card by looking at how much I have spent.

If the credit card balance is reaching the number I have set aside for “fun” money then I have to take a step back and judge if I can really afford what I’m spending my money on.

You could do the same approach but by using a separate bank account or savings pot for spending money, however, a credit card will provide you with cashback, better protection and better customer service, so ideally you will use one, which moves us nicely onto the topic of credit cards and sorting out your credit score 😎.

Step 2 - Credit score and credit cards

I’ll start by saying that credit score in the UK isn’t as important as it is in other countries, but it is still somewhat relevant if you’re looking to buy a house or make a large purchase. As long as you pay all your bills on time, have a decent salary and don’t get into large amounts of debt you will be fine. You can read more about credit score here.

The primary reason that credit score is being mentioned is to get access to better credit cards, for example, the Platinum Cashback Everyday Credit Card will make your spending 1% cheaper, also the offers AMEX users get are typically far better than those offered by regular credit card companies.

The only drawback is if you don’t pay it off in full you’ll have quite high-interest to pay back. This card should be used for everyday spending and you should always pay it off in full every month.

Although, the pay it off in full every month rule applies to any credit card you take out that is not a 0% interest credit card. If you’re able to, you should always pay off your credit card and always avoid debt that has any interest to avoid debt piling up.

There are a few types of credit cards:

Balance transfer cards: More or less a trap to keep you in debt, avoid this like the plague or you may find yourself in a loop of using credit cards to pay off other cards.
0% interest cards: Useful for spreading the cost of a large purchase with 0% interest, should be used with caution and ideally for managing cash flow and not to buy things you can’t really afford.
Reward cards: Your standard credit card, typically they will give you some points or cashback in return for using one, but if you miss a payment you will pay interest on the balance. Best used for monthly spending you’d do anyway.
Credit builder cards: Ideally you won’t need one, but this will be a very low limit card intended to allow you to prove you can pay back regular payments, very very high-interest rates and no rewards.

You should not be afraid of getting a credit card, they have many benefits when used correctly and can help you manage your cash flow, as well as act as a mini emergency fund if you’re in a rough spot. But as with all things, you should make sure you understand exactly how much you’ll have to pay and treat it as if you’re spending money that is in your bank account right now every time you make a purchase using one.

Use credit cards for their cashback, customer service and offers, not because they don’t take the money from your bank account immediately so you can pay it next month as that can lead to overspending.

Step 3 - Understanding tax brackets and higher rate taxes

We can start understanding tax by looking at our payslip and figuring out our income and how we can optimise that before we even start budgeting. This will give us a good base to start from and we’ll know exactly how much money we’ll have each month as well as how retirement will generally look.

You may have heard things such as “40% tax over £50k” and other things that sound scary on the surface.

It is also a common misconception that earning £49,999 could be better than earning £50,001 - that is not how it works, it’s on a sliding scale.

The higher tax brackets actually mean “income over £50,000 is taxed at 40%”.

If you’re in this bracket or higher, you should begin looking at ways to reduce your salary to minimise your tax losses on your income, anything under that salary band is still taxed at 20%.

There are a few ways you can reduce your income in order to lower the amount of higher rate tax you pay, the easiest and best option would be to increase your pension contributions, meaning you can contribute £5000/year to your pension, which will then reduce your salary for £50,000 and all of that income will be taxed at the regular rate.

Example:

Income: £55,000/year. £5000 of that will be taxed at the higher rate of 40%. After NI & Student loans this means ~£1500 will be lost to higher rate taxes on that higher rate income of £5000.

- Annual net income (incl NI): ~£41,130
- Monthly net income: ~£3425
- Amount lost at higher rate tax per year: ~£1,500
- Overall income including pension: ~£41,130

If you were to put 1% annual income (£550) into your pension you would receive £220 of tax relief (40%).

This means we want to keep increasing the percentage we pay into our pension until the tax relief is no longer giving us 40% tax relief.

This is roughly ~7%.

Meaning our new, no longer higher rate tax paying income would look like this:

- Pension 7% (yearly): £3,850
- Pension 20% tax relief: £770
- Pension 40% tax relief: £770
- Total cost of actual pension contributions: £2,310
- Annual net income (incl NI): ~£38,796
- Monthly net income: 3,233
- Amount lost at higher rate tax per year: £0
- Overall income including pension ~£42,646

By doing this our net worth per year is increased by roughly £1500 that we now avoid paying at the higher tax rate. This will only become larger the higher the salary is.

Total cost of actual pension contributions refers to how much we’d need to place into our pension per year to have the government give us back the full £1500 we would otherwise lose.

You can also look into other ways to reduce your income tax if they’re available, such as salary sacrifice schemes (e.g bike to work scheme), which also would lower your national insurance payments.

Higher rate tax relief

When paying into your pension it’s important to check if your pension provider automatically claims at a higher rate or not, a majority of them do not and you may need to do a self-assessment in order to claim back the additional 20% at a higher rate, all pension providers should claim the 20% basic rate.

Step 4 - Pensions, SIPP and retirement

Always auto-enrol into your pension ASAP, you may have to request to be enrolled when you join a new job, they’re legally allowed to delay it up to three months, but must enrol you if you request it. If you don’t do this you could lose out on thousands of pounds.

Check your contract, it should show how much the company will match your pension up to, if not it should display on the website when you log in. You should always match the maximum the company will provide as it is free money.

By now you should have a good idea of what your income is, how much you want to pay per month into your pension and how much you’ll have remaining per month after that thanks to your budget.

How can you get the most out of your pension though? What happens if your current employer has a really bad pension scheme with high fees, such as the UK government NEST pension a lot of people are on?! 😱

That’s where a SIPP can come in to save the day, especially since we’re interested in controlling our own financial future.

A SIPP is a Self-Invested Personal Pension, which does what it says on the tin, you can pick and choose exactly what you want to invest in and you can even gather up your older pensions into your SIPP and control everything yourself from one place.

By using a SIPP you can:

Avoid higher fees
Choose much better funds that match your risk level
Control everything yourself and pick and choose exactly what you want

As an example of how poor some default pensions can be, the government NEST pension has 0.3% fees, underperforms compared to pretty much any other pension, and by default opts you into terrible funds that will leave you losing potentially huge amounts of cash if you don’t pay attention to this!

It is really important that you take some time to look at your pension(s) and move them to the highest risk possible if you’re not closing in on retirement any time soon. The amount of money you can lose by keeping things on their default settings is insane when you factor in compound interest, fees and the risk a fund is taking.

Note: When mentioning a high-risk pension, even the highest risk pensions are still not that risky as they are typically well-diversified funds.

I am at a company using NEST at the moment, so I am only placing the absolute minimum I can into it to get the company match, then the rest goes into a SIPP which also contains my previous company pensions.

I am using Hargreaves Lansdown for my SIPP, I find that HL gives the most options and ability to invest in more or less anything I could possibly want.

Currently, I am primarily choosing Blackrock Consensus 100 which is similar to Vanguard LifeStrategy, a low-cost (0.11%) fund that is medium-high risk but performs well.

This means that when I get paid:

5% goes into my company pension through NEST (minimum contribution)
Company matches 3% (minimum contribution)
£160 goes into my SIPP
HL tops up my personal contribution with an additional 20% (£40) for a total of £200
HMRC gives me a tax relief of 20% on the 5% and £160 contributions each tax year

Onwards to investing

So now we have covered budgeting, credit scores, tax and pensions you should have a nice idea of how much money you’ll have at retirement as well as exactly how you can get there and how to make the most out of your salary. 🥳 🎉