“Money can’t buy you friends, but it does get you a better class of enemy.”
Spike Milligan (British author and comedian, 1918-2002)
When it comes to money, a lot of people are their own worst enemy.
They fritter away funds. They buy things they don’t need with money they don’t have. In the process, they run up huge debts.
Decades of interest payments… on mortgages, car loans and credit cards… buy fat cat bankers their country mansions and shiny yachts.
I’m guessing that’s not something at the top of your bucket list.
Conspicuous consumption provides only a fleeting thrill. The latest gadget… the new model car… the exotic foreign holiday… often purchased merely to keep up with the proverbial “Joneses” next door.
This kind of behaviour rarely ends well. In fact, it’s the well-trodden path to the poor house.
Poverty is not a pretty thing, especially when people don’t see it coming.
I’ve known at least four affluent, middle class families destroyed by bankruptcy. I’ve known many more who lived beyond their means for decades and retired into grinding poverty.
There’s no reason why you should fall into the same traps.
Of course, you personally may not be at the extreme end of the consumption spectrum. But it’s still highly likely that you could take some simple steps to radically improve your financial situation, and thus your future.
None of this means you have to live badly. It certainly doesn’t mean you have to behave like Ebenezer Scrooge, the miserly character in “A Christmas Carol”, written by Charles Dickens in 1843.
Instead, it’s about living better, with confidence, with control over an essential part of your life… namely, your money.
How do I know this?
Because I’ve done it myself.
Why it’s worth it
About 15 years ago, I decided it was time to really get on top of my own finances. I had a family on the way. Or, as my Dad put it, I now had “responsibilities”. It was time to get serious. I’ve never looked back.
Taking control of your finances isn’t difficult. Admittedly, it takes a little time at first. But it gets easier and easier.
The benefits are substantial. Having strong finances improves your personal freedom. If the price of freedom is just a little of your time, then I’d say it’s time well spent.
This report is dedicated to how to achieve that financial freedom. It consists of four basic steps. I’ll get to those shortly.
But before we step forward into a brighter financial future, let’s briefly step back into the past… and how I’ve come to realise the importance of financial freedom.
When I was growing up in the 1970s and 1980s my parents had friends who seemed to live a lot better than us, at least in material terms. Even a child, as I was then, I could see that plainly.
Most of my friends’ parents had relatively well-paid professional jobs with regular hours. Whereas my Dad had a small agricultural business and worked from dawn ‘til dusk, often seven days a week.
Other families had exotic foreign holidays on sun-drenched beaches. Our family rented a cottage in a damp part of Britain and were marched up rain sodden hills. (Long live the “staycation”!)
They had newer and bigger cars, and new kitchens. My Dad often bought second hand vehicles. Cooking and heating in our kitchen was done with a dirty old coal-fired stove, and the coal was stored on the other side of a muddy garden.
Kids in my schools had a lot more toys than me, and shiny new bicycles (although, to be honest, I was pretty happy sitting up a tree or making swords out of sticks).
I’m not sharing any of this to make myself out as some kind of victim, as is so fashionable these days. On the contrary, I had a great childhood.
Instead, what’s important is that I learnt stark lessons. That’s after I saw what happened to many of those other families down the road.
Quite a few of those same people – who lived large in middle age – ended up with hardly a bean to their name in retirement. They lived beyond their means for decades and spend their last one or two in poverty.
I don’t know about you, but that’s something I’ll do my best to avoid.
When outgoings constantly exceed income, capital is drained and debts are racked up over time. It’s obvious enough, but I’ve seen plenty of people fall into the trap.
The end result is bankruptcy, and all the unpleasant implications of that.
It happens slowly at first, with pressure building up over decades. Then it happens very quickly… as meagre savings are exhausted, or loan interest spirals out of control and everything implodes.
Misery ensues as families and friendships are torn apart.
The victims become wards of the state, relying on government welfare just to eke out an existence. Freedom is a thing of the past.
If you consider yourself middle class then this outcome is totally avoidable. Even people with relatively low incomes could avoid it, although they have a higher mountain to climb.
Look, I understand. Getting on top of your finances doesn’t sound sexy. In fact, it may seem downright boring for a lot of people.
But are you really going to give up in the foggy foothills, at the first sign of effort? Or is it worth pushing upwards, through the clouds, until you savour the fresh air of freedom at the summit?
At times, most worthwhile things can seem like a drag. As a dad, I know that raising young children can be tough. But that’s no excuse to give up on it, and just let things turn out as they may. You have to work on it. And you do work on it, because it’s worth it in the end.
When it comes to facing up to money matters, many people make weak excuses, such as “I’m not good with numbers”. But absolutely anyone can do it if they want to.
We’re adults. We need to act like them. It’s really not that hard.
It’s just about applying yourself to a problem… one that’s definitely worth solving. Getting to grips with your money comes with serious benefits.
Over time, as your financial security builds, you’ll find you feel more relaxed.
You’re not worried about the next mortgage or rental payment. You’ll be more certain that you can afford a comfortable retirement when the time comes.
The stress and worry of potential redundancy is diminished. Even better, you can quit your job if you don’t like the new boss.
That’s what I call freedom. If you get on top of your finances, you’ll be much freer to set your own destiny, instead of having it dictated to you by circumstances… or by other people.
So let’s get into how to achieve that pleasant outcome. I’ll outline a plan. But it’s down to you whether you act on it.
Remember: it’s your money, your future, your freedom.
No one but you can make this happen.
The Four Steps to Financial Freedom
There are four simple steps to financial freedom:
- Understand your finances
- Cut waste from your outgoings
- Make saving your top priority
- Invest to protect and build your assets
Step 1: Understand your finances
You don’t need a financial training to understand your finances. You just need to be able to read (you got this far!), and be able to add and subtract numbers.
Pick a quiet day, take a deep breath, and get moving. Once you get started, and jump the first hurdle, it’ll get easier over time.
To understand your finances, the starting point is to work out what you have to your name today. This is simply done by making a list of all that you own (assets), and a separate list of all that you owe (liabilities, or debts).
The easiest way to do this is on a computer spread sheet. If you don’t know how to use those then just do it on paper.
(There are probably tools on the internet as well. But I believe you should keep your personal finances private, as far as possible. So I’d never use such a thing.)
List all the assets in a column on the left and write down the value in pounds next to each item. Estimate the values if you don’t know them exactly (you can always refine it later). Be conservative and realistic.
Include your house, bank and other savings accounts, pension fund, brokerage and investment accounts, other properties, cars, art, gold and silver coins, rare collectibles like inherited jewellery or antiques – everything.
Then list all your debts on the right. Mortgage, car loan, credit card debt, student debt, credit agreements for technology gadgets or furniture (what’s left to pay) – everything that has to be paid off in future.
Add up each list. Then subtract the total liabilities (debts) from the total assets. The result is your current financial position. It’s your “net worth”, in monetary terms at least.
Congratulations: you’ve just drawn up a personal “balance sheet”, even though you’re probably not a professional “bean counter”. This is your very own statement of financial condition. (Remember to keep it private.)
Once you’ve done this, you’ll have a pretty clear picture of where things currently stand. If the result – your net worth – is positive, then you’re starting in a solid place. If it’s negative, then it’s more important than ever that you take steps to change the situation.
Now you need to know how your financial condition is likely to develop. To do this you make a list of all sources of income and all outgoing expenses.
Start with net annual income from your job or business, after tax. If you’re an employee, this is simply twelve times what lands in your bank account each month, plus any expected bonus payments. Add any other substantial and reliable income sources, such as net rental income from property.
Ordinarily, there’s likely to be interest income as well. But interest rates are so low at the moment that it’s likely to be pitifully low.
Add up the income items to get a total, annual expected income.
Next you need to look at your annual outgoings. This can be a little more involved, since we tend to make lots of small payments.
So there’s a certain amount of reviewing bank and card statements to work out where your money is going. You’ll also need to make realistic estimates for some things.
But you can refine it all over time. The important thing is to make a start.
Also, some payments are monthly, such as utility bills. Others might be quarterly, such as health insurance premiums. Yet more could be annual, such as your car insurance renewal. Remember to work out the correct annual amount for each item.
Here are some of the main items you’re likely to have:
- Rent or mortgage payments
- Council tax
- Property service charges or maintenance costs
- Utility bills (water, electricity, gas)
- Car insurance, maintenance, MOT, fuel
- Food & drink consumed at home
- Eating out and takeaways
- Taxis, trains, buses
- Flights, hotels
- Clothes shopping
- Club memberships
- Health insurance
- Help in the house or garden
- Fees for education
- And so on… everything you can think of.
How you group things is up to you. The important thing is to capture as much as you can think of.
Add them up. Add another 10% to the total for the things you’ve missed.
Trust me, you’ll miss something, especially the first time you try this.
The extra 10% is also to cover contingencies – those unexpected big bills that come around from time to time.
(Once you’ve done this for a few years – which is a good habit to get into – you can be more confident about the accuracy. At that point you can reduce this extra amount to a lower number, say 5%.)
So now you have one total for your annual net income and another for your expected spending, or outgoings, during the year.
Subtract the total outgoings from the total net income.
If the result is positive, and you’ve done it correctly, then you are saving money.
If the result is negative you’re spending more than you’re making.
Simple. You’ve now created a personal “profit and loss” account (P&L).
Once you’ve done these two things – preparing a personal balance sheet and a P&L – you’re set for the next step.
Step 2: Cut waste from your outgoings
Chances are, you’ll be shocked by the size of some of the expense items. This is especially likely if it’s the first time you’ve tried summarising your finances, or if you haven’t done it for a long time,
I know I found a few surprises the first time I did this properly.
This next point is extremely important:
Cutting your outgoings doesn’t mean living badly, unless you are extremely poor.
Instead it’s about cutting out waste.
In my case, when I first did this about 15 years ago, I realised I was wasting a huge amount of money on insurance cover I didn’t need.
It was an easy win to get rid of it and save thousands of pounds every year.
Well, the form filling was dull. But I had the satisfaction of knowing that I was no longer lining the pockets of faceless insurance conglomerates. There were plenty of other easy wins as well.
Of course each person’s situation will differ.
But, overall, you won’t make a big dent in your costs by trimming a bit here and a bit there, or by collecting discount coupons.
I’ve learnt this in business. If you want to make serious savings then you need to make fundamental, structural changes. The same goes for our private lives.
Get rid of unnecessary insurance cover…
…cancel or don’t renew the club of gym membership that you hardly ever use…
…fly in economy instead of premium…
…stay at cheaper hotels when on holiday…
…change your car less often by keeping it for longer…
…sell the barely used sports car that’s lurking in the garage…
…downgrade your premium bank account and avoid the pointless account fees (possibly hundreds of pounds a year)…
…perhaps get rid of your fixed line phone (assuming you have a mobile phone already)…
Etc, etc, etc…
You’re bound to find some substantial things that you can do without, and probably many things.
But, for the stuff you can’t get rid of you need to make sure you aren’t getting ripped off.
When was the last time you shopped around for a mortgage, or the insurance policies for your health, home and car?
Every year I do a little dance with a health insurance company. They send the annual renewal letter and typically want 20-30% more money than the year before.
I phone the insurance company and politely, but firmly, explain that there’s no way they’re going to get that much. The call centre operative, probably reading from a script, explains that health costs are going up much faster than everything else. I grunt understanding and tell them to give me a better deal.
Typically, once all’s said and done, the renewal premium ends up less than the year before. That’s 30-60 minutes well spent, saving hundreds or even thousands of pounds a year.
Dull minutes perhaps… but worth it.
The bottom line is this: almost everyone could reduce their spending by hundreds of pounds a year – and in some cases by many thousands – without a noticeable difference to their standard of living.
I recommend you do the same.
Step 3: Make saving your top priority
This one is easy, conceptually at least.
Saving should be your TOP priority, not an afterthought.
Work out what’s coming in each month. Save at least 10% of it, for example using a standing order that sends it off to a separate savings account.
10% should be a minimum target. But it’s even better if you can save more. That’s especially true if you’ve started later in life and don’t have substantial net assets yet (see step 1 above).
“Saving” includes paying off all debts as fast as possible, and cutting out the interest costs.
For most people this process of increasing your savings doesn’t have to hurt. You can start by cutting out the pointless waste buried in your spending (see step 2 above).
What’s left, AFTER putting aside money for savings, is what you can spend. If it’s not enough for your current lifestyle, having already followed step 2 of cutting out obvious waste, then there’s no real alternative.
I won’t sugar coat it.
You need to change your lifestyle.
Remember… this is about taking control of your money, being an adult, and achieving financial freedom.
Ultimately, even if the decisions seem difficult today, you’ll be much happier in the long run.
So what can you do? Well, there’s plenty.
You can start by downsizing your house or flat. Is it more than you really need? If it is, then consider moving somewhere smaller, or to a cheaper area.
Other obvious things to look at are your car, the kinds of holidays you take, and your social life – whatever suits you best.
Just don’t let your current lifestyle destroy your future life. Go for delayed gratification, not the instant kind. Don’t be a slave to your assets, your outgoings, or your perceived social standing in the local community.
One of the easiest ways to deal with that last one, if it’s an issue, is simply to move somewhere else. Start anew, without the social and emotional baggage.
Actually, I’ve found having less stuff is liberating. You unclutter both your physical and mental worlds. Less stuff means less admin, less form filling and less maintenance.
Trust me, I know. I’ve been through this process of simplification. At one time, I owned four cars. With hindsight, that seems absurd. But, most of all, it was a lot of hassle… not to mention cost. Now I have just one, slightly ageing car. After all, I don’t drive often and I can only drive one vehicle at a time…
Don’t get me wrong… I still live well. I have all I need and great friends. But I’m no longer a slave to my lifestyle or belongings. I feel richer for it.
Steps 1 to 3 good, step 4 even better
If you follow those first three steps then you’ll already be marching along the road towards financial freedom.
- You’ll know where you stand financially
- You’ll have cut out waste
- You’ll have made saving your top priority
This will place you in the happy situation where you add to your savings each year.
But there’s still one crucial challenge that you need to face: what to do with that money.
By that, I mean what you have to do to protect it and grow it over time.
Over time, the prices of the goods and services that we buy go up. This is what’s known as price inflation. What causes it is beyond the scope of this report. It’s just enough to know that it’s always there.
What this means is that the pound loses purchasing power over time. A pint of beer that costs £4.00 today may cost £5.00 a decade from now… or £5.50… or £6.00. It depends on the future rate of price inflation.
In fact, if the price of beer rises by just 2% a year, that four quid pint would cost £4.88 in 10 years’ time. But if inflation increases to just 4% a year, it would leap to £5.92 after a decade, which would add nearly half to today’s price.
This is important because it means your savings are under threat. If you don’t take action, you may not even be able to afford to drown your sorrows in future.
The steady drip of inflation erodes your savings’ value, in terms of what you could buy with them. What’s more, over longer time periods, the effect can be dramatic.
Imagine you have a £10,000 bank deposit that pays no interest (and let’s face it, even the “best” interest rates are pathetic these days). Then let’s say that the cost of living goes up by a steady 2% a year in future, which is consistent with the Bank of England’s inflation target.
After 10 years, that £10,000 would lose about 18% of its purchasing power (I won’t bore you with the maths… just trust me). Put another way, in today’s money it would only be worth around £8,200.
That’s bad enough, but it gets worse. After 20 years each pound would buy 33% less than today, making the total worth around £6,700 expressed in today’s money… after 30 years the drop in purchasing power would be 45%.
And that’s in an assumed low-inflation environment. If inflation accelerates, the situation could be much, much worse.
In a world where the average person is living into their eighties, and retirements often last for 20 or 30 years, there is a serious implication to this.
If you leave your savings in cash deposits for a long time, with their pathetic interest rates, effectively you stand to lose a fortune. It will happen slowly… perhaps so slowly you don’t even notice it over short periods.
But, given enough time, inflation will have its wicked way.
Fortunately, there are things you can do to stop that happening.
In short: you need to invest your money in assets that will protect it from the long-term ravages of price inflation.
In the current environment, this essentially boils down to three main potential areas:
- Directly owned property (or “real estate”)
- Precious metals, especially gold (and sometimes silver)
- Reasonably priced shares of companies (also known as “equities” or “stocks”)
You’ll probably notice that I haven’t included bonds in that list, including “gilts”, which is the name for UK government bonds. Bonds are just loans made by investors to bond issuers, such as HM Treasury, in return for some kind of income.
The reason I’ve left out bonds is because the yields on almost all bonds – meaning how much annual income a bond investor can expect to make – are ultra low these days.
In most cases they are below the likely rate of future inflation. In some cases, they are actually negative. That means a guaranteed loss for anyone that buys the bond today and holds it to maturity (when the loan is paid back by the issuer).
In the rare cases where yields are still higher than expected inflation, the bonds come with other risks, such as simply not getting your money back at all (if the borrower goes bust).
There are complex reasons why the bond markets are in this situation. But, for now, I simply recommend that investors steer clear of them, at least for the most part. If inflation were to pick up in the future, which is what many people expect, bond investments could be decimated.
So let’s get back to the investments which should provide “real” (above inflation) returns in the long run.
1. Directly owned property (or “real estate”)
A lot of people like directly owned property, as witnessed by the boom in the Buy-to-Let sector in the past. This is understandable, since “bricks and mortar” are fairly easy to understand. You can see them, touch them, stub your toe on them.
But property isn’t a shoo-in for great profits. Prices can move up or down dramatically with economic cycles. Deep recessions, or increases in mortgage rates, can cause substantial price falls. (Just ask anyone who bought a house in the late ‘80s, and watched the price collapse in the early ‘90s.)
At such times, owners with significant mortgage debt can see their capital wiped out, and end up in the dreaded “negative equity” zone. That means they owe more than they own, which is a dreadful situation to be in.
On top of this, rental yields in much of the UK are pretty low these days. They’re barely enough to cover maintenance, taxes, mortgage interest and other running costs. Plus, difficult tenants can be a real pain in the neck, as any experienced landlord will tell you.
Finally, to own even a single property means sinking a lot of capital into one single asset. So the risk is very concentrated, if the investment goes badly.
For these reasons, I’m generally cautious about directly owned property. If you get it right, in a rising market, you can do well. But no one should pretend that it’s “safe as houses”. Or maybe it is, but houses aren’t actually that safe as investments.
2. Precious metals, especially gold (and sometimes silver)
Next is gold. Some people see gold as the only true money. Others value it for its insurance value in times of financial catastrophe. Alternatively, an investment in gold can be viewed as stockpiling the raw material for jewellery, which is what most of it ends up being used for.
Either way, gold has a strong track record of preserving its value over time, meaning it rises with inflation… or better.
These days, India and China are the countries that buy the most gold. Given that both have huge populations, deep cultural affinities to gold, and relatively fast-growing economies, I believe there is a strong, long-term tailwind behind the price of the yellow metal.
That’s as rapid wealth growth in the world’s huge developing countries collides with a steadily slowing growth rate in the world’s total gold stock.
Put another way, there’s quite a bit of gold about already, but it’s getting harder to find and mine. Yet, at the global level, more and more people both want it and can afford it.
That imbalance between supply and demand should keep driving the gold price up over time. In the long run, I expect it to outperform inflation rates, perhaps by 1-2% a year, perhaps more.
Of course, this doesn’t mean that the gold price can’t or won’t drop hard over shorter periods. Government and central bank policies and the actions of speculators can have a big effect. But gold should do well over longer periods, and certainly over time spans that are measured in decades.
So I believe that everyone who is serious about protecting their money from inflation, and from periodic financial crises, should own at least some gold.
3. Reasonably priced shares of companies (also known as “equities” or “stocks”)
The third way to protect against inflation – and in fact to beat it substantially – is investing in the stockmarket, the home of shares or “equities”.
A lot of people get nervous about investing in equities, and that’s understandable. The stockmarket is often referred to as a “casino”.
Understanding which companies have good business prospects can be complex. Working out whether current share prices are good value or not can require a great deal of financial training and skill.
But, approached correctly, there’s no question that the stockmarket is one of the best places to protect and grow your money over time.
I’m a private investor, and I always have most of my investments parked in the stockmarket. I just change which equities I own from time to time, based on current market prices and expected company prospects.
Why do I do this?
It’s because a carefully selected range of stockmarket investments, or a share “portfolio”, provides a powerful combination of growing investment value – rising share prices – and a growing income stream over time.
That income comes in the form of dividends, which are payments that companies make to their shareholders out of the profits generated.
Of course, stockmarket investments don’t go up in a straight line and dividend income reduces sometimes, such as during sharp economic recessions.
But the historical evidence is clear. Equities are one of the best places to invest money for growth and income.
In the US stockmarket, which is by far the largest in the world, equities returned an average 9.6% a year over the 120 years to the end of 2019.
That’s according to the Credit Suisse Global Investment Returns Yearbook 2020, an authoritative source on historical investment returns. (Credit Suisse is a large Swiss wealth manager and investment bank.)
Over that same period, US inflation averaged 2.9% a year. In other words, the US stockmarket outperformed inflation by 6.5% a year.
This isn’t just a US phenomenon either. In the UK, the stockmarket beat inflation by 5.5% a year between 1900 and 2019, again according to the Credit Suisse report.
That’s despite two World Wars, the economic misery of the 1920s and 1930s, post-WW2 austerity, 1970s stagflation and the Global Financial Crisis that got going in 2007.
Put another way, even if things feel uncertain right now, sooner or later the stockmarket will carry on making profits for investors, and protecting them from a loss of purchasing power.
But 120 years seems like a long time. So let’s dial it in a tad, in historical terms.
Over the 50 years since 1970, the UK stockmarket’s outperformance against inflation – its “real” return – was 6.4% a year (versus 6.2% a year in the US).
Historically, shares have also beaten returns on cash deposits and government bonds, all around the world.
Across each of 22 analysed countries with long data sets, the same Credit Suisse report found that shares comfortably beat bills, which are very short-dated government bonds with returns similar to cash deposits, in every country. The average outperformance was 4.3% a year.
It’s clear from this data – and many similar studies that I’ve seen – that the stockmarket is one of the best places to invest if you want to protect and grow your capital.
This is highly likely to continue in future. Especially since interest rates and bond yields are both ultra low at the current time.
That means that cash deposits and bond investments are especially unattractive places to put money at the moment, for anyone who wants to protect and grow their wealth.
In fact, overall, shares are also likely to beat property investments most (but not all) of the time. Property prices tend to rise with inflation in the long run, say 2-3% a year. Current rental yields are in low single digits in much of the UK, especially after costs (maintenance, taxes, etc.).
So it’s hard to see how most property investments will make more than a percentage point or two above inflation. Whereas the right stockmarket investments should do far better over time.
Of course, investors in stockmarkets still need to be selective. Not all shares are attractive all of the time.
Here at Southbank Investment Research, our aim is to help identify the best ideas.
Some of our recommendations will seek to provide steady income and modest capital gains from investments in solid companies. Others will be more speculative, offering the possibility of very substantial profits in businesses with high growth prospects.
If you choose to follow any of our suggestions, it’s important that you pick the ones that are right for you. By that, I mean the ones that you’re comfortable with.
But we’ll provide plenty of details each time a recommendation is made, and track performance afterwards.
When it comes to money, a lot of people are their own worst enemy. But they don’t need to be.
This report has outlined The Four Steps to Financial Freedom.
In a nutshell, those steps are:
- Understand your finances
- Cut waste from your outgoings
- Make saving your top priority
- Invest to protect and build your assets
If you haven’t done it already, then I highly recommend you get started today.
Financial freedom awaits!
Rob Marstrand,
Investment Director, Fortune & Freedom