Before embarking on investing a lump sum it is advisable to check your financial health, to see how you measure up to the ideal.
Preparing background information
If you consult a financial adviser, you will first be asked for some background information. Here you are the adviser as well as the client so, although much of this information will be obvious to you, it is still worth writing it down as it will affect what comes later.
A financial adviser will ask:
- your age;
- whether you are employed, self employed, unemployed or retired;
- Whether you are married, have children still dependent on you (or any other dependants, such as a widowed mother without much pension); and
- what is your highest income tax rate (your marginal rate).
If you do not have a clear idea of your weekly or monthly income and expenditure, prepare a budget. Include in it any savings you are making for a specific event.
Your financial assets and liabilities
List any savings and investments you have, followed by a list of any liabilities bank overdraft, credit card debt, etc. The difference between the two is the value of your net current assets (if it is a negative amount, you need to plan to reduce your debt).
Your mortgage is a separate issue because it is a long term liability.
Doing your financial health check
The ten steps which follow are in order of priority.
1. Reducing borrowing
Are you borrowing money, except against your home? If so, consider paying it off as soon as possible as the interest will be expensive.
2. Establishing an emergency fund
Have you got a cash reserve to fall back on at least one month’s normal expenditure and preferably two or three, in an instant access deposit account or as a borrowing facility? At least half the population has less than £1,000 readily available and 10% have nothing at all.
3. Avoiding financial disaster
Is your income protected by insurance against the death, sickness or permanent disability of the breadwinner? Do you have adequate home and car insurance?
4. Retirement planning
Are you paying towards a pension? It is never too early nor too late to start.
5. Getting tax and social security advantages
Are you getting all the income tax allowances, reliefs and credits, and social security benefits you are entitled to?
6. Estate planning
Will your heirs have to pay inheritance tax? If so, consider how to avoid it or pay for it yourself.
7. Saving for special events
Do you need to save up for your next holiday, a new car, a wedding, long term care in old age? Putting aside just a small amount regularly is the best way.
8. Paying for education
If you have young children, are you saving up to pay for private education and/or university?
9. Reducing your mortgage
It is worth considering a reduction before investing surplus income or a lump sum.
10. Investment planning
Have you surplus income which can be channelled into a savings scheme or do you have a lump sum to invest?
Making strategic decisions
The result of your financial health check may cause you to change your budget, for example to pay for more insurance cover.
Or you may wish to change your existing savings and investments to fit in with the ideal – perhaps to put more into your cash reserve.
Make a list of your shortcomings compared with the ideal and decide what action to take.
Saving to invest
If you do not have a lump sum to invest but can afford to save, there are many investment products which accept regular monthly payments.
In other cases, where the minimum investment is low and monthly savings are high enough, they can be invested directly. For example, National Savings certificates have a minimum of £100.
Otherwise, savings can be put into deposit accounts until enough has been accumulated to make a lump sum investment.
The advantage of investing regular savings is that there need be no commitment to maintaining payments, e.g. there is no harm done by missing a monthly purchase of a savings certificate.
Analysing your savings needs
If you need or wish to save, consider the following:
- What are you saving for to increase your cash reserve, for a special event, for your children’s education, for retirement and how much do you need? If you have more than one reason, decide the priority.
- How much can you save, each week or month, and so how long will it take to achieve your objective?
- Do you need quick access to the money? Bear in mind that, if not, you might get a higher return from a longer notice deposit account, or even in an equity investment, which should grow more in the long run (say at least five years).
- Do you pay tax and if so what is your marginal rate? Compare returns on an after tax basis.
- Can you save regularly? It is better if you can, but be wary of committing yourself to a regular savings contract if there is a penalty for missing a payment. Irregular deposits when you can afford them are better than nothing.
- Is your priority income or capital growth? Some investments are better for one, some for the other, but many achieve both.
How much risk are you prepared to take? Higher risk should lead to higher returns but only in the longer term.