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The ultimate New Year money makeover
By Sam Barrett
Whether you want to take up a new exercise regime, kick a cigarette or chocolate habit or learn a new skill, the New Year is the ideal time to introduce some improvements.
The same is true of your finances. So, if your credit card is looking bloated, your savings are on the thin side, or your mortgage a bit last season, now's the time to get your finances fighting fit and give yourself a full money makeover.
Draw up a budget
"You've got to start with a full financial review to identify your weak points," explains Bob Riach, proprietor of Riach Independent Financial Advisers.
As most people receive a monthly salary cheque, it makes sense to work out your budget on a monthly basis. Your bank statements can help, but also make sure you take into account less regular expenditure such as quarterly energy bills, holidays and any unexpected outgoings.
This exercise will, for many of us, turn the spotlight on one major problem - a shortage of cash. If this is the case, Mark Osland, director of independent advisers Formula, suggests starting a spending diary. "Write down everything you spend. This will highlight what's essential and what isn't," he explains.
Within your main budget, include essentials such as your mortgage or rent; household bills such as energy, water and insurance; food; travel costs; and payments on any loans or credit cards. Once you've identified essential outgoings, consider setting up direct debits, either to the provider or to a separate 'bills' bank account of your own so you always have the money to cover them ready to hand.
Next, consider ways of reducing your expenditure on essentials and non-essentials. Take a look at some simple steps that could help boost your cash levels without forcing you to cut back on anything. Shopping around for a better deal could, for example, save you more than you think.
"Switch energy providers and find a better tariff for your mobile phone - many people are paying more than they need for these services," says Simon Webster, managing director of IFA Facts and Figures Financial Planners.
Finding alternative ways to pay your bills, such as a monthly direct debit or opting for paperless bills, could also help your bank balance.
As well as these pain-free steps, you may also want to take more belt-tightening decisions to get the elasticity back into your monthly income. These may only need to be short term, especially if the cash they release helps to pay off loans and credit card bills.
Owen Temple, director of Eldon Financial Planning, has the following tip to help you make the sacrifices. "If there's something you really want, such as your own home or a dream wedding, then think about what you would be prepared to give up for it," he suggests. "This can make it much easier."
Pay off your debts
Credit can be a great way of improving your lifestyle and, for most of us, it's the only way we can afford to buy a home. But if you fail to manage your debt, it can quickly spiral out of control and ruin even the most carefully planned budget.
"The golden rule is to pay off the most expensive one first," says Ray Boulger, senior technical manager at mortgage broker John Charcol. "Take a look at all your debts, such as your mortgage, credit card and loans, and compare the interest rates."
Credit cards are likely to have the highest interest rate and switching to a 0% deal can certainly help. Look out for balance transfer fees, although it's often worth paying these anyway if you've got a card with a high interest rate. And make sure you don't spend on your new card, as this will usually incur instant interest charges because it stays on your card for longer than the transferred balance.
Falling interest rates may give you some respite, but instead of spending the extra cash, Boulger recommends taking advantage of lower rates to clear your debt faster.
"Check with your lender - even if you haven't got a flexible mortgage, most will allow you to overpay by 10% a year or £500 a month. Keeping your mortgage repayments at the same level as before the rate cuts can take years and thousands of pounds off your mortgage," he explains.
For example, if the mortgage rate fell from 6% to 4%, the monthly repayments on a repayment mortgage of £200,000 would fall from £1,288 to £1,055. Maintaining the old repayment level would cut 6.8 years off the term of the mortgage and save you £34,625 in interest.
Speeding up repayment is very effective, but some of us may need to take more radical measures. If your interest payments increase each month and you're finding it difficult to cope, then it may be worth contacting a debt counselling charity like the Consumer Credit Counselling Service (0800 138 1111) or the Money Advice Trust (0808 808 4000). Also get in touch with your lender - they could offer you a repayment holiday or even lower your rates.
Get the savings bug
"You need to have enough savings to cover your outgoings for at least three months - or better still, six months. This is especially so in the current economic climate, with unemployment on the rise," says Tim Cockerill, head of research at IFA Rowan & Co.
A cash ISA is usually the best place to star. You can put up to £3,600 a year (2008/09) in a cash ISA. At the moment you can expect to earn around 4% tax-free.
If saving is a new venture for you, then it's a good idea to commit to putting something aside on a regular basis. You could go for a regular savings account. These tend to offer better rates than their instant access counterparts, but you have to commit to making regular contributions from around £10 up to £250 for at least a year.
But if you fail to do so, the rate usually drops. "A regular savings product will help you get the discipline," says Mark Osland.
Wherever you stick your savings, make sure you regularly review the rate you get, as even the most competitive deals can slide. The latest deals are usually the most attractive.
Start investing
History has shown that over time equities have almost always outperformed savings accounts. For example, figures from Lipper show that over the last 20 years, if you had invested £1,000 followed by £100 a month in the average UK All Companies unit trust it would be worth £42,228.38 now, compared with £31,297.10 in a typical deposit account.
"In the long term, if you invest in assets you'll always get a better return than if you lend money to the banks and building societies in the form of savings," says Owen Temple.
This doesn't mean this will always be the case in the future. It's therefore important to take a long-term view when investing, and you also need to consider your attitude to risk. As a minimum time span, Temple recommends five years.
A regular savings plan could be an ideal way to start building up your investments. For example, you only have to invest £20 a month into Interactive Investor's Funds Builder.
Cockerill says: "You can start regular savings with as little as £20 a month and there are no charges for setting up or stopping the plan. Also, as you're dripping money into the stockmarket you'll be able to buy more units when the price falls. When the market recovers, the returns can be very impressive."
He adds: "Purchasing a number of funds to provide diversification is sensible, but traditionally the bulk of your investment should be in the UK to eliminate currency influences."
Higher-risk investments should only be considered if you have a lengthy time frame.
And wherever you invest, use your ISA allowance. Even with £3,600 going into a cash ISA you can still squirrel away a further £3,600 (or £7,200 if you haven't got a cash ISA) into a stocks and shares ISA every tax year and avoid paying income or capital gains tax on the proceeds.
Plan for your future
For example, state support towards your retirement, or if you're unable to work due to illness or disability, is slight, so it's worth making your own provision.
There are several protection products available. Life insurance will pay a lump sum if you die; critical illness will pay out if you are diagnosed with a serious condition such as cancer; and income protection will pay you an income if you're unable to work due to sickness or disability.
"If you've got financial dependants then life insurance is essential as it will ensure they can maintain their lifestyle even if you do die," says Osland.
With all these protection products, it's best to start as early as possible - the younger you are when you take them out, the better your rate will be.
For example, a 25-year-old man would pay £6.68 a month for £150,000 of life insurance over a 25-year term. If he waits until he's 30 the same cover will have increased to £8.42 a month.
Another part of your financial planning that costs more if you delay is your pension.
However, it's not always best to throw all your cash into your pension. As Bob Riach reminds us, "a pension isn't the only place to save for your retirement".
Other investments that can be used for your retirement income include an ISA, a buy-to-let property, a unit trust or investment trust or a share portfolio. Younger savers should also prioritise making repayments on debts to prevent interest charges racking up.
And, just as making all those final, finishing touches to your home before you try to sell it - hanging new curtains or ensuring the kitchen is clean and tidy - might seem an unnecessary chore, they could make all the difference between a fast sale and having to struggle to get your property off the market.
The same goes for your forward financial planning. Writing a will, for example, might not seem like something that is particularly important right now, but it's essential if you want to ensure your hard-earned cash goes to your loved ones when you die.
"There are DIY kits for writing wills, but I'd recommend seeing a solicitor," says Bob Riach. "It will cost more but it will make sure your wishes are accurately detailed." You can expect to pay around £100.
Alternatively, you can help charity by using Will Aid. This runs a campaign every two years in which a solicitor writes your will in return for a donation to charity.
You also need to check whether you will be hit by inheritance tax. This tax becomes payable if the value of your estate, including your home, exceeds £312,000 (2008/09). Simple steps can be taken to avoid being stung by IHT. For example, you can give away up to £3,000 a year tax-free. For more complex arrangements to avoid IHT, such as trusts, it's best to seek professional advice from an IFA, trust specialist or solicitor.
Great funds for first-time investors
• M&G Recovery (medium risk) "This fund invests in companies that have fallen on hard times. There are lots of opportunities at the moment and the fund has a very good record."
• Artemis Income (medium risk) "This invests in companies that are making profits which are then paid out as dividends - so it tends to invest in solid, established companies. Younger investors may not want income, so this should be reinvested; over the long term more than 50% of return comes from income."
• Schroder European Alpha Plus (medium/high risk) "This offers exposure to European markets and is managed by one of the most respected European fund managers."
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