Last week, we covered savings and investment and hopefully you are now on the way to making your next million. This week, John Lowe the Money Doctor addresses borrowings, insurance and money management.
Albert Einstein is credited with saying "Compounding is mankind's greatest invention as it allows the reliable systematic accumulation of wealth". When there were decent deposit interest rates, yes, compounding worked.
Best current demand deposit account interest rate is 0.15% ( net 0.0975% after 35% DIRT Tax). However, there is a corollary to this statement in that compounding also works AGAINST you when you are borrowing.
Borrowing made simple
Let’s start with the basics. If there is something you want to buy and you don’t have enough money to pay for it, then you may be tempted to borrow.
The person or organisation that lends you the money (known as the 'lender’) will charge you for the privilege. The money you give to the lender is called ‘interest’. The amount of interest you pay will depend on how much you are borrowing, in what form and for what purpose.
Lenders are worrywarts and fret that they may not get their money back. The more risk they feel they are taking, the more interest they are likely to charge you. If you can give them security, the right to sell something of yours if you fail to repay them, then you should enjoy a lower interest rate.
Missing payments and allowing arrears to mount up increase the costs of that borrowing and allows compounding to ferment. Rather like the penalties and levies Revenue charge you if you are late with your tax payments or incorrect on the calculations.
Some borrowing makes sense. For instance, without mortgages it would be impossible for most people to buy their own homes, and without student loans it would be impossible for most students to continue with their education.
Other borrowing is positively toxic, for instance loans taken out to pay for day-to-day living expenses (like food) or to pay for luxury items (like clothes).
If the thing you are borrowing money for won’t last longer than the time it will take you to pay for it...don’t! Borrowing money to go on holiday is, therefore, probably a bad idea because the holiday will only last a week or two but it could take you months to pay for it. The same for Christmas presents – it comes around every year.
In recent years, due to relatively low interest rates, many people in the Ireland borrowed considerably more money than was sensible. It is vital, if you want to make the most of your money that you don’t now borrow recklessly. Independent professional financial advice is a must and ideally should be paid for.
Insurance made simple
Life is a dangerous business. Every day, all around us, terrible things are happening. Some of these terrible things happen to possessions. For instance:
- houses burn down
- cars crash
- roofs are blown off
- holidays are cancelled because of strikes
- bicycles are stolen.
Some of these terrible things happen to people. For instance, people:
- fall ill
- get hurt in accidents
Obviously, some of the terrible things that can happen are worse than others. Having your bicycle stolen is hardly as serious as breaking a leg and generally nowhere near as bad as dying. Anyway, every terrible thing that happens will have financial consequences, for instance:
- If you own something that is lost, damaged or stolen, you will have to spend money to replace it.
- If you are ill or have an accident, you may be off work and unable to pay for all your living expenses.
- If you die (especially when you have a family), you may leave people behind who were depending on you to support them financially.
The idea of insurance is to make sure that when something terrible happens, money is there to help pay for it. Broadly speaking, insurance divides into:
- ‘General’ insurance: this pays out when something happens to possessions such as cars, homes, pets, motorbikes, valuables and so forth. It also includes things like holiday insurance and accident insurance.
- ‘Life’ insurance: this pays out when people fall very ill or die.
It is worth remembering how insurance works. In many ways it is like a savings plan. A group of people who are worried about the same terrible thing happening, say, their houses burning down, decide that they will join forces. Together they save money and build up a pool of cash.
Then, if the worst does happen and one of their houses does burn down, there is money available to pay for re-building. In the beginning, insurance plans were run like clubs. Then business people got involved and started insurance companies. These insurance companies expect, of course, to make a profit.
The key things to remember with insurance are:
- It is easy to end up buying insurance you don’t need and not buying insurance you probably do need. Use a reliable financial adviser or your common sense (or both) to help you.
- It is a ruthlessly competitive market. Shop around before you buy any cover. Shop around before you renew cover. Keep checking prices for cover that doesn’t have an annual renewal date, too.
- There are lots of ways to bring insurance premiums down, ways that won’t necessarily mean less cover. Seems silly not to exploit them, really, doesn’t it?
Money management made simple
‘Money management’ sounds complicated but actually it comes down to:
- keeping track of all the money you receive
- keeping track of all the money you spend or give away
- making sure your money is somewhere safe where it can’t be stolen
- paying your bills, including (argh!) your tax bill
- checking that you aren’t spending too much
- planning for the future
- deciding how you will use your money.
There are no absolute rights and wrongs when it comes to money management, but there are sensible and less sensible things to do. For instance, if you want to make the most of your money, it is sensible to:
- keep money records, basically notes of what you earn (or get given) and what you spend (or give away)
- open a bank account
- make sure that you don’t spend more than you receive
- keep bank charges down to a minimum
- keep your tax bill down to a minimum.
There you have it. No excuses now. You know it all.