A millennial guide to personal finance

Millennials – defined as those born between 1981 and 1996 – will live for longer than any previous generation. They need to start saving now to pay for their long retirements. However, spare cash isn’t all that easy to find if you graduated during the 2008 financial crisis, find yourself racked with student debt and face a steep climb to the first rung of the property ladder.

Millennials may have faced some obstacles, however there are some ways in which those who began their careers during the financial crisis can optimise their financial resources.

Start saving today, and not in cash

It’s easy to think that stashing away £50 per month in a cash savings account will alleviate your financial concerns. What you may not realise, is that when low interest rates are combined with high inflation, the purchasing power of your savings will fall every year. The base rate in the UK is currently 0.75%, while inflation is 2.3%. The interest that your bank pays you every month is not sufficient to counter the eroding effects of inflation and over time, your purchasing power will suffer. Unless these negative real interest rates change, a cash deposit account will not help you realise your retirement dreams.

Let me be clear by saying that investing in capital markets by no means guarantees financial success, but you at least stand a chance of generating above-inflation returns. The FTSE 100 has climbed almost 11% over the past five years and S&P 500 over 70%. And the sooner you get started, the more your savings could reap the valuable rewards of compounding.

Compounding means that any interest, yield or capital gains generated remain invested, instead of being spent. Individually, these additions may seem small, but when combined over a long time period, they create far greater growth than would have been possible from the original investment alone.

If you were to invest £50 today and leave it in an account which returned 6% per year for 20 years, you would find yourself with £160 in 20 years’ time. Not bad for doing nothing. That number would increase enormously if you paid in an extra £50 every year – at 6% over 20 years, you would end up with a staggering £1,950 – significantly higher than the 20 lots of £50 you paid in over that time (£1,000). Compounding alone would have generated an additional £950, almost doubling your original investment.

The question is: which vehicle do I use to capitalise on these potential returns?

Take advantage of tax wrappers

Tax wrappers are a good place to start. ‘Wrappers’ mean that any money you invest will not be liable for income tax or capital gains tax, greatly boosting your long-term returns. Most readers will have heard of an Individual Savings Account, or ISA, one of the most popular tax wrappers.

Millennials would be wise to open a stocks and shares ISA and utilise it as much as possible, up to the annual allowance every year (£20,000 2018/19). The great advantage that ISAs have over other tax wrappers is liquidity; if you need the money in your ISA for any reason, you can simply cash it in. The other well-known tax wrapper, the Self-Invested Personal Pension (SIPP), doesn’t allow for the same flexibility. Any money that goes into a SIPP stays locked in until the age of 65. Early withdrawal incurs huge tax bills.

SIPPs, however, do have their advantages, and if the monthly budget can stretch to it, millennials could benefit from opening a SIPP account too. Money paid into a SIPP automatically receives basic rate tax relief (20%), so if, for example, you put £8,000 into your SIPP, the government will automatically top it up to £10,000. Higher and additional rate taxpayers can claim back an extra 20% and 25% tax relief respectively. Like an ISA, SIPP contributions also grow free of income tax and capital gains tax.

Pay down high-interest debt

Ends are hard to meet and credit cards easy to come by. Racking up credit card debt to pay for everyday expenses is an all too common scenario for a lot of millennials, however, it is an eye-wateringly expensive way of solving monthly cash-flow problems

The national average annual percentage interest rate on credit cards is about 16%. As you may remember from the section above, the UK base rate is currently 0.75%. Your bank is paying you 0.75% interest, but through your credit card, you are paying your bank 16%. Suddenly that £200 dress has cost you £232. If you have any debt charging this level of interest, it’s worth paying it off before you start saving anything.

You still have to have some fun!

Saving for your future is important. But don’t scrimp and save so much that your Friday nights start to equal solitary baked bean feasts. You still need to allow yourself some disposable income so that you can remain an active part of the millennial generation. Budget carefully every month and make a note of your spending but do allow yourself a little fun on weekends.

As a final thought, it’s worth setting up a direct debit into your ISA or SIPP on payday to prevent any momentary lapses of self-discipline.

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