FOOL'S EYE VIEW
You Can Change Financial Gear!

By Cliff D'Arcy
June 9, 2005

How would you describe your personal finances in motoring terms?

At one end of the scale, they might resemble a wrecked Austin Allegro, leaking oil and spewing steam on the hard shoulder of life. At the other, they could be a sleek, shiny Aston Martin V12 Vantage S, cruising smoothly and almost silently along the road to success.

But is it possible to upgrade from the Austin to the Aston Martin in a realistic timescale? I believe that it is, but as well as changing gear, it requires a little effort to change your attitude and your relationship with money. As in real-life driving, your finances can't jump from first to fifth gear without doing some damage! Hence, I'll attempt to explain the five 'gears' of financial life, and what you need to achieve before stepping up to the next gear.

So, you've fired up the engine, your foot's on the accelerator, but your financial gearbox is in neutral. Clearly, you're raring to go, so let's floor the clutch and start with:

First gear: Better budgeting and spending

This is the point at which most people's finances stall. It's not surprising really, given that schools teach next to nothing about sensible financial management, and most parents aren't much help, either! However, the technique itself is simple, which is more than can be said for learning to drive in London! The answer is to spend less than you earn or, as the Romans put it, Sumptus Censum Ne Superet – "let not your spending exceed your income".

This is dull but worthy stuff, and there are few ways to dress it up nicely. One approach is to think of yourself as a City fat-cat: the chief executive of 'Me PLC'. Your shareholders (you and your dependents) want you to maximise revenues, slash overheads and produce the maximum surplus cash for them. Hence, it's all about boosting your income and cutting your expenses. What's more, balance the books properly and you can avoid the perils of going deeper and deeper into debt.

Learn more in A Dozen Ways To Make £500 and 25 Quick Money-Saving Tips.

Second gear: Manage your borrowing

In many ways, borrowing is like smoking. The habit is easy to pick up, yet fiendishly hard to quit, plus both send your money up in smoke! Personally, I can think of only one good reason to borrow money: using a mortgage to buy a roof over your head. Still, we've become a nation of credit addicts: our total mortgage debt hit £901 billion in April and, together with £187 billion owed on loans, credit cards and overdrafts, we owe a tasty £1,088 billion.

For the record, our mortgage debt has doubled since October 1998, our other debt has doubled since May 1998, and our overall debt has doubled since August 1998. That's nothing to be proud of, is it? Another frightening fact is that our debt has been growing by around a tenth (10%) each year since 1998, whereas wages have been rising by roughly 4% a year. That's a recipe for financial apocalypse, make no mistake!

If you'd like to get to grips with your debt, read Winning The War On Debt and visit our Get Out of Debt centre.

Check out the great rates in our Credit Card, Personal Loan and Mortgage centres.

Third gear: Save for a rainy day

Third gear looms, which means that we're halfway through the gears and cruising along nicely. Having balanced your budget and tackled your debts, you're ready to start saving. There are several reasons why you need a pot of ready cash: to cope with unforeseen emergencies and unexpected bills, to save for holidays and other goals, etc. Everyone needs a rainy-day fund, not least because 'self-insuring' in this way means that you spend less on rip-off warranties, insurance and so on.

Learn to be a smart saver: read Five Silly Saving Mistakes and Three Steps To Becoming A Super Saver.

Earn more interest today! Visit our Saving and tax-free Cash Mini-ISA centres.

Fourth gear: Protect your wealth and lifestyle

For some reason, most of us find fourth gear particularly difficult to find. However, it's a crucial step because, without it, all your plans can go down the plughole. I am, of course, talking about that old chestnut, insurance.

Attractively priced insurance has a place at the core of any sensible financial plan because, like it or not, things do go wrong. In my many years in the insurance industry, I saw thousands of claims from people who, just like you, thought that it "couldn't happen to them". And, naturally, some of us end up as victims of cruel fate – it's the way of the world.

Although there may be a small risk that something may go wrong that puts a spanner in your financial works, the consequences can be huge. Think about these everyday risks of life and the impact that they have on our plans:

Death: low risk, but massive financial fallout
Long-term sickness or injury: again, low risk, but potentially disastrous
Fire at home: low/medium risk, but may be catastrophic
Burglary: medium risk, but unlikely to be ruinous
Unemployment: high risk during working life, impact varies
Car accident: high risk, unlikely to prove fatal or devastating

Interestingly, we're more likely to buy adequate cover to protect our homes and cars than we are to protect our lives and incomes adequately. It's ironic, isn't it, that we readily insure our material possessions, yet fail to protect our greatest assets? It just goes to show that humans are bad at assessing risk!

The trick is to buy cheap 'catastrophe' cover for the most extreme risks, and insure the small stuff yourself (such as mechanical breakdowns, appliances going kaput). Learn more in Protect Your Wealth! and Ten Ways To Protect Your Wealth

Pay less for a dozen different policies in our Insurance centre.

Fifth gear: Invest for the future

Ah, this is when life is sweet: you've got the top down, your foot to the floor, nothing can touch you – and your money goes to work on your behalf!

Many people believe that it's possible to go straight to fifth gear and start making big bucks from investing in shares. Sadly, most of these poor unfortunates come a cropper and end up losing a substantial slice of their capital.

The way I see it is this: investing in shares is not gambling, and wildly different from buying a lottery ticket. With the Lotto, you should expect to lose roughly three-quarters of your stake over the long-term – a 75% loss. Ouch! On the other hand, investors in shares have, since 1918, enjoyed average returns of 11% a year (with dividends reinvested), or 7% if you account for inflation (rising prices). Investing in shares also means receiving delightful dividends, which are the income you receive from the companies which you own.

So, which would you prefer: to spend, say, £50 a month on a dead-cert losing bet, or invest £50 a month and have, say, £72,673 after 25 years of 11% annual growth? Of course, no-one can predict what will happen to the stock market tomorrow, never mind over the next 25 years. However, I'm willing to bet that shares will beat cash, bonds and other mainstream investments between now and 2030. A cheap, simple, flexible way to invest in the stock market at low cost is to put your money into an index tracker. You can learn more about index trackers in The Stock Market Needn't Be Scary!

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Once you've got used to driving in fifth gear, you may try your hand at picking your own shares. However, it's far from easy to pick stocks consistently well, so you're bound to make a few blunders along the way. Before you invest in any company, make sure that you DYOR: do your own research. You can give yourself a head start by signing up for a FREE thirty-day trial of our Value Investor newsletter, in which we provide three share tips each month.

So, start today, and your finances could be purring like a well-oiled engine within months!

More: Find better Credit Cards, Personal Loans, Mortgages, Savings Accounts, Insurance and ISAs.