FOOL'S EYE VIEW
My Five, Best Ever Financial Decisions

By Alison Hunt (TMFAlly)
November 3, 2005

Unless you were born into an extremely wealthy family, with more money than you could ever spend and maybe a few inherited properties to boot, you're likely to need to make some pretty serious choices regarding money. Well, of course wealthy people must make choices too, but the consequences of their actions may not be as critical as they are for the rest of us!

The trouble is, when it comes to organising your finances, it's hard to know where to start. What's more, how can you be sure that the choices you make are the right ones? I remember deciding, whilst in school, that I would never have to worry about money as I intended to marry a billionaire (well, a million doesn't go very far these days). Unfortunately, that didn't happen and I had to learn how to manage financially, just like everyone else. Sigh. However, although I've made many mistakes, there are a few choices that I've made that I feel were more successful than others. So here are five of what I consider to be my better financial decisions.

1. Create a Budget

Although it sounds like such a simple thing to do, it's amazing how many people have never bothered to create a budget. The trouble is, if you don't know how much money you have coming in and going out each month, how do you know how much you can realistically afford to save? By not having a budget, many people decide to save an arbitrary sum each month, which is usually far too high (resulting in them having to raid their savings each month) or too low (which makes them wonder why it takes them so much longer than others to achieve their goals).

Creating a budget doesn't have to take long. Grab your last few month's bank statements and a pencil and paper. Alternatively, create a spreadsheet and benefit from it doing all of the calculations for you. Now, fill in all of your income on one side - include your salary and any other money you have coming in. On the other side fill in your outgoings: bills, mortgage/rent, council tax, satellite TV fees, subscriptions etc. on one side. This article may help. Now you need to figure out a spending allowance to take into account the amount you'll need set aside for food and drink, and entertainment. Depending on your lifestyle this can be as mean or as lavish as you can afford, but if you really want to save some cash you should possibly consider moderating your needs a little!

Now it's a simple case of deducting the outgoings and spending allowance from your income. What's left over (assuming there is some) is available to be saved. If you have no money left over (or you're actually into negative figures) or your left-over sum is very meagre, it's time to cut back that spending and trim those expenses. And if you stick to your budget each month, you'll find your savings can increase dramatically, allowing you to either build up your rainy day fund, or achieve your goals more quickly.

What I particularly like about using a budget is that it makes you very aware of where your money goes and highlights areas of possible overspending. It also makes you think carefully about whether or not you will get your money's worth from that gym membership etc. before you sign up!

Get help drawing up your budget in our Get Out of Debt Centre.

2. Maximise pension contributions

Although many of us can afford to, few of us pay as much into our retirement plans as we could. And the reason why is simple we won't see that cash again for many years, whereas we could really use it now. I know because I used to think like that too.

As a result of spending quite a long time in higher education, I started working long after some of my friends. Once I started receiving a salary, saving for a car, house deposit, you name it, everything seemed more important than my retirement fund. So although I did contribute to my company's pension plan, it wasn't a great sum.

However, I had my eyes opened when I started reading the Fool's website, and understanding just how pensions work. I already knew that the taxman effectively gives us back the basic rate income tax paid in the form of tax relief (although we will be taxed when we eventually draw an income from it). Higher rate taxpayers can claim a further 18% via their tax returns. Pretty good so far.

However, I then found that many employers contribute to their employees pension funds too. I did some checking and found that my company would indeed match its employee's contributions, up to a maximum of 5%. So someone earning £25,000 a year would effectively be turning down a potential extra £1,250 in his or her pension pot, by not joining the scheme! What's more, annual bonuses, when placed into a pension fund can maintain their full value (as opposed to being received with a huge chunk of tax missing, in a pay packet). It didn't take long for me to increase my contributions!

As a result I now try to pay in as much as I can into my pension, however painful it may seem at the start. Increasing pension contributions by just one per cent, every few months can make a massive difference, whilst not seeming to affect a salary too hideously. If you need some inspiration, why not read about David Bach's methods of how to become an automatic millionaire? And finally, pensions are by no means the only way to save for retirement (though if your employer contributes to yours, it's certainly a lucrative one). There are many other ways to save and invest for the future, which leads me nicely into my third decision.

Learn more and open your own, personal pension in our Pension Centre.

3. Investing via an Index Tracker

We all know that savings accounts are great for short-term growth, but if we want to make some serious money over five or more years we should look to the stock market. And although the stock market can seem like a scary place where people do a lot of shouting and can lose or gain millions in seconds, there are far more sedate ways of investing in it.

Though I have tried my hand at buying managed funds, the method I now choose to invest by is via an Index Tracker. Essentially, a tracker is a fund that attempts to emulate the performance of a particular index, by owning the same shares in the same proportion as the index it tracks. This can mean your money is being invested in over 700 companies at once. Unlike managed funds, trackers don't have fund managers, which is one of the reasons I prefer them. After all, with no expensive team of fund managers to pay, I get to keep more of my profit.

Trackers may not be the most exciting way to invest but it takes very little effort on my part, which suits me! Trackers also offer consistency and when you realise that up to nine out of ten managed funds fail to beat the index long term, trackers certainly become an interesting option.

Find out more and apply for an Index Tracker in our ISA Centre

4. Mortgage Overpayments

Regular readers of the Fool will know I harp on about this quite regularly, so you may be pleased to realise I do practise what I preach! Essentially, making mortgage overpayments is a way of taking full advantage of flexible mortgages - mortgages that calculate interest on a daily, rather than annual basis. As a result, it can mean you pay off your home loan years earlier, and save a fortune in interest, too.

Flexible mortgages are still a relatively new concept in the UK, having only really been around for the last ten years or so. The important thing to remember is that every pound counts and the earlier you can use the extra cash against your loan, the more interest you can save.

For example, say Jim has a 25-year, £100,000 repayment mortgage at 5%APR. His monthly payments are around £585. By the time the house is his, he will have paid nearly £75,400 in interest.

Now, say Jim cuts his expenses and realises he could afford to pay an extra £100 per month into his mortgage. How will that affect things? Well, as Jim's mortgage is flexible, that money goes to work straight away to reduce the loan. As a result, he finds the house is his in just 18.8 years, saving 6.2 years and nearly £21,000 in interest! Blimey.

You'll find that, however small, any sum you can afford to overpay by each month will make a difference, with the effects more marked in the early days. So start overpaying today!

5. Switching Mortgage Provider

And sticking with mortgages, my final best financial decision has been to ensure that I move mortgage provider promptly, whenever its introductory rate is reaching its end. Although the mortgage rate we sign up to is often quite competitive, deals don't last forever and when they expire your lender will be hoping to make some serious cash from you. It's at this point you will find yourself transferred to your lender's Standard Variable Rate (SVR) which is often around 6.75%APR a big change from that rate you signed up to.

When we first bought our house, my husband and I weren't quick enough to switch when our mortgage deal expired, and found ourselves paying our lender's SVR for a couple of months as we frantically moved to a better deal. As this rate was a good two per cent higher than what we'd been used to it stung enormously, and made us vow never to pay an SVR again! As a result, we're now quick off the mark to apply for a better deal when our re-mortgage point approaches and as a result, we know we're saving a small fortune in extra interest.

Find a better mortgage deal in our Mortgage Centre.

So, these are just a few of my favourite financial decisions, maybe they can help you, too.