Capitalizing on Current Financial Opportunities: Savings, Investments, and Mortgage Strategies
As we head into the new year, is it time to save, invest, or even pay off your mortgage to get the most out of your hard-earned money? We've got savings rates at some of the highest levels we've seen in decades, the stock market has just had an amazing year, and we know that mortgage rates will hit us if they haven't already. So what do we do? Starting from the top and the simplest one, let's talk about saving money right now. The base rate here in the UK set by the Bank of England is 5.25%. This is the highest level it's been for 15 years, as the last time we saw rates this high was just before the global financial crash.
Now, if you didn't already know, this rate has a huge impact on what you can get as a saver because as the rate goes higher, you can also expect to see better rates. When shopping around for savings accounts, for example, have a look here at some of the best rates which are now available to you. Even in flexible savings accounts where you can take money in and out, everything is above 5%. This means that if you had £1,000 in that account and left it for 12 months, by the end you'd have £1,050. Not bad. And then if you're able to lock your money up a little longer, say for 1 year, here are some of the best rates you can get, and they're closer to 5.5%.
Understanding Tax Implications on Savings: Maximizing Allowances and Minimizing Liabilities
Don't forget that when you do earn interest on your savings, you could be liable for taxes. Everyone in the UK gets an allowance each year before they have to start paying taxes on interest from savings. In the current tax year, here's what that looks like: If you're a basic rate taxpayer, which means you earn less than £50,270 in a year, then you can earn up to £1,000 a year from interest income. Once you start becoming a higher rate taxpayer or even an additional rate taxpayer, then unfortunately you no longer get any tax-free benefits or your allowances do get reduced.
To put this into perspective, if you were a basic rate taxpayer, say you earned £35k a year and you also had a savings account worth £20,000 which was paying an interest rate of 5%, that 5% would give you £1,000 of interest that year, and that would fall into your £1,000 savings allowance so no extra tax would have to be paid. Now, if you had something like £30k in savings and got 5%, then your interest would be £1,500, and once you take away your £1K allowance, you would then be left with £500 that is taxable. The rate of tax you'd pay is the same as your tax bracket for income, so in this example, it would be 20%, and 20% of £500 is £100, leaving you with £1,400 in total.
Just quickly, don't forget that this is based on using just a regular savings account. There are ways to pay no tax at all on your interest, and you can do this by making sure that you use one of your ISA accounts. If you use a cash ISA, there's no interest to pay, and you can put in up to £20,000 per tax year into your ISA. But do just be aware that that £20K allowance is the total amount that you can put in across all of the different ISA accounts.
The Pros and Cons of Savings Accounts vs. Investing: Making Informed Financial Decisions
Now let's talk pros and cons. Savings accounts right now are looking pretty healthy, 5% interest, which is virtually guaranteed with almost no risk, is sounding nice for a lot of people. But let's just consider what the downsides are as well. Firstly, they depend on the base rate, and although it's good now, they are expected to come down in 2024, so these rates don't last forever. Secondly, in the long term, savings rates aren't going to be other kinds of investments like stocks, which we'll be talking about in a moment. And finally, something that all of these choices have to take into account: don't forget about inflation.
Inflation in the UK is currently around 4%, according to the latest figures. So this means if you make 5% in your savings and then remove the effects of inflation, then your real rate of return would be just 1%. Now, it's still better than losing money, but don't forget about this part. Inflation has a huge impact on your finances, and if you do nothing with it, then you're guaranteed to make a loss anyway.
Let's move on to my favorite topic that I've built this whole channel on: investing. This can be a scary word for most people when they first hear it because they think investing is too risky and they'll end up giving all of their money away to someone. But I think if people learned a few basic lessons and focused long term, this couldn't be further from the truth. So what do we mean when we say investing? Well, for me, I'm talking about using your money to invest in the stock market, and that money will buy shares in companies who over the long term will grow, make profits, and become worth more than they are today. It sounds easy, but it's not guaranteed and will almost definitely be a very bumpy ride.
Understanding the Long-Term Benefits of Investing
Here's a chart showing the returns of the S&P 500, which is one of the most popular stock market indexes in the world that a lot of people like to use as their benchmark. It includes all of the biggest companies in the world like Apple, Microsoft, Amazon, Google, and many more. Now, as you can see, over the last 100 years or so, the stock market has had a very bumpy ride. Some years have been really good, and other years have been really bad, especially during crashes like the Global Financial Crash or the Dot-com bubble. But here's a couple of things worth paying attention to: the long-term average return of the stock market is about 9%, and it's even a bit higher if you take the last 20 years or so rather than go all this way back.
Now what this means is that if you manage to invest, let's say £300 a month for 20 years, and you got that 9% as an average, you'd end up with almost £200,000, and the best part is that over £120,000 of that would have been gains compared to the £7K or so that you would have actually put in over that time. Just quickly, compare that to a savings account that we spoke about earlier. Let me show you the difference that investing can make compared to saving in the long term. If we run the same example again but now only get the average savings rate of the last 30 years, which is about 4.29%, we end up with £13,000. Still a nice return, but that's nowhere near what we would have got by investing our money. Investing in the long run has beaten savings rates, but just be warned that it only works in the long term. When we look back at 1, 2, or even any time period up to 5 years, things can turn out very differently.
For example, think about 2022 for a minute. The stock market dropped by almost 20%, and if you chose to invest your money for a year rather than put it into a savings account, well, you would have lost a huge amount of cash. But if you had been investing for the last 5 years at least, you would have seen your investments rise by almost 100%, and this would have been way more than you would have got back by using a savings account, as interest rates have been almost zero after 2008. So investing is amazing in the long term, and you get to use the benefits of compound interest, which is when year after year your money makes more and more money as it gets bigger. Also, even with great rates for savers, 2023 was a stock market rally that seemed to come from nowhere, and now the S&P 500 at least is up around 25% for the year. Imagine if you sold everything in 2022 and only had a savings account. You'd be pretty annoyed right now, and I'm sure that a lot lot of you out there who actually did this are sitting like that. And sure, anything can happen in the short term, but just be warned trying to time the market when it comes to investing is not a smart thing to do.
Benefits of Investing and Considerations for Paying Off Your Mortgage Early
Now, I've done loads of articles to help people get started investing, so I'm not going to go into too many details here. And also, if you do want to get started this year and open up your own stocks and shares ISA, I keep the links to my favorite investing platforms in the description below where you can get yourself free cash or even free shares to help you get started. I strongly recommend that you use the stocks and shares ISA in the UK as this type of account, just like the cash ISA, is one where none of the gains you make are taxed, so anything that you make is all yours. Either way, remember I'm not a financial advisor, so please do be careful, do your own research, and find out what works for you. Okay, quick pros and cons list: investing is definitely riskier than saving, but with that risk does come greater rewards. It's also something that you must take a long-term view on and can't try and time in and out. It's not a get-rich-quick scheme, and it's not meant to make you rich, so don't fall for any of this passive income nonsense online. But over the long term, stocks have been the best way to build wealth, better than any other kind of investments, yes, even property, which might surprise a lot of people here in the UK.
And on that note about property, what about the most interesting question of all, our final thing to consider: paying off your mortgage early? This also ties in heavily to what we mentioned earlier about interest rates and inflation, as your mortgage and the interest rate on your mortgage are all tied up in this whole mess. So, firstly, consider interest rates. As they've been put up over the past couple of years, this has led to the cost of borrowing money to get more expensive. If you want a new loan, a credit card, or even a mortgage, the rates that you've been offered have been going up. This makes sense, as think of it like this: a bank could get 5% on their money from the Bank of England, so why take the risk on you and your mortgage unless you give them a little bit of a premium on top?
Now, although some people in the UK are on a variable rate mortgage, meaning that their interest rate gets changed almost immediately, most people are on some kind of fixed deal which is usually 2 to 5 years, where the interest rate is fixed. At the end of the deal, we then have to remortgage, and at this point, if interest rates are a lot higher than they were at the beginning, this is where the pain starts to kick in. Let's just run a quick example to see what early repayment might mean. I'm going to say that we have £150,000 mortgage with 20 years left on our repayment schedule. I'll say that our interest rate is 4.5%, which is about what people are getting now. If they have to remortgage, if we say we'd like to repay £200 a month extra as an overpayment, here's what we get: We save 5 years on the mortgage, and we also save £21,000 in interest. Also, this would mean in 20 years time we'd have no mortgage so that £1,149 we're currently paying could be put towards anything we like.
Analyzing the Options: Savings, Investing, or Paying Off Your Mortgage?
Now, on its own, this information doesn't tell us much. You have to compare it to something else; otherwise, there's no way to know if this is a good use of your money. Firstly, let me quickly show you the same example where the interest rate is just 2% in case you're on a low rate right now. As you can see, you actually save way less money and even a tiny bit less time. Just £8,000 is saved on interest because the rate is so low that you're currently on. Obviously, this is because with a very low rate of interest, there's less interest to pay and therefore less incentive to pay it off early. Now, what about the alternative? Let's say that you take £200 a month and invest it or save it. If we use the average numbers we spoke about earlier, here's what you might get if you save your money for 20 years or invest. Pretty nice, then definitely more than the savings we saw earlier of £21k on a 4.5% mortgage. But let's just make things fair and see if we can make this even more interesting. After 15 years, remember with our mortgage paid off, technically we'll have 5 years where we have no mortgage payments but all this extra money to play around with.
So what if we use all of that money, including the overpayment, and stuck it into an investment account for the final 5 years and see what happens? And with the power of editing, here on screen is what that might look like: investing £1,149 a month for 5 years, getting a 9% return gives you a very healthy £88,500. Now, it's still not as good as investing your money; it is slightly better than saving your money, and you also have that huge peace of mind knowing that your mortgage is completely paid off. And that is something that seems to be really important to most people. In almost every article you read or watch about people who've paid off their mortgage early, they all mention the fact that it's not all about the money. Most of them realize that they might have been better off by investing, but then they also know that nothing's guaranteed, even though we've had a really good market for investing over the past couple of decades.
There's nothing better than a paid off mortgage to help you sleep better at night. Also, let me just throw in a bit of a curveball here when it comes to talking about debt and mortgages when you have high inflation like we've had over the past few years, this is actually good for anyone with debt. Debt gets smaller in real terms with high inflation, and this includes your mortgage. If you have £100,000 left to pay and your interest rate is about 2% but inflation's been running around 6 to 10% for the year, then your debt has actually been falling in real terms. £100,000 is worth less now than it was a few years back. In fact, £1,000 3 years back would need to be worth £120,000 to have the same buying power as we've had almost 20% worth of inflation when you actually accumulate it over that time. So as a general rule, if the rate of inflation is a higher percentage than your interest rate, then paying down debt early makes almost no sense at all, at least in financial terms.
But here's where things get interesting because as most of us are going to have to remortgage in the next couple of years, we're almost certainly going to have higher rates than we do now. I know I'm going to have to move from 2% to something like 5% maybe in a couple of years. So there is definitely an argument that says, well, why not pay down the debt now while your rate is cheap to save the interest later on? I mean, it makes sense to me, but again, I think this kind of decision is more of a personal, emotional one rather than a straightforward down-the-line financial one. And I think that actually this is a really good reminder that any decision you make in the world of personal finance is always going to be personal to you. Nobody can tell you what's right for you other than you, as only you know the level of risk that you're happy with. Whether to pay off your mortgage even though investing is probably better over the next 10 to 20 years, totally a personal decision, and I don't think you'll care with a paid off mortgage when everyone else around you is getting up early for work and stressing about paying for it.
And this leads us nicely to a bit of a wrap-up and comparison. I think this question is about three different things: your level of risk, how long you have, and finally, how something's going to make you feel. Saving is very low risk; the money's protected, at least under £85k here in the UK. You can use a tax-free account like an ISA, and the current interest rates are better than they have been for more than a decade. Saving also gives you huge peace of mind knowing that you have money available in case anything goes wrong, something I always support doing before you even consider investing. Now, on that topic of investing, it's a lot riskier in the short term at least. There's no way to know what you'll end up with. You can also use tax-free accounts like ISAs again. Don't forget to check out my links below. But the rewards, at least if you look back through history, are likely to be the best you can get, and there's no limit on what you can grow when you compare that to a savings account. Put it this way, nobody got wealthy using savings accounts over 20 years. Finally, paying off your mortgage early, another choice that's very low risk.
Conclusion
You know what rate you're paying off, and there's no surprises at all. I think this decision is all about personal choice and how you feel because there's almost no way that it makes financial sense over the long run, especially when you compare it to investing. But if that end goal of having no mortgage is that motivational force you need and it's something to work toward and you can't bear looking at an investing account losing money, then hey, maybe this one's for you. I do think with higher interest rates, this decision is now harder than ever. When I did this article last year, it felt like a no-brainer for me to say that investing really is the way to go in the long term, at least. The truth is that it's all up to you, and you can pick one or all of these things at the same time if you're lucky enough to have that kind of spare money left at the end of the month. Anyway, I'd love to get your thoughts below in the comments. Let me know if I've missed anything off and what you're choosing to do this year: saving, investing, or paying off that mortgage. And on that note, see you in the next article. Happy investing!