Don’t sit worrying over the figures

Claire Sutton is a 28-year-old working in London as a PR manager and is hoping to use her recent pay rise to gain more financial security.

After graduating, Sutton worked in low-paid jobs and accumulated credit card debts of £2,000. Recently she was awarded a pay rise and now has an annual take-home salary of £30,000, with possible bonuses of up to £2,000. Sutton moved her credit card debts to a bank loan six months ago. Since then she has reduced the loan to £1,600 and has built up Isa savings of £1,400.

As she has no dependants, Sutton enjoys a lifestyle that includes spending on holidays, clothes and entertainment. “When I first moved to London I didn’t realise how expensive everything would be and I really struggled to make ends meet,” she says. “I’ve been here for six years now and am a bit more savvy, but I’m still not sure I am making the right decisions with my money.”

Sutton wants to make her financial situation more secure and save up for a deposit on a house. “I don’t know if this is a viable option as I live in London,” she says. “Even with my pay rise I don’t know if my salary will stretch far enough to buy a house.”

Jason Witcombe, certified financial planner at evolvefp, says that Sutton is clearer in her goals than many young people and this bodes well for her potential to meet them. “The key is to build a structured plan and stick to it. Essentially, her main asset is her future earnings potential,” he says.

In terms of financial protection Witcombe says that the main financial risk Sutton faces is being unable to work for a protracted period of time because of illness or disability.

“Some employers offer income protection benefits through work, sometimes covering up to 70 per cent of earnings,” he says. “She should check whether she has access to such a benefit and if not she should consider taking out some insurance.”

Insurance against illness and disability is relatively cheap for young people. Critical illness cover, which provides a lump sum in the event of illness, is also popular, but Witcombe says it can be unnecessary if an individual already has good income protection cover.

As for the loan, the advisers say there is no need to continue maintaining a loan with a high repayment rate as Sutton has sufficient savings to pay it off.

Paul Garwood, director of Smith & Williamson, says that debt repayment is a good use for excess cash.

More risky is Sutton’s plan of purchasing a home in the near future but Garwood says that if she can afford to, it makes sense to get on the ladder as soon as possible.

However her chances of buying property in London are limited. “It is unlikely she would be able to borrow more than four times her earnings although some lenders will stretch to five or six times,” says Garwood. “I would strongly advise her against taking on too much debt unless she feels confident that she can continue to repay the interest.”

The maximum amount Sutton is likely to be able to borrow is around £120,000, and the interest on this will vary depending on whether she has a fixed or variable rate mortgage. Discount variable rates are currently available around the 5 per cent mark, while fixed-rate mortgages will have rates between 5.5 per cent and 6 per cent for two to five years. Sutton’s mortgage repayments would therefore be between £6,000 and £9,000 annually, which exceeds her current rent payment of £5,000 but is affordable.

Sutton has accumulated almost £3,500 in her employee-run scheme. She has chosen a plan that will change as she grows older to reduce risk. Although the advisers note that such forward planning is admirable, Robert Lockie, certified financial planner at Bloomsbury Financial Planning, says the benefits of a pension scheme for Sutton are reduced compared with higher tax earners.

“Saving for the period when you are not dependent on earned income to meet lifestyle costs is important, but a pension scheme is merely one route to do this,” says Lockie.

Sutton might consider building up her assets and dividing these into three elements – a cash reserve for unplanned contingencies, a short-term portfolio to meet expenses in the next 10 years, and a long-term portfolio which would comprise the pension.

The short-term and contingency money could be split 50-50 between real assets such as equity and nominal assets such as bonds. Lockie recommends putting money each month into an investment trust such as Alliance Trust or Foreign & Colonial, which have low costs and are highly diversified.

“At this stage of life there is no need to do anything complicated,” says Witcombe. “Pay down the debt and build up a deposit for a future house purchase. Make sure you are getting the most out of employer benefits and be careful with expenditure.”

Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools. Please don't cut articles from and redistribute by email or post to the web.