A two parter for you, with a completely gripless cliff hanger in between.
Save a pound a day for million days and you’ll be a millionaire. Scratch that, owing to the wonders of compound inflation (“eighth wonder of the world”) it would actually take around 43,000 days, or 117 years.
Daniel Kahneman is a psychologist who paradoxically it may seem, won the 2002 Nobel prize for economics because of his study, amongst other things, behavioural economics. In a recent BBC documentary, he cited the example of New York taxi drivers. He had learned that the ‘typical’ driver knows how much he has to earn each day to make living, pay his expenses and so on. What Dr. Kahneman further observed is that when the weather was good, there was less demand for taxis, so the poor drivers had to do longer shifts to get their daily income. During the bad weather of course, when cold and wet as it often is in New York, taxis are in great demand, and so the daily threshold might be reached in half a day, at which point the driver goes home. At a glance, all seems reasonable, but Dr. Kahneman pondered why not do the longer shifts when the weather was bad, earn above the threshold, and spend the nice days relaxing in the park?
There is much of what follows that can be debated and subject to numerous variable and changing circumstances, but I am using a simplified set of examples just to examine what some might seem as illogical financial behaviour displayed by more than half the population.
In the UK, home ownership, as opposed to renting is higher than in many other European countries, and for most the process is much the same. Spend hours searching, find the place we can afford and if lucky like as well, then pay out a range of fees to set up the deal. Survey, mortgage arrangement fee, legal work, repairs removals, and so on. All in all an involving and expensive thing to set up, and not without significant risks. However, this is just the beginning. Homes bought by those in work using a mortgage, have the joy of monthly repayments to look forward to. Here are some numbers:
You borrow £150,000, and agree to pay it back over 25 years on a repayment basis. Let us say the interest rate on average is 5%, then the monthly repayments are around £877 and you will do almost anything to ensure those payments are maintained, understandably because you want to keep your house and enjoy a good credit rating. Assuming nothing else changes, the total amount repayable excluding the set up fees is around £263,000. This £263,000 is the money you have earned, so seeing as you pay income tax and national insurance, the true cost could be described as £375,000 of earnings for a basic rate taxpayer. Of course, we haven’t considered the costs of maintenance and insurance etc.
At the end of the 25 years, in the words of Al Pacino, as voiced by Rob Bryden, Whaddyagot?” A house, a place to live, hopefully a secure asset, that still needs insuring, maintaining etc. It may have increased in value, quite a lot as it happens if this had been over the last 25 years, and once paid off, a lower cost of living.
Let us play with another idea. You pay someone a fee to help you set up, or you can DIY set up, and pay into a savings plan of some sort; bank account, unit trust, whatever, the point is you regularly save, and somehow, that same motivation to maintain the payments no matter what is in place. So, you pay £877 per month into a fund of some description, and on average, you get 4% return. You’ve still paid in around £263,000, or £375,000 of your earnings, but “Whaddyagot?” Around £452,000. Had you paid into a pension plan, then you would have had around £565,000. In today’s terms, allowing for inflation, this is still over £330,000.
So the obvious problem is if you only buy the house, you may have something to live in, but nothing to live on, unless you sell the house…
If you save, you have something to live on, but nothing to live in, plus you will have had some sort of housing costs for those 25 years. Is it then a fair conclusion that the correct solution is you do both? Well that would be nice but by and large unaffordable for most, particularly with the artificial house price inflation that governments and banks love so much.
Much is written of parents or grandparents helping young adult children with house deposits and, then the young adults hopefully can meet the repayments but often little else, certainly in the early years. Here’s a thought. Imagine an accepted practice would be for parents and/or grandparents to save a regular sum into two funds from the day a child was born until their age 25. Just for comparison, let us use the same monthly figure of £877. Pay one third into a fund accessible at age 25, and two thirds into a pension plan, tied up until their age 55. We invoke Mr. Pacino once more:
At age 25, the accessible fund is £150,000, or £90,000 if allowing for inflation.
The pension fund is £376,000 . Nothing else is paid into this, it is just left invested, and at the ‘childs’ age 55, the fund is £1.25 million, or £750,000 if allowing for inflation. Therefore, funds available for house deposit, no need to save into pension, the pension funds would be payable like a life assurance if the child died before retiring so life insurance premiums saved, and financially secure in retirement, ready to pay into their grandchildren funds.
Although not necessarily realistic, the benefits of using time to your advantage are clear. Save sooner, pay debt off quicker, and financially at least, life could be better. Next time, a real life example of a version of this that has been happily running for the last 13 years.
Bye for now.
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