Four important financial concepts that most people miss

We all strive to make “good” money decisions, but with the day-to-day hustle and bustle of everyday life, good intentions alone might not be enough.

The truth is, while many people implement basic financial principles, such as budgeting, there are several important financial concepts that many still miss.

Here, discover what these are and find out if you’re including them effectively in your financial plan.

1. Compound interest

Often dubbed the “eighth wonder of the world”, compound interest is the phenomenon where you earn interest on both your initial amount and the accumulated interest from previous periods.

It can create a snowball effect, where your money has the chance to grow exponentially over time.

This is why starting to save and invest as early as possible, even in small amounts, can lead to substantial wealth accumulation. The longer your money has to compound, the more significant the effects could be.

For example, if you were to save £40,000 and then continue saving £400 each month for a set period, you’d earn increasing amounts every year just on compound interest alone.

The data in the table illustrates this and assumes an interest rate of 3.5%.

Source: Aviva

2. Lifestyle creep

Lifestyle creep is a subtle trap that can derail even the most meticulous financial plan. It happens when your spending increases in line with, or even outpaces, your rising income.

For example, a promotion at work might lead to you upgrading your car, moving to a bigger house, or dining out more often. While there’s nothing inherently wrong with enjoying the fruits of your labour, unchecked lifestyle creep can make it difficult to grow your savings and investments in line with your increased income.

Examples of lifestyle creep include:

• Dining out often and at more expensive places
• Regularly buying new, more luxurious clothes
• Upgrading your car to something more expensive
• Spending more at the grocery store without a budget in mind
• Buying or renting a home that’s more expensive than necessary
• Purchasing more “nice to haves” than you really need, such as multiple cars.

Indulging in the above or more has the potential to create a perpetual cycle where you need to earn more just to maintain your current lifestyle, rather than building wealth over the long term.

3. Tax breaks

A lack of understanding about your taxes can result in missed opportunities to save money or even cause costly and otherwise avoidable mistakes.

From neglecting tax deductions to failing to plan for future tax obligations, you could be leaving money on the table every year.

Here are the various taxes you could expect to pay or encounter at some point:

• Income Tax
• Dividend Tax
• National Insurance contributions (NICs)
• Capital Gains Tax (CGT)
• Inheritance Tax (IHT)

Remember, paying more tax than necessary can reduce your disposable income and erode your ability to save.

Fortunately, there are plenty of ways to minimise your tax burden, many of which your Financial Planner can help you with.

Whether it’s increasing contributions to tax-advantaged accounts such as workplace pensions or Individual Savings Accounts (ISAs), finding more productive tax strategies for your finances could help boost your long-term financial plans.

4. Financial advice

While it can be empowering to take control of your finances, not seeking professional financial advice could be detrimental to your long-term wealth accumulation. A qualified Financial Planner can offer tailored guidance, help you navigate complex decisions, and even make it easier to avoid potentially costly errors.

Indeed, research by Vanguard highlighted the tangible value of financial advice. Their study showed that people who received professional financial advice saw an average annual boost to their wealth (in both pensions and financial assets) of 3%.

While 3% might not sound like a lot, remember the value of compound interest.

Let’s assume that you have £250,000 in investments. In an average year, these investments might grow by 5% per year. Over a period of 15 years, Unbiased calculates that your investments would grow to £519,732.

This is with no further contributions.

If you worked with a financial advisor and achieved the extra 3% a year, the same investment could grow to £793,000.

We’re here to help

Ultimately, making “good” money decisions is about aligning your financial actions with your personal values and long-term goals. It requires a blend of knowledge, discipline, and a willingness to adapt your approach as your circumstances evolve. By understanding these key concepts, you can potentially avoid common pitfalls and build a more secure and prosperous financial future.

This is something we can help with.

Whether you’re an existing client looking to review your strategy or a new client seeking expert guidance, talk to us today to find out what we can do for you.

Email us at enquiries@pen-life.co.uk, or call 01904 661140 to learn more.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

The Financial Conduct Authority does not regulate tax planning.