I read an article today, which granted is a few days old, about how to escape the insanely high charges and fees linked to many overdraft facilities offered by high street lenders. Overdrafts, in my experience, tend to be overlooked as a form of debt but that is exactly what they are. Overdrafts can also be one of the most expensive forms of debt you have. The image below, taken from the Daily Mail article, illustrates the equivalent interest charged by main high street banks for their overdraft facilities.
This is not an article to argue that overdrafts are evil; far from it actually. As I argued in my blog on credit cards, it is not the facility itself that is evil. The core problem is that people are, generally speaking, bad at managing money. According to a fairly recent article in The Guardian, the average household in the U.K. spends almost £1,000 more than it earns in a typical year. Without seeing the raw data, only certain conclusions can be drawn. Any "average" can be skewed by outliers in the data set but with credit card debt in the U.K. standing at over £70 billion it is clear that something is not quite right in how people manage their money.
The article that prompted this blog suggests that a potential way to escape the overdraft prison is to use a credit card to pay off the overdraft. Initially, I can see how someone who is not financially literate may believe this to be a good idea. Some credit cards offer a low, or even zero, interest arrangement to move funds from the credit card into a bank account to clear the overdraft. The amount of interest charged would drastically reduce and everyone is happy. Unfortunately, it is not that simple.
The one question that is not being asked here is how did the overdraft debt accumulate in the first place? If Mr Customer is spending more than he earns, then clearing the overdraft is probably only a temporary reprieve. The debt, whether on the credit card, the overdraft or both will continue to build up. Transferring debt from overdraft to credit card, without addressing your spending, is like taking a painkiller for a broken leg without treating the break itself.
Overdrafts can be useful as an emergency form of credit. In my experience, so many people live in their overdrafts and ignore the fact they are paying what is essentially another form of tax each month. It all comes down to money management and financial education. Swapping one form of debt for another is not sound financial advice if day-to-day spending is not carefully controlled. The key to financial stability is learning how to budget.
The FIRE Movement
I didn't realise that my philosophy towards money actually had a movement named after it. FIRE is an acronym for "financial independence, retire early" and looks at how prudent spending and investing can allow for one to build up a portfolio of investments that provide passive income, allowing one to retire from paid work.
The FIRE plan calls on followers to save 25 times what they think they need to live off for a year; in other words work out what you annual income you need from investments generating a 4% return. If you think you need £12,000 per year, you would need investments worth £300,000 that have a yield of at least 4%. I personally aim for a 5% yield, so £12,000 in income would require £240,000 worth of investments.
I strongly believe that as a goal or ideal, this can work. However, you need to be earning a good amount of money. With the best will in the world, earning minimum wage will not let you work towards this goal in a realistic fashion. This should not put those people off completely though. Investing any surplus income, no matter how small, is generally a good idea. Surviving in retirement is only likely to get more difficult and anything you can do to help yourself in retirement is a bonus. Even if you cannot accumulate enough passive income to retire early, you may still be able to make your eventual retirement more comfortable.
My goal is to be able to retire by the time I am fifty. I am currently on track for that, and I've only this month turned 35. I have fifteen years of work ahead of me. It seems like a long way off but watching my investments grow is all the motivation I need on days like today, and today has been a particularly stressful day.
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