Financial capability: Managing money and planning ahead

By Marianne Curphey

Whether or not you are financially capable may seem like a subjective judgment. After all, you might think you're financially capable as long as you can pay the bills, while your friend thinks you can't be considered financially capable unless you can pay the bills and have enough saved for at least three months' worth of expenses.

However, a recent report from the Office for National Statistics, which studied adults in Great Britain from 2010 to 2012, gives some solid guidelines to go by. It says only one in 100 people studied are truly financially capable, meaning almost everyone has room for improvement in at least one area.

The organisation defines financial capability as "having the skills, knowledge and behaviours needed to make informed decisions and take positive action about their finances". The ONS measured capability using six dimensions. It scored individuals on a scale of 0 to 10:

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Financial capability:
How do Britons measure up?

This is the first part of a three-part series on financial capability. Check out the rest of the series:

Part two: Staying informed and choosing the products.

Part three: Making ends meet and controlling spending.

  • Planning ahead. Brits scored the lowest on this dimension, with a mean score of 2.3.
  • Having organised money management. (Mean score: 6.7.)
  • Making ends meet. (Mean score: 7.0 -- the highest of all the dimensions.)
  • Controlling spending. (Mean score: 6.7.)
  • Staying informed. (Mean score: 3.2.)
  • Choosing products. (Mean score: 6.6.)

Though the study revealed that certain groups, such as childless couples
or those in higher socioeconomic groups, did well overall, every group
suffered in at least one category. For instance, those with the highest incomes scored well in choosing products and making ends meet, but not in planning ahead. Those with lower incomes scored the lowest overall, but did well in money management, presumably because they have to budget more carefully than people who earn more.

In a short series of stories, UK.CreditCards.Com will break down each category and what steps you can take to eventually improve your overall score. We're starting with money management and planning ahead.

Periodic adjustments are key
One cause for even the wealthiest to fail at good money management is complacency, according to Justin Modray, financial services expert and founder of money management website CandidMoney.com. You need to periodically review your finances and adjust to changing circumstances.

For a lower income household, that routine might mean putting all money toward bills and debt, and barely having enough to scrape by until next payday. Higher earners may simply not pay attention to what they're spending, knowing that their salary is good enough to cover whatever they need.

"If you don't have much money and are struggling to make ends meet, then you have no choice but to make your money stretch as far as it can," Modray says. "However, if you can borrow freely and know you have the capacity to pay back your debt at some time in the future, then you may not be so concerned about careful money management."

Look at your budget carefully, says money expert Lisa Conway-Hughes, an independent financial adviser with Westminster Wealth Management. Pay attention to which categories of spending eat up most of your earnings. Remember that your incomings and outgoings aren't the same year-round. You might get an annual bonus in January or February, but have more expenses in December. Or perhaps your children are in school autumn through spring, but you need to pay for extra child care during the summer.

"I recommend looking at your income and outgoings every six months, and also taking time to draw up an annual budget to get an estimate of what the cost of holidays, children, eating out and other expenses are likely to be over the next 12 months," Conway-Hughes says.

Even if you live comfortably enough that you don't feel the need to use such a fine-toothed comb on your budget, you can still benefit from it, Modray says. For instance, you might be able to spot that you aren't getting the best deal on your borrowing, or that you are paying for unnecessary items.

"For example, you may have set up a credit card to pay off the minimum each month, when in fact you have sufficient savings built up to clear the debt in one go and save yourself the ongoing interest," he says. "If you do still need to borrow, check what interest rate you are paying and whether that is really the best option; there are plenty of good deals that you could switch to. Check if you have old direct debits going out each month for gym memberships or other services and whether you actually recognise them or need them."

Once you have money management under control, planning for the future should naturally follow, as you'll discover exactly how much you have left over for savings, or discover where you can cut your budget to start a savings. Conway-Hughes suggests using a 30%/70% method to split up where your money goes.

"Set aside 15% of your income for retirement planning, 5% on insurance and protection, and 10% on medium-term cash savings," she says. "Then the 70% that is remaining can be used to pay your mortgage, and other expenses."

When you have these two aspects under control, a third will naturally start fall into place: living within your means, says Nick Hill, proposition and product development manager for the Money Advice Service. In other words, a detailed, dynamic budget is a powerful tool in boosting your financial capability.

See related: How can you improve your financial literacy?, Making budgets work when money is tight, Tips from the pros: Sorting your financial clutter

Published: 7 August 2015