Dear Monzo, I’m saving £200 a month – but where’s the best place to put it?

I finish paying my student loan off in March 2020, which will mean I’ve got £200 a month to spare. 

Should I put the extra into an ISA, increase my pension contributions, half and half, or something else?

Firstly, make sure you mark this momentous occasion! I read something wise the other week about how we ought to celebrate our money successes more. 

Just like you might write down three good things you’ve achieved in a day to lift your sense of self-worth, note down when you’ve made positive financial decisions or hit a money goal – whether that’s saving as much as you’d hoped, or resisting the temptation of an EasyJet sale email.

This is a nice antidote to constantly berating ourselves for being weak-willed, overspending, and feeling in a permanent state of doom about money. Sometimes we make silly money mistakes. But sometimes we do things worth celebrating! And that includes clearing your student loan.

Although I'm sorry to those reading who’ve been to university since 2012, when it’s going to be a lot harder to celebrate this milestone. As tuition fees were much higher, you might have to plan yourself a party for your mid 50s, when after 30 years any outstanding debt will be wiped.

I’m also impressed that you’re not immediately jumping on that extra £200 to upgrade your spending, which would certainly be my first instinct.

Lifestyle creep is an interesting phenomenon. Why is it that once we earn more, we suddenly want more expensive things? 

If you can fight the urge to settle into a new wealth bracket whenever you get a pay rise or an unexpected injection of cash, you can end up better off.

So, having decided that you’re going to do something sensible with that extra £200 a month, what’s your best move? The answer’s not straightforward, and it really depends on your aims and ambitions in life.

Do you own a home? If you don’t, ask yourself if you’re spending a huge amount of money on rent, and could benefit from channeling that cash towards a mortgage instead? That might save and earn you more money in the long run than having a big pension you can’t access until you’re 55.

It’s also worth remembering that if you’re still paying rent when you’re retired, that’ll cut into your retirement income. A lot of the models that show how much you should save for retirement assume you won’t have housing costs when you retire. But for many people in their 20s and 30s now, that just won’t be the case.

If you do decide to save for a deposit (and it’s your first time buying a house), I’d consider a Help to Buy ISA or Lifetime ISA. They offer a bonus from the government if you use your savings to buy a property.

If buying a house isn’t your priority, think about what else you want to save for, and when you need the money.

If you don’t have savings set aside for an emergency, it could be worth prioritising that first.

Financial advisers always go on about needing an emergency savings pot, and the oft-cited figure is three to six months of essential outgoings. This is cash you should keep handy in case something unexpected should happen, like if you lose your job or get ill. 

It’s useful, therefore, to make sure you have a comfortable safety net of savings before you start boosting your pension, so you’re not living paycheck to paycheck and have a buffer if you need it.

Think about it like this: what if you put all your spare money in a pension, then find yourself in a situation where you need cash urgently? If all your money’s tied up in a pension you can’t access until you’re older, you could end up in incredibly expensive debt.

I wouldn’t automatically opt for an ISA for your emergency savings though, because the fact that you don’t have to pay tax on the interest you earn isn’t as valuable as it used to be.

That’s because you now you get a personal savings allowance, which means you can earn a certain amount of interest on your savings before you have to pay tax, whatever kind of account they’re in. This personal savings allowance is generous: £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. 

Given that the interest rates you’ll earn on savings are fairly low at the moment, it’s unlikely you’ll earn enough interest that you’ll have to pay tax. So if that’s the case, your priority should simply be getting the best interest rate on your savings.

Consider getting a regular saver instead, where you can save a set sum a month (usually no more than £200), and get a higher interest rate in return.

Pensions are much more generous in terms of tax. So your £200 a month will grow more significantly if you’re prepared to lock it away. This is especially true if your employer is making a contribution. And if you increase your contributions, many employers will top theirs up too.

Pensions also benefit from the magic of compound interest. So the earlier you start saving, the longer that money has to grow. Compound interest even means that if you start putting money aside when you’re younger, you’ll actually need to save less than if you wait until your 30s or 40s, to end up with the same amount.

It might be time to sit down and figure out how much you actually need to save for retirement. It’s worth trying to get a bit of a picture now about what your pension might look like in the future. 

Start by plugging some numbers into a pension calculator (there are lots online!). You can type in how much you earn, how much you have in a pension already, how much you’re saving towards it, and when you want to retire. You’ll then see how much you should put away by the time you want to stop working.

This number can seem pretty terrifying. But you can use it as a guide to start thinking about how much you need to be saving and where you should put it.

Ultimately, what you do with your extra £200 depends on what you want the next decades of your life to look like. Is it more important for you to save for the near future, or for your old age? Only you can really know that.

Good luck!