Using the snowball effect to grow your portfolio

Saving and the snowball effect

It’s not the sexist topic, but saving up for that first deposit is super important. It’s important because the quicker you make it happen, the quicker you feel the benefits of compounding. That is, the quicker the “snowball effect” kicks in, and the faster you can start to build real wealth through property.

In this post, we’ll look at how to calculate the amount you need to save for your first investment. We’ll also look at where to stash your cash while you’re waiting to invest. We’ll discuss some of the Government schemes you might be able to take advantage of along the way. And, using some simple calculations, we’ll show you how the snowball effect can start to do some of the hard work for you over time, as your portfolio grows.

Calculating your savings target

How much you need to save for your first investment depends on where you’re planning to invest. It also depends on the kind of property you want to buy. If you’re planning to invest in a northern powerhouse city like Manchester, Liverpool or Leeds, you’ll need less cash than if you plan to invest further south. Also, you’ll need less money down if you’re planning to buy a one-bedroom apartment, as opposed to a three-bedroom family house.

A simple example

Let’s take a simple example and walk through how to calculate the amount you’ll need. I’m going to assume you’re aiming to buy a two-bedroom apartment for £160,000 somewhere in the north.

The deposit – For a simple buy-to-let investment, you’ll need to put down a deposit of at least 25% of the purchase price. So, you’ll need to save at least £40,000 for the deposit.
Stamp duty land tax – You’ll need to pay stamp duty of £5,500 on a property worth £160,000. This figure includes the stamp duty surcharge you’re subject to as a UK property investor.
Furnishing and redecoration – If you plan to do any redecoration after you buy the property, you’ll need to pay these costs upfront. Let’s assume we’ll spend £2,000 on redecoration and £1,500 on furnishings.
Legal and other fees – Legal fees could be up to £2,000. This includes the cost of independent legal advice on personal guarantees, if you’re investing through a limited company. In addition, the mortgage valuation fee might be £500, and a mortgage broker could be £500.

Therefore, you’d need to save £52,000 to do this deal. This includes all the funds you need to get the property into a great condition to let out.

Adapting these workings

You can adapt these workings as needed to set your own savings target. You should base your figures on the areas you’re looking to invest and the kind of properties you’re planning to buy. Remember to make sure you’re working from the latest stamp duty rates and thresholds. You can find the latest rates on the gov.uk website. Also, remember to make sure you build in the 3% surcharge for second homes.

Where to invest your funds

Depending on your target, it could take a number of years to build up enough funds for your first deal. While you’re waiting, you should keep your savings somewhere safe. Also, you should try to generate some extra return by investing them. This will lower the amount you need to save to meet your target, so it will help you get there a little bit quicker. Let’s look at some key considerations when choosing where to park your monies.

Time horizon

Your investment time horizon is likely to be fairly short. That is, you’ll probably want to withdraw your funds in a couple of years’ time at the point where you’re ready to invest. In practice, therefore, you won’t want to keep your savings locked away for periods longer than one or two years. So, this will rule out fixed-term, higher rate savings accounts that keep your money tied. It will also rule out a variety of long-term bonds, e.g. five or ten-year government and corporate bonds.

Volatility

Because your investment time horizon is short, you should avoid asset classes that are too volatile. In practice, this means you should avoid the stock market, cryptocurrencies like Bitcoin, and investments where the volatility is typically in excess of 15% to 20% per annum. Afterall, you don’t want to save hard for two years to build a deposit of £50,000 only to have the stock market crash and the value of your savings fall to £30,000. Falls of this magnitude are possible in the stock market at times of market turmoil and stress. Therefore, you should make sure you’re not exposed to this risk.

Tax efficiency

Finally, you should also look for savings options that are tax efficient. In the UK, you might, depending on your circumstances, need to pay tax on savings interest. You can check out the gov.uk website for full details on the various rules and allowances that cover tax on savings. In practice, it’s often simpler and easier to stick with one of the tax-exempt savings vehicles. This includes cash ISAs (Individual Savings Accounts) or Premium Bonds, offered by NS&I. The prizes on Premium Bonds are tax-free, and the effective interest rate is better than you’d get in most bank accounts right now.

Schemes to help you out

It’s also worth thinking about whether there are any government schemes you could use to speed up your progress. You won’t be able to use them to invest in buy-to-let properties or to carry out that next flip. However, these schemes might help you if buying, refurbishing or extending your own home forms part of your property strategy.

The Lifetime ISA

You can use a Lifetime ISA to buy your first home or save for later life. The general idea is that you can put in up to £4,000 each year and the Government will add a 25% bonus to your savings, up to a maximum of £1,000 per year. You can withdraw your money and use it to buy your first home, provided that the property costs £450,000 or less.

Help to Buy Equity Loan

With the Help to Buy Equity Loan, you can get a low interest loan from the Government to put towards a deposit.

The home must be a new build available through one of the Help to Buy Agents and be the only property you own. You can’t sublet it or rent it out. The price must be less than £600,000 in England (or £300,000 in Wales). You need to put in a 5% deposit, the Government will lend you up to 20% to top up your deposit, and the rest you’ll buy with a mortgage. You pay no interest on the Government loan for the first five years. After that, you’ll be charged a fee of 1.75% p.a. of the loan value.

You’ll need to pay back the loan when you sell the property. The amount you pay back will be scaled up or down in line with the increase or decrease in the market value of the property.

Staying up to date

These kinds of schemes change all the time, so you should make sure to check out what’s available to you at the time you’re deciding on your own strategy. Check out the gov.uk website for the latest detail on all these schemes.

Also, don’t fall into the trap of letting the tail wag the dog. That is, don’t let your strategy be determined by one particular scheme. If you find you’re trying to twist your plans and tactics just to make use of a particular scheme, then it might not be right for you in the long run anyway.

What is the snowball effect?

Getting started in property is hard. It takes a special kind of determination and belief to stick with it over the long term, setting aside savings month after month, year after year, with an uncertain future payoff. But for those who stick with it, the rewards can be handsome, and at some point the snowball effect will start to help you out along the way.

To illustrate how this concept works, let’s take a look at the length of time it could take for us to save for each extra property that we’re planning to purchase. There’s no fancy mathematics here, and we’re not employing any other strategies that might speed up your journey. We’re simply taking a look at how long it would take us to grow a portfolio of 20 properties through the brute force approach, i.e. via raw savings power only.

The snowball effect in action

Suppose we’re aiming to buy several properties around the £160,000 mark. Per our example above, we’ll need to save around £50,000 for each deal. Therefore, let’s assumes that we’re capable of saving around £2,000 per month or £24,000 per year. This means it will take us £50,000 ÷ £24,000 = 2.1 years to save for our first deal. However, if we achieve an ROI of 6% p.a. on our cash, then our first property will generate £50,000 × 0.06 = £3,000 per annum or £250 per month of additional cash flow, which will help us save for our next property deal more quickly.

In the table below, I’ve set out how long it will take us to save for each property in our portfolio using this approach.

Property	Annual savings	Time taken to save
1	£24,000	2.1 years
2	£27,000	1.9 years
3	£30,000	1.7 years
4	£33,000	1.5 years
5	£36,000	1.4 years
6	£39,000	1.3 years
7	£42,000	1.2 years
8	£45,000	1.1 years
9	£48,000	1.0 years
10	£51,000	1.0 years
11	£54,000	0.9 years
12	£57,000	0.9 years
13	£60,000	0.8 years
14	£63,000	0.8 years
15	£66,000	0.8 years
16	£69,000	0.7 years
17	£72,000	0.7 years
18	£75,000	0.7 years
19	£78,000	0.6 years
20	£81,000	0.6 years

The Snowball Effect – Time taken to save for each property

The power of the snowball effect

From the table, you can see that it will take us 8.6 years to save for our first five properties, 5.6 years to save for our next five properties, 4.2 years for the next five, and 3.3 years for the last five. That’s the power of compounding and the snowball effect. Therefore, even if you started your property journey at 45 years old, you could still grow a portfolio of 20 properties bringing in £5,000 per month by the time you retire. With the help of some capital growth along the way, you might even be able to do a lot better than this.