Why making money is like driving a car

We explain how to get into top gear on the road to riches.

When I was learning to drive about 15 years ago, my driving instructor explained that cars have different gears so as to overcome different challenges.

Also, a car’s gears can be likened to different animals. First gear is like an elephant: strong and powerful to pull away and climb steep hills, but unable to reach high speeds. Top gear is like a cheetah: great for high-speed cruising, but lacking raw power.

The road to riches

In many ways, your financial progress through life is like working your way through a gearbox. You need to start well, build up momentum and then hit top gear on the road to riches. Do this smoothly and you can cruise along, enjoying the ride.

Here are my five gears for financial success:

First gear: Budgeting

You mustn’t pull away from the kerb without being in first gear. Likewise, without learning the basics of budgeting, you can’t set off on the right road to riches.

Although many people find budgeting boring, it can be summed up in three simple sentences:

• Spend less than you earn.
• Live below your means.
• You can spend it only once.

In other words, by maximising your income and minimising your expenses, you can create surplus cash to build a nest egg for your future. Of course, without proper budgeting, your financial journey can still begin, but you may drive up a dead-end street.

Try lovemoney.com’s online banking and budgeting service!

Second gear: Borrowing

Moving into second gear involves learning how to borrow sensibly.

It makes perfect sense to borrow to buy a home or start a business. However, borrowing merely to subsidise your current lifestyle makes no sense at all. What’s more, it can be hugely expensive: a typical credit card charges a yearly interest rate of over 18% APR, and interest rates on rip-off store cards can exceed 30% APR.

So, finding second gear means being sure to borrow only what you can afford to repay, while paying the lowest possible rates in order to minimise your interest bill. For example, thanks to ultra-low mortgage rates, remortgaging can lead to yearly savings of £1,000 or more. Similarly, replacing expensive card debts with a 0% balance transfer is a smart move.

Third gear: Saving

Saving brings us to the midpoint of the gears -- ideal for city driving, but not good for long motorway hauls.

What I mean is that saving in cash is perfect for the short-term, but unlikely to make you rich in the long run. This is because, historically, returns on cash have only just kept ahead of inflation (the rising cost of living). Even worse, with the Bank of England’s base rate at a 316-year low of 0.5% a year, savings rates today are as low as they’ve ever been.

Nevertheless, your goal as a saver should be to build up a cash pot, rainy-day fund or nest egg to tide you over life’s little difficulties. Ideally, you should have three to twelve months’ living expenses in a high-interest savings account to smooth out the bumps in the road.

You should aim to find the best possible combination of high rates and easy access. Also, try to avoid paying needless tax by making full use of your yearly cash ISA allowances.

Fourth gear: Insurance

Now you’re gathering speed, it’s time for fourth gear: protecting yourself, your family and what’s precious to you.

Many insurance policies (such as payment protection insurance, extended warranties and identity-theft insurance) aren’t worth the paper they’re printed on. Indeed, they’re sold to profit their providers, rather than provide value-for-money cover for customers.

Then again, some protection is vital if you don’t want to spin off the road. For example, at various times in your life, you will need car insurance, home insurance (buildings and contents), life insurance and travel insurance.

In short, all insurance is a gamble, so always weigh up the risks and rewards of each policy before buying. Also, don’t automatically renew a policy without shopping around first, or you’ll get mugged.

Fifth gear: Investing and pensions

Finally, we reach top gear: building wealth over the long term.

This involves two approaches: saving for retirement (usually via a workplace or personal pension) and building wealth by investing in the stock market. Pensions are a thorny issue and something of a political football, so we have lots of articles on this topic here.

As for investing in shares, it’s not like buying a lottery ticket. By buying into strong, well-managed companies, you can share in their future success. This means making money from capital gains (share-price increases) and dividends (the income paid to shareholders).

To learn how to become a part-owner of many businesses, read our Grow your wealth section. Also, be sure to protect your investment gains from the taxman with a stocks and shares ISA.

Finally, getting swindled out of your hard-earned cash is like having your car stolen, so watch out for these scams.

Enjoy your ride!

More: Find your perfect savings account | Your ISA can make you a millionaire | Use your PC to get richer