When to start saving for retirement?
Why is compound interest so important?
What is simple interest?
Many people believe they are too young to start saving towards retirement as it’s so far away, but this couldn’t be further from the truth and we are going to examine why.
When you are just starting out in your career, the prospect of retirement in 40-plus years seems so far away that you hardly give it a second thought. Even in their 40s and 50’s some people still feel retirement is some way off so don’t set up a strategy of how to achieve retirement goals. Although it can feel a long way off, the sooner you start planning and saving for retirement the less you will need to save each month and the less you will notice those savings being deducted from your income.
Statistically, only 1 out of 6 people save enough in the UK to enjoy a comfortable level of income in retirement. For an individual, this is estimated to be approximately £33,600 per annum which would provide a lifestyle that allows you to be more spontaneous with your money. You could have a subscription to a streaming service, regular beauty treatments, and two foreign holidays a year.
Without any savings of your own, the only income you would receive in retirement is your state pension which will provide you with approximately £9,628 per annum (Assuming you have made sufficient National Insurance Contributions), some way short of the £33,600 required for a comfortable lifestyle. The earlier you start to save for retirement, or any financial goal for that matter, the less you will need to set aside each month, not only because of the additional time you have to save but also because of the effects of something called compound interest.
So what is compound interest, and why is it so important to your savings? Firstly let’s look at a simple interest example. If you have savings of £10,000 and it achieves growth of 6% per annum on the initial investment only, after 1 year you will have £10,600 and after year 2 you would have £11,200. After 10 years this would be £16,000. You would have made £6,000 over 10 years or 60% of the original investment. It would take you nearly 17 years to double your money and will not double again to £40,000 until year 50.
Compound interest differs from this as you not only earn interest on the original capital but you accumulate interest on the previous year’s interest as well. Using the previous example if you invest £10,000 and achieve a growth rate of 6% per annum after 1 year you will have £10,600. In year 2 you then earn 6% on the £10,000 original capital and the £600 interest previously earned.
This would mean a total of at the end of year 2 £11,236. In the early years, this may not seem like much of a difference however, after 10 years the total value of the compounded savings would be £17,908. This is the total growth of 79% rather than 60% using simple interest. With compounding, in this example, it would take you 12 years to double your money to £20,000 and a further 12 years to double again to £40,000. It would continue to double every 12 years.
The following table shows how effective this, combined with making savings for longer can really reduce the amount you need to save from different ages to retire at 68 with a comfortable standard of living (income of £33,600 per annum). I will continue to use the 6% growth rates as per my previous examples. I will also assume long-term inflation of 2% per annum. (see my previous article about inflation here)
Age Monthly Savings Required
As you can see the earlier you start to save the less you are likely to notice it each month from your disposable income. When saving for retirement there are a number of different ways to do this, it doesn’t just need to be into a pension. Although there are lots of tax advantages when saving into pensions there are disadvantages too. There are other investments and savings products that are available all of which will have positives and negatives when targeting your retirement goals
Whether you are starting to save for retirement now or if you started many years ago and want to know if you are on track to achieve your goals, contact Howard Wright today. Not only will we be able to work with you to tailor a strategy to your specific income and capital goals, but we will also be able to ensure you have contingencies in place so that your plan does not fail should you be unable to work due to long term ill health or, if saving as a couple, if one of you passes away.
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If you would like to discuss saving for the future and your retirement planning with Ashley Smith one of our Chartered Financial Planners at Howard Wright, you can call him on 0345 688 4939 or you can fill in our enquiry form below, it only takes 20 seconds to complete. We look forward to hearing from you and seeing how Ashley can help.
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