Counting budget

The Accumulation Stage

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Saving enough money to be able to live off for the rest of your life is a quite a challenge. If I said to you that for the next 12 months you will work from January to June, but then you will be unemployed with no income from July through to December, how would you manage your cash flow? Most people would ensure they save 50% of their earnings in the first six months to ensure they have enough money for the second six months. So why don’t people realise this applies to their whole life? They work for around 40 years, and then have about another 20 years where they don’t work. So by that standard they should be saving one-third of their earnings to live off later.

The question I get asked most often about retirement planning is, ‘How much should I be saving in my pension?’ Whilst there are countless ways of forecasting this figure, probably the easiest rule of thumb is to use half your age as a percentage of your earnings. So a 40-year-old should save 20% of her earnings. Whilst this isn’t taking account how much income you need or any other more complicated factors, this simplistic approach serves as a good starting point. A more detailed method of forecasting is the Lifetime Cash Flow Forecast.

The earlier you can start saving, the better, but it really is never too late. A little is better than none. There used to be a silly part of the State Pension that was means-tested; in other words, if you saved a little instead of none, you got the same pension income. This system didn’t provide any incentive for the less well-off to save. Thankfully the Coalition Government had the sense to scrap that, so the more you save, the more you benefit.

It’s so important that’ll I say it again: It’s never too late to start to save, but the sooner you start, the better. Not only will you save for longer, you will also start to benefit from compound growth. To explain how this works, I want to tell you about a game of golf I played with my best man.

Chris, my best man, lives in Singapore. He was in England for a couple of weeks, so we said we would go and swing the clubs together. Anyway, walking up the first, the Investment Banker in him came out and he said we ought to be playing for money. I said I was happy to take his money off him, but I didn’t want it to get embarrassing, so I suggested we play for ten pence per hole. ‘Ten pence a hole sounds a little pathetic,’ he says. ‘Let’s do that, but double it each hole.’ ‘Ok’, I agree. On the second hole we are playing for 20p; no stress there. 40p on the third and 80p on the fourth are also fine with me. By the seventh, though I am starting to sweat a little, as we are now playing for £6.40. I play reasonable golf, so I am confident I can take it off him. However, it quickly starts getting out of hand. By the fourteenth we are playing for £819.20 a hole, and by the sixteenth for £3,276. As we walk down the eighteenth, we are supposed to be playing for £13,107, but both of us had chickened out long before then! It was too big a gamble even for an Investment Banker, which is saying quite a lot.

What is happening here? This is what is known as compound growth. It is the effect of the growth on the growth on the growth. To look at it another way, if you look a standard piece of paper (0.05mm thick) and folded it in half 50 times, it would reach about 100 million kilometres high, which is about two-thirds of the distance between the Sun and Earth. Amazing, isn’t it? That is compound growth at work.

How does this help your pension? The longer you can leave your money to grow, the more impact doing so will have on your savings, because you will benefit from the growth on the growth. Let’s look at an example:

Mr. Jones is 40 years old and he decides he is going to save £100 per month until he retires at age 65. He invests in a fund that grows at 6% each year. Over that 25 years, he has invested £30,000, but with the growth on the growth on the growth, his fund would actually be worth £107,000. That’s growth of 360% over the 25 years—not bad.

What if Amy Jones, his daughter, also decides to start a pension at the same time? She is 20 years old, and can only afford £56 per month into the same 6% fund. Coincidentally, this means she also invests £30,000 between 20 and 65. So she has put in exactly the same amount of money as her Dad, but over 45 years instead of 25. Instead of the £107,000 that Mr. Jones’ pension reaches, Amy’s pension will be worth £153,000. That is 510% growth instead of 360%. To look at it another way, that’s 43% more than her Dad had for saving the same amount, because her money is invested over a longer period of time. The sooner you can start saving, the better it will be. Even if your monthly savings don’t seem like large amounts, over time the money will grow.

Where should you and your children be saving? As a result of the tax relief, a pension is the obvious starting point for the long term, but as I have already explained, it is much better to get to retirement with your money in different tax wrappers, so that you can minimize the tax you pay and maximise the income you take.


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