People in Britain are not saving enough for their retirement. That’s probably not news to you. But the scale of the problem and the extent of under-provision might come as a surprise. Recent government research revealed 11.9 million people are likely to struggle to make ends meet when they quit work. That’s because, on average, they’ll have built up pension pots only one quarter the size they need. So how much do you need in your pension pot?
The facts about how much people are saving
A study carried out by Brewin Dolphin, the wealth manager, revealed that only one in four people were saving nothing towards their retirement. A further 18 per cent of respondents were saving less than 5 per cent of their net income.
Overall, UK households on average now save just six pence out of every £1 they earn. That’s a sharp drop from the 15 pence in the pound saved by households in 1992.
UK households are now saving less than half towards their retirement than in 1992.
This level of investment means that the average size of a worker’s pension pot at retirement is expected to be just £175,000.
How much do you need in your pension pot?
Today’s 18 to 44-year-olds want to enjoy an income in retirement of £30,000 (a personal pension of £22,000 and state pension of £8,000). That figure’s roughly the same for older people too.Liz Alley, the director of financial planning at Brewin Dolphin, says: “To achieve their desired income in retirement they would need to save £437 a month from age 18 or £793 a month from 30, assuming a return of 4 per cent net of charges.”
This level of investment would build a pension pot of £725,000 in today’s money by retirement. That’s how much the average person needs to save. But it’s four times the amount people will actually save. A big problem.
Lack of knowledge only part the problem
Some people are under-saving due to lack of knowledge about how much they need in their pension pot at retirement. However, this is not the main reason for the low savings rate.
According to the Department for Work and Pensions, the majority (59%) of those who are not making adequate provision for their retirement are failing to do so for financial reasons. Put simply, they cannot afford to make the contributions required.
And that is true even of the wealthy who believe they do not have enough spare cash to save. Almost a quarter (23 per cent) of those in households with an income between £60,000 and £70,000 are saving less than one per cent of their net income.
Taking a long-term approach could help boost your pot
So how can someone who hasn’t got that much spare cash increase the value of their retirement savings?
The tax protection that comes with your pension provides a really quick win. As a higher rate taxpayer, HMRC boosts every 60 pence you invest by a further 40 pence. That’s an immediate 67% return on your investment.
You can also boost the money you invest by spreading your investment over a longer period. This helps in two ways.
Firstly, it means that you can benefit from the compounding effect of dividend reinvestment. You can make additional returns on the returns you’ve already earned.
JP Morgan calculates that a one-off investment of £5,000 in the UK stock market in 1985 would be worth £24,857 if dividends had been taken. This number would treble to £75,400 if those dividends had been reinvested though. You’ll make more from the same initial investment if you keep your dividends reinvested and stay in the market for longer.
The easiest way to build a bigger retirement pot is to make regular contributions into your pension over a longer period.
Secondly, saving for the long term is also a very good antidote to market volatility.
Let’s look at US share returns between 1950 and 2015. Say you had invested in the market for any one year in that period. Depending on the year you invested, you would have experienced a return ranging somewhere between +61 per cent (positive) to -43 per cent (negative). That’s a pretty wide variation.However, if you invested over 20 years rather than one year, the annualised returns would vary only from 4 per cent to 18 per cent. Whichever 20 year period you invested in, you’d have made a profit. On the basis of past performance (which is never a guarantee of future performance) you’re better off by saving for longer.
Avoiding “School Boy Errors”
Building your pension pot requires you to navigate avoidable losses. One of the most common errors that I see novice investors make is to panic and sell their shares during a period of market turbulence. This is almost always a mistake and doing so can have a hugely detrimental effect on their pension pots.
The reason why they lose out is because these investors tend to end up being out of the market when prices recover.
To demonstrate how significant this effect can be let’s look at the example of someone who invested £10,000 into the FTSE All Share from 1995 to 2015.
If that investor had stuck with their strategy and kept their money in the whole market, they would have an investment worth £45,519 at the end of the 20 year period. However, being out of the market for its ten best days would have cut the value of their investment by 46% to £24,631. Ouch.
Turning theory into practice
This independent analysis illustrates the wisdom of taking a long-term perspective on your pension investments.
Keeping your pension funds invested, with constant monitoring and professional management is a shrewd and sensible long term strategy – a strategy that our Portfolio Management Service is designed to deliver.
We cannot guarantee outcomes, nor can we prevent short-term fluctuations and market volatility. But with our professional portfolio management expertise and passion for achieving the best possible outcomes for our clients, we strive to navigate through inevitable short-term challenges and optimise your investment returns.
Do you have any questions about this analysis? Does it reflect your experience? Comment below and join the conversation.