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The biggest and most daunting financial goal that most of us face is how best to save for our retirement. But you first need to have a realistic idea of the pot of money that you’ll eventually need.
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The average basic cost of being a pensioner is £11,200 a year, almost double the full state pension of £5,881, according to analysis by Key Retirement* of government figures on household expenditure. This includes spending on food, clothes, travel and heating.
Taking away today’s state pension, to achieve this sum – which is based on an average life expectancy of 80 years – you would need private savings of £132,975, from which you would take a top-up income of 4% from your savings each year.
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However, if you want to retire earlier than state-pension age or want a higher standard of living, then you’ll need to save much bigger amounts. If you don’t want to rely on a state pension, you need to aim for a pension pot of £280,000 to achieve the basic standard of living.
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There are various ways of growing your money and the returns depend, to a large extent, on a high- or low-risk approach to investment.
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Isas
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Savings accounts are a low-risk way of saving money. Funds held in a savings account are generally more secure, accessible and provide more predictable growth. A cash Isa is a great way to save, as any interest earned is tax-free, as opposed to a normal savings account, where you pay tax on any interest earned.
Les Cameron, a tax specialist at Prudential, says: “Isas are generally regarded as the first step in financial planning. They’re a fairly simple way to protect up to £15,000 of your savings a year from unnecessary taxation.”
New Isa rules introduced in July 2014 increased the annual Isa allowance, which can be held in either cash and/or stocks and shares, to £15,000 and allowed for transfers between stocks and shares to cash. This allowance usually increases every tax year, with the 2015/16 allowance increasing to £15,240.
Isas are not investments in themselves but are tax wrappers into which you can put savings and investments. Many people buy investment funds managed by professionals to hold in their Isa. Any growth on the investments held inside Isas and pensions is free of capital gains tax. With Isas, you don’t have any upfront tax relief on your salary but can withdraw a tax-free income. So the tax wrappers are complementary.
There is also the option to select a fixed-term Isa, which means keeping your savings in the account for a fixed length of time, you will generally be rewarded with a higher interest rate.
It is important to understand how much you can afford to save and that you shop around to get the best rates for your money. Karen Barrett, chief executive of unbiased.co.uk, says: “Although you may not be able to set aside the full amount each year, making sure you are not paying unnecessary tax on your savings will go a long way. If you consider how much you could build up in Isas over five or 10 years, you start to realise the real benefit of having protected your savings in the most tax-efficient way possible.”
However, March 2015 will mark the six-year anniversary of UK interest rates lingering at the all-time low of 0.5%, so your investments need to work harder to generate a decent level of income.
As holding your savings in cash could result in low returns, you have the option to take higher risks with your money in order to build up a retirement fund. And this means investing in the stock market to potentially achieve higher returns.
Investing in the stock market
Fidelity Personal Investing calculates that if a saver had invested £15,000 into the FTSE All Share Index, of about 1,000 companies traded on the London Stock Exchange, over the 10 years to 30 January 2015, they would have more than doubled their savings to £31,542. If, however, they had invested their £15,000 into the average UK savings account over the same period, they would have just £16,346. That’s a significant difference.
Investing in the stock market can be a daunting prospect, and you always have the risk of losing money, but it doesn’t have to be complicated and you can find ways to reduce the risk. For example, you could go for a FTSE 100 tracker fund, an investment fund that aims to reflect the performance of the UK’s 100 biggest companies. This will spread your money between the performances of many well known blue-chip companies, including household names such as Vodafone, Next and Unilever. You could simply put a regular amount into a FTSE 100 tracker fund and let your funds build up over time. But once you start investing in the stock market, you may find that you want to learn more and do things differently.
‘I always want a core of lower-risk stocks that pay dividends’
Jack is 20 and has built up a stocks-and-shares portfolio of £1,000 over three years. He says: “I want to achieve long-term portfolio growth and to learn as much as I can about investing. I have a core holding of blue-chip income stocks from which I reinvest all the dividends received. I also have some riskier holdings that I invest for capital growth.”
Jack holds a FTSE 250 tracker fund and a US tracker fund. He also has several direct holdings in company shares. “As I’m young, I’m open to risk and look to take on more as I get more comfortable with investing. I always want a core of lower-risk stocks that pay good dividends,” he says.
“I study geology at Leeds and have a strong interest in oil and gas companies – they make up about 25% of my portfolio.”
Most investors are better committing to saving a regular amount each month to smooth out the highs and lows of the stock market. Also, if you pay into an investment plan automatically, via direct debit on the day you are paid, then you will get used to not having the money.
While investments could significantly increase your savings pot, it is important to note that the value of an investment is not guaranteed and can go down as well as up, and you may get back less than originally invested. Past performance is not a reliable indicator of future performance, which means that investing on the stock market holds more risks, while funds held in a savings account are generally more secure, accessible, and provide more predictable growth.
No matter which way you decide to save, to make the most from your savings, it’s important to start saving as soon as you can. Giving your money time to grow and allows you to take full advantage of compounding, which can make a significant difference to your investment’s total return over time. Compound interest is the friend of the long-term investor. It arises when interest is added to the sum invested, so that, from that moment on, the interest that has been added also earns interest. Over the long-term this can boost your funds to give you a much more comfortable retirement.
* According to analysis by Key Retirement of government figures on household expenditure
