Wealth or poverty. It’s your choice.
Do you fancy surviving ice-cold winters without heating? Or rummaging through value ranges at the supermarket for cheap reconstituted meat every week? I didn’t think so. Unfortunately, that’s the prospect for millions of people who have reached retirement but will have to make do with the measly basic state pension, after having failed to plan effectively for their retirement years.
The stark reality is that putting something aside for old age has become an unavoidable necessity these days.
No matter what age you are currently, the best time to start planning your retirement is right now. Every year that you let slip by without doing anything is another opportunity lost that puts more pressure on you to make the right decisions in the future.
To put it simply, you can expect the effects of interest to have much more of an impact over 30 years than you can in 10 or 20. Therefore, every single year that you are saving for your retirement is going to boost your funds and, potentially, your lifestyle in the future too. This is especially important if you are planning on retiring early, but “start planning for your retirement now” is a sound piece of advice for anyone at any stage of life.
It’s also important not to feel too downhearted if you have left it a bit late before starting to plan and save. It is still far better to begin to save and plan now rather than giving up because you feel there isn’t enough time left to make a difference. Saving something is better than saving nothing as you near retirement, but the greatest gains will come by making small, regular contributions over many years. Starting a pension early is an excellent way to build up a big retirement fund for later in life, as the power of compound interest is allowed to work the hardest for your money. Even if you can only afford a small amount, it puts you in the frame of mind to continue a lifelong savings habit.
To illustrate exactly how powerful compounding is, let’s imagine for one moment that you’ve been given an option for taking some prize money. You’re offered the chance to either have £1 today, and then double it every day for 30 days, or you can have £10,000 a day for the next 30 days.
Those who don’t understand compounding will no doubt take the £10,000 option and walk out the door feeling very pleased with themselves. But those of us in the know will happily accept the £1 per day that doubles in size for the next 30 days. By taking £10,000 per day, you’d end up with £300,000, not bad for one month of work. But look what happens to that £1 when it’s doubled again and again. After 30 days it grows to an incredible £5,368,000!
The incredible power of compound interest
So what exactly is compound interest? Compounding is where the money you invest earns more money through interest, which in turn goes on to earn even more money through interest, which in turn goes on to make even more money through interest. You can probably see where this is leading but let’s examine it a little further.
Three key ingredients are critical to the wealth you create through compound interest. The first is the quantity you invest, the second is the length of time that you invest it for, and the third is the amount of interest that you have working for you.
Compounding just cannot function if you don’t give it anything to work with, and the amount that you’re able to invest is an essential part of the compounding cycle. For example, if you manage to invest £250 for every month of a 47-year working life, and it earns 10% interest each month, then from age 18 to age 65 you’ll have amassed an impressive £3,231,501. But increase the amount you invest by just £10 a month to £260, and you’ll end up with £3,360,761, an incredible £129,260 extra!
Let’s imagine another scenario where you are given £10 for your 18th birthday. You put it in your bank account, and it earns 10% interest every year. In 10 years your initial £10 investment will have grown to £25.90. Not particularly impressive, but at least your money has increased by two and a half times without you lifting a finger. In this same scenario, you’ve also gained the ability to live for another 200 years. You might be surprised to look inside your future bank account and find £4.465 million sitting there!
The differing interest rates you earn on your investments are another influential factor that can have a huge impact on your returns, even if the changes are seemingly minimal.
Thinking about the regular £250 monthly savings we looked at earlier, let’s make a couple of changes. Instead of earning 10% interest monthly, we manage to find an investment that pays 1% more at 11%. At retirement, you’ll now have £4,701,000, an unbelievable £1.5 million extra. Conversely, let’s say we only manage 9% interest per month. Come retirement you’d have £2,238,000 sat in your account, a disappointing loss of a million Pounds for only a 1% difference in interest rates.
The conclusion we can take away from this is that if you want to live a wealthy and worry-free life in your retirement years, then you need to start saving as early in life as you possibly can, and keep saving regularly. But saving into your standard bank account just isn’t going to cut it in today’s low interest-rate environment. This is where the power of the stock market can come to your rescue, as long as you make sound investment decisions with the big blue-chip stocks that are likely to last through the years. So forget about exciting micro-cap tech stocks for your retirement portfolio, and instead build a portfolio mix of bonds and boring-but-quality stocks that you can keep topping up whenever you have the funds. Then start enjoying your life, safe in the knowledge that your retirement years will be a time to look forward to.