In the past, relying on cash savings and occupational pensions was enough to allow many people to retire comfortably.
But final salary pensions and jobs for life are now mostly a thing of the past. And interest rates on cash savings are well below the rate of inflation, so the purchasing power of our cash tends to fall each year.
For many people, I think a more active approach to retirement saving is needed. Here are three things I wish I’d known when I started out in the world of work.
1. The eighth wonder of the world
Albert Einstein once said that “compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t, pays it”.
If you’re unsure what compound interest is, you’re not alone. But it’s simple enough. Compound interest means earning interest on interest. In other words, it means reinvesting interest payments, rather than withdrawing them.
This may sound like a small thing, but it’s not. For example, let’s imagine that you invest £3,000 in an investment that returns 5% each year for 15 years.
If you withdraw the interest each year, then by the end of the final year you’ll have received £2,250 in interest and would have a total of £5,250.
If you reinvest the interest each year instead of withdrawing it, you’d have a total of £6,237 at the end of 15 years. That’s 19% more than you’d have got by withdrawing the interest.
2. Don’t refuse offers of free money
Millions of us turn away gifts of free money every year, by refusing to sign up to workplace pensions, or by paying the minimum allowed each month.
I can understand this. Around the time I got my first proper job, pensions had a bad name. Lots of my older peers had suffered as a result of mis-sold personal pensions in the late 1980s.
The young, inexperienced me decided that paying into a pension was probably a waste of time. So I cut my monthly contribution to the minimum allowed and took home the extra cash instead.
Of course, what I should have done was to pay in the maximum allowed. This would then have been matched by my employer, doubling my pension contributions.
When you’re getting 2-for-1 on your savings, even a very average investment is likely to deliver attractive gains over long periods.
3. I should have trusted the stock market
I wish I’d understood the long-term earning power of the stock market. Over the last hundred years or so, the UK stock market has delivered an average return of around 8% each year.
If you invest £200 per month at 8% for 20 years, then my sums suggest that after 20 years, you should have about £120,000.
If you pay in for 30 years, the power of compounding means that you’ll have about £298,000 after that time, even though you’ll only have paid in an extra £24,000.
The best part is that this kind of return is easily and cheaply available to everyone. All you need to do is invest in a FTSE 100 tracker fund, preferably in an ISA or low-cost pension. With minimum monthly payments as low as £25, there’s really no reason not to get started today.