When we come into some extra money - whether through a dividend, a pay rise or work-related bonus - it is tempting to think about how we may spend the windfall. But before we make plans to splash out, we should consider how investing a meaningful part of it could make a significant difference to our future.
Why we may need to save more now
The average real wage in the UK is lower than it was ten years ago in 2008. This may come as a surprise to some, given how many people are employed (the unemployment rate currently stands at 4%)1 and the strength of the latest wage growth statistics released by the Office for National Statistics (ONS) of 3.4% year on year2.
Yet wages pretty much stalled over a decade because in most years after the financial crisis of 2008 they have decreased in real terms when viewed against inflation, and after years of lacklustre growth have only really picked up in the last few years. This is because inflation3 has been positive throughout this period, particularly in the first five years after the financial crisis, peaking at 4.5% in 20114, which has decreased the effects of any nominal wage growth.
One noticeable implication of this drop in real wages is the fall in the UK household saving rate5 to 3.8%, even at a time when mortgage costs are at historically low levels. Combine this decline with our need to prepare for living longer, and it is vital we think hard about how much of our disposable income we should save versus how much we spend.
We all have non-discretionary spending needs (such as groceries, transport and housing) but it is our discretionary spending habits (such as meals out, designer clothes and holidays) which we should regularly review to keep them in check. By saving now you are giving up the immediate pleasures of spending today, but in doing so you can benefit from the fruits of your labour in the years to come.
How saving just a little each month can amount to a lot
Even if you save just £100 per month you would accrue £36,000 over a period of 30 years. If you were to invest that £100 each month and receive an annual return of 5% you would accumulate £81,870. Depending on your circumstances and ability to save, you may wish to save more or less each month, but the point is the same: by making regular savings over a long period of time you can benefit from the compounding of returns to achieve a significant sum.
|Time period:||30 years|
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In this example, the investor sets aside £500 a month to supplement their £50,000 ISA pot. The outcome means that in 30 years’ time their money could be worth £607,000 based on an average projected annual return of 4.9%. Depending on your individual needs, this is not a bad amount to have as your retirement pot especially given the tax-free investment wrapper with tax-free withdrawals.
What is interesting to note is how a small change in the annual return figure (highlighted) can impact the value at the end. The 1.5% return difference shown here equates to £236,000, so it is worth making sure that your investments are being managed in a cost-efficient way to avoid unnecessary costs and charges. Even a 1% saving in fees can make a dramatic difference to an investment pot over time, as this article illustrates.
To a great extent, you can shape your own future
Thinking hard about how much you should be saving, rather than spending, can have a dramatic impact on your ability to provide yourself with a sustainable retirement income.
You can enhance your prospects by optimising for the factors which are within your control when you invest – including reducing unnecessary costs and minimising tax by making use of tax allowances such as ISAs and pensions.
But the key is really about making this choice: do you want to spend more now, or do you want to live more comfortably for longer?
Start preparing for your preferred retirement outcome now
Having your potential retirement outcome to hand by being able to model for your specific situation can make a big difference. Review your financial circumstances and financial plans now by using Netwealth's powerful online tools and projections yourself: www.netwealth.com/start
Please remember that when investing your capital is at risk.
1 Office for National Statistics. Unemployment rate. Sep-Nov 2018 seasonally adjusted. https://www.ons.gov.uk/employmentandlabourmarket/peoplenotinwork/unemployment
2 Office for National Statistics. Average total pay growth. https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/timeseries/kac3/lms
3 Office for National Statistics. Consumer price inflation. https://www.ons.gov.uk/economy/inflationandpriceindices/datasets/consumerpriceindices
4 Statista. Year on year percentage change of the Consumer Price Index. https://www.statista.com/statistics/306648/inflation-rate-consumer-price-index-cpi-united-kingdom-uk-y-on-y/
5 Office for National Statistics. Households’ saving ratio. https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/dgd8/ukea