Investing Is ‘Risky’!
I often hear people say that ‘investing is risky’ or ‘the stock market is risky’ Well let me tell you, hoping to retire on a pension is ‘risky’ nowadays!
Working a 9-5 job from the age of 18-70 is considered the lowest risk approach to your working life because if you are a good boy/girl and work hard your whole life (as the story goes) you will be gifted with a magic pension pot that (just like Jack and the beanstalk) will appear, as if by magic, out of the ground and pay you a salary each and every month until you depart this beautiful planet. But even this seemingly ‘low risk’ strategy depends on a few variables that most people haven’t given a second thought, and that is:
1, How much has been invested into the pension pot each month and
2, Where the pension has been invested . . . because guess where your pension is invested? Yep you guessed it . . . the same ‘risky’ stock market nobody wants to invest their hard earned money into.
So if there hasn’t been enough invested or it hasn’t been invested into the right funds guess what . . . you are going to outlive your pension pot! And that sadly is the state many pensioners of this next generation are going to find themselves in through no fault of their own . . . (well maybe through a bit of burying their head in the sand but we’re all guilty of that). Well keep reading this blog because it’s my mission to educate people on the mystical ways of the financial industry and give people the confidence and motivation to start diving into this stuff and getting a grip on their personal finances.
Whether you realise it or not YOU are now in FULL control of your pension!!
Yes . . . YOU!!
It’s not changed this week or this month but over the last few years the onus has been slowly changing under our noses with just small whispers of what this means to employees but nobody has really been paying any attention.
Final Salary Pension
Your company used to invest an amount into a pension scheme for you (often with no payment required from yourself) and manage the investments for you too and whatever happened in the market you ended up with a guaranteed percentage amount of your final salary for the rest of your life (NICE).
Now this was very expensive for employers so they have slowly been hacking away at these plans and the terms and conditions for years. So now the government has realised the pension burden was going to fall on them and guess what . . . the government are even worse at managing their money than our employers are.
So with encouragement from the government employers are now required to provide each employee with a pension plan and pay in a minimum of 3% of your salary each year. You are also invited to contribute 4% into it in an ‘auto enrolment’ process rather than an ‘opt in’ process (and you really should if you want any hope of retiring before the age of 100 🤦🏻♂️, the figures below will scare you), then the government adds tax relief of 1% too. You can opt out if you wish but then your employer will also stop paying the 3% (which is effectively free extra money being paid to your future self that you will be forfeiting). Martin Lewis has deep dived into all the figures and theory behind workplace pensions here so I’ll leave all the nitty gritty to him!
Workplace pension percentages correct at time of publishing (June 2021) but can change in the future. Please check the government’s website for current up to date figures HERE.
What Does This Mean For Employees?
Ok so we’ll go through the figures below but what does this mean for you? Well . . . not only do you now need to be paying a percentage of your salary into your pension each and every month but you also need at least some investment knowledge to know what your pension is invested into.
I find it crazy that people have absolutely no idea what their pensions are invested into. Literally everyone I ask has no idea! If I said to you – “give me £300 per month for the next 50 years and I’ll make sure you have enough in the pot see you through your retirement”, wouldn’t you want to know what I was doing every month with your money? You would probably think I was a con man and was just pocketing your cash . . . but that’s exactly what most people are doing every month with their pensions! The biggest gains don’t come from the money you are investing, the real gains come from the interest you receive and the interest on the interest (compound interest) which is entirely to do with where your money is invested!
NOTHING in this blog (especially the following) is financial advice please read the disclaimer at the bottom of this page!
I did a brief audit of my own pension last year (2020) after covid hit and the results were quite surprising! My fund was apparently medium risk but it lost 30% with the covid crash. I was also shocked to find some of the ‘low risk’ funds had also lost the same or more. So just choosing a fund based on its risk level isn’t a fool proof plan either. Some of these funds de-risk the plan by investing into worldwide assets/ currency etc but considering the last 2 crashes 2008 + 2020 have both been global crashes this doesn’t offer much protection. I found a fund that was apparently ‘high risk’ (7/7 risk) but it had actually gained around 80% that year including through the covid crash so that seems like a much better fund to be in doesn’t it? One that actually does better during the crash than the low risk funds. This fund had only been running for 3 years but had beat all the other funds when compared to them over 5 years. Now 3-5 years isn’t really long enough to compare results and past results are in no way a guarantee of future performance but it gives you an idea of the possibilities available to you. I would sooner invest my money into a ‘high risk’ fund that has been profitable over 3-5 years than invest into a low risk fund which has lost money 2/5 years . . . but that’s just me.
So let’s have a look at some figures then shall we? How much do you need in your pension pot to retire comfortably? Firstly how much do you want each year? 20-30k? How long are you going to live for? 20-30 years? It’s a tough one isn’t it. Some people save for retirement their whole life then die before they can enjoy any of it but I’d sooner that than be stuck at 80 with no money, homeless or asking friends and family for money wouldn’t you? Let’s retire with some dignity shall we!?
Oh and before we start I’ll throw in another curve ball (or kick in the nuts) for you to consider, we haven’t even mentioned inflation yet! What is inflation? Well inflation is the reason a 10p Freddo now costs 25p . . . that’s a 150% increase in price! Or a Mars bar has gone up from 30p to around 70p. Inflation is the purchasing power of your money that gets eroded by around 2% each year because everything you can buy with your money gets more expensive every year whether that is phones, laptops, cars, or even down to essential items like food, clothing and bathing products. So if you held £1000 in a bank for 1 year paying 0% interest it is effectively (due to inflation) worth £980 after 1 year, £960.40 after year 2, £941.19 after year 3 etc because the amount you can buy with that money each year is decreasing.
PHEW . . . are you still with me? This has been a long one!
Fact & Figures – YAWN
Ok so here are the hard facts! I have played with some figures using the pension calculator on: moneyadviceservice.org.uk for different ages based on an average income level using the government’s current advised minimum pension contributions and the results are pretty shocking. I suggest everyone takes 10 minutes out of their day to fill this calculator in and see whether you are on track to have the retirement you are hoping for.
This calculator is based on buying an annuity (guaranteed income for life) with your pension pot which is what most people with zero investing knowledge will end up doing. I’m not saying this is the best or worst option but it is an option a lot of people will take and provides a good line in the sand for basing the figures on.
All these results are based on the current retirement age of 68, and working towards a retirement income of £20,100 which is the recommended base level to aim for on this calculator.
So here goes:
Scenario 1 = Best case
21 year old, £40,000 salary, £0 current pension pot, paying in 4% (£1600) of salary per year + employer paying in 3% (£1200) per year.
State pension = £9,339 per year + annuity £9,578 per year = £18,917 per year total income.
This means a shortfall of £1,083 per year (£90.25 per month). To make this up the 21 year old would need to pay in 4.8% of his salary rather than the 4% minimum set by the government! So this is NOT a good start is it? This was meant to be my best case scenario as I don’t know ANY 21 years olds that are on £40,000 per year and are paying in 4% of their salary into a pension. I was hoping to start off with some good news and say if you start off early it becomes much easier to reach the desired outcome . . . . but no good news here!
Scenario 2 = Average case
33 year old, £30,000 salary, £10,000 current pension pot, paying in 4% (£1200) of salary per year + employer paying in 3% (£900) per year.
State pension = £9,339 per year + annuity £5,812 per year = £15,151 per year total income.
This means a shortfall of £4,949 per year (£412.42 per month). To make this up the 33 year old would need to pay in 11.1% of his salary per year rather than the 4% minimum set by the government . . . which is £3,330 per year (£277.50 per month). Can you afford to put £277.50 of your wages into your pension every month?
Scenario 3 = Bad case (I’m not going to say worst case because I’m sure there are people reading this who are potentially even worse off than this).
40 year old, £30,000 salary, £0 current pension pot, paying in 4% (£1200) of salary per year + employer paying in 3% (£900) per year.
State pension = £9,339 per year + annuity £3,746 per year = £13,085 per year total income.
This means a shortfall of £7,015 per year (£584.58 per month). To make this up the 40 year old would need to pay in 17.2% of his salary per year rather than the 4% minimum set by the government . . . which is £5,160 per year (£430 per month). Can you afford to put £430 of your wages into your pension every month? I’m guessing for most people this would be FAR from possible.
These scenarios are purely examples and no figures should be taken as accurate. There may be mistakes and their could be errors in the calculator formula, please only use as a reference and talk anything through with a qualified financial adviser before making any investment decision that could affect your pension, future or retirement.
So as you can see the government and our employers have us on a guaranteed path to one train wreckage of a retirement! Even the best case scenario misses the mark when you break the figures down . . . . so what is the answer?
What do we do?
Well the easy answer is to use the pension calculator above and work out how much you need to be saving into your pension every month and just start TODAY. If you can’t manage the full amount today at least start cranking up the percentage you are paying in by a few percent and write down a plan of how you are going to achieve the percentage amount required over the next few months – 1 year. Maybe crank it up by 2% extra per month or even 1% extra per month? At least you are making progress and heading towards your goal. Isn’t it better now you KNOW about this short fall? Your retirement is currently on a train track that is heading off a cliff, but there are some forks ahead we can take to divert us back onto a nice, calm journey to retirement. At least now we are armed with the knowledge to do something about it.
Punch your details into the calculator to find out your own personal projections. Most advice I have read is an absolute minimum of 15%, so why is the total minimum workplace pension contributions set at 8%? We’ve just proven than even on £40,000 per year and starting at 21 years old this amount is not enough! So we need to gain some confidence and take ownership of our own pension because nobody is going to sort this out for us, or come and help us in our 70’s when we can’t afford to feed ourselves! This requires some tough love now, that our future retired self will thank us for!
Pensions aren’t the 1 and only way to retire though! They are often the most popular as they require the smallest amount of effort, but they are not always the best! Subscribe to receive emails below and I’ll let you know when my next blog comes out which will be exploring some of the easiest ways to retire . . . EARLY (and well before 70 🤦🏻♂️). What are you working for anyway?
Please don’t bury your head in the sand! The aim of this blog post wasn’t to scare you, or overwhelm you but just a friendly gentle prod (while it’s hopefully still early enough to do something about it) that this is not the sort of thing you can just ignore and it goes away. It’s like a leaking roof, the longer you ignore it, the worse the damage will be! The longer you leave it, the closer you will be to retirement and you will have to save more each month and will have less time for compound interest to help you along. The best time to start saving for retirement was as soon as you started working . . . The next best time is TODAY!!
Nothing in this blog should be considered financial advice. The author is not a financial adviser and has no training in this field. He is just sharing information and ideas he has either formed himself through his own experience or that he has read up on from other sources. Please do your own research before making ANY investment or financial decision. Money and finances are one of the leading causes of depression and divorce, please treat your finances with the respect they deserve. The author and this blog/website accept no responsibility for any financial loss or hardship as a result of blindly following any of the information contained within.