To avoid making the worst retirement savings mistakes, you need to be realistic about your future spending expectations and savings challenges. It pays to do as much research as possible, taking the bull by the horns and getting control of your retirement savings pot before it controls you.
With that in mind, here are three major mistakes that could cost you a fortune in later life, as well as my tips on how to avoid them.
1. Putting off saving
The most common mistake retirement savers make is to put off saving. The fact of the matter is, the sooner you start saving, the better.
The longer you have to save, the less money you will have to contribute each month. For example, if a saver put away £100 a month for 50 years with an average annual interest rate of 5%, from a standing start, they would accumulate a pension pot worth £268,000.
However, if the same saver started saving for the future with only two decades to go until retirement, a contribution of just £100 a month would only build a pension pot of £41,000.
The saver would have to put away around £600 a month over 20 years to accumulate the same level of savings they would have if they started three decades earlier.
2. Not saving enough
The second common mistake many retirement savers make is not saving enough for retirement.
It is quite challenging to figure out how much money we will need in order to live comfortably in retirement, but there is a simple way to get to a ballpark figure. The multiply-by-25 rule gives you a rough idea as to how much money you will need to have saved by the time you come to retire based on your targeted annual income.
The formula suggests that a saver targeting an annual income of £20,000 would need to have put away £500,000 by the time of retirement. When you have this figure, you can work backwards to try and figure out how much money you should be putting away every month.
3. Invest your money
Over the past 100 years, UK stocks have produced an average annual return of around 5.5% after inflation.
Today, you’ll be lucky to get an interest rate of 1.5% on cash savings, that’s before taking inflation into account. After factoring in inflation, the rate of return you are likely to receive will be negative. It is going to be impossible to build an acceptable pension pot with your money losing purchasing power every year.
In my opinion, the best way to invest your money for retirement is to use a low-cost passive index tracker fund.
A fund that tracks an index like the FTSE 100 or FTSE 250 will give you exposure to some of the biggest listed companies in the UK without you having to do any work. It is also relatively straightforward to buy these funds. They usually only charge a few tenths of a percent in management fees every year.
Using the numbers above as an example, to accumulate a pension of £500,000 before retirement, I estimate a saver will need to put away £160 a month for 50 years to hit this target at a real annual rate of return of 5.5%. It would be impossible to hit this target without investing your cash unless you’re willing to contribute much more every month.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019