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Two four-letter words I'll teach my daughters

04 November 2016 | Topical insights

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Commentary by Colleen Jaconetti, senior retirement strategist with Vanguard Investment Strategy Group.

Colleen Jaconetti

My two daughters pick up all sorts of … well, interesting language at school or on the playground.

While our conversations are usually about why some words shouldn't be part of their vocabulary, there is a pair of four-letter words I intend to teach my daughters that they might not otherwise learn at such young ages: S-A-V-E and T-I-M-E. (Your mind probably went somewhere else; what words did you think I was going to use?)

For many younger investors, saving for retirement may seem like a daunting task, but it doesn't have to be. Here is the advice I would give to my daughters:

  1. S-A-V-E for yourself. The surest path to a successful retirement is to save for yourself. While the markets or your employer can certainly help, they can't be relied on to do all of the heavy lifting. That part needs to come from you. If you're fortunate enough to work for an employer that provides a savings plan with matching contributions, be sure to take full advantage. Every pound your employer saves on your behalf is one pound less that you have to save. Essentially, this is a 100% return on one's investment, which is a rarity.
  2. Develop good habits by "paying yourself first". By this I mean have your savings automatically deducted from your salary, if possible. While the initial amount may not be a lot – especially given other financial obligations you might be juggling such as university debt, saving for a first home or the financial responsibilities of having young children – consistent savings and the power of compounding over time can go a long way.
  3. Increase your annual savings as your income rises. I've found this to be an effective way to increase my savings rate through the years. As your salary increases over time, these savings bumps can make a meaningful difference in the amount you have at retirement.

Too often, the idea of saving more (or spending less, depending on your disposition) has a negative connotation: To save or invest for the future, you must forgo spending money today. But this perspective ignores an important point that might even have been lost on the great statesman and inventor Benjamin Franklin: A penny saved can equal a lot more than a penny earned, particularly for young investors who have T-I-M-E on their side.

Investing is a partnership in which the investor provides the capital and the market provides the return. Given time and even a modest return, small savings can really add up. For example, if you skipped a few impulse purchases, turned down the heat in your home a little or brought lunch to work a few days each month instead of ordering takeaway, how much could you save? Fifty pounds a month? £100? More?

Let's look at a hypothetical example. Assume you save £100 a month. Also assume that you earn a modest 4% real (that is, inflation-adjusted) return on the money you save. A year later, you've earned £26 (not counting the original £1,200 you saved – more on that in a moment). After ten years, you've earned £2,774 and after 30 years, it's £33,636.

Now, you may be thinking that £33,636 might not be worth 30 years of modest lunches – and to a point, you might be right. But if you ended up needing that money in future, I doubt you'd regret all those home-made meals and other foregone purchases. For many people, £100 a month wouldn't be that much of a sacrifice. We all probably have a lot of other areas where we can save as well, resulting in an increase in our monthly savings assumptions.

So far, I've talked about returns, rather than overall growth in wealth. In our £100-a-month example, the total portfolio, including savings plus net earnings, would be worth £69,636 after 30 years. That's a lot of extra wealth to provide for future spending needs, just by saving a bit of money on purchases you may be able to do without.

To give you an idea of the impact of additional daily/monthly savings, below is a chart showing savings scenarios for a hypothetical investor whose investments receive a 4% real return:

The impact of saving regularly

Figure 1

Source: Vanguard. These examples are hypothetical and do not represent the return on any particular investment. Calculations assume an average of 30 days each month.

For this hypothetical investor, moving from £100 to £200 per month requires an additional savings of a little more than £3 per day, while a £500 monthly contribution requires an additional savings of a little more than £13 per day. Over time, those higher savings levels could add up to hundreds of thousands of pounds in additional assets (£69,636, £139,273 and £348,181 respectively), perhaps allowing you to spend your retirement doing the things you enjoy most.

Over time, saving can really add up

Based on saving £3.33 daily or £100 monthly

Figure 2

Source: Vanguard. These examples are hypothetical and do not represent the return on any particular investment. Calculations assume an average of 30 days each month.

My advice to investors – even very young ones like my girls – is to focus on things you can control: S-A-V-E early in life and put T-I-M-E on your side. Fortunately, these are four-letter words that are more likely to let you end up retiring your way, rather than ending up in detention.

Thanks to my Vanguard Investment Strategy Group colleague Don Bennyhoff for his contributions.

Important information:

This article is designed for use by, and is directed only at, persons resident in the UK.

This article was produced by Vanguard Asset Management, Limited. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

The opinions expressed in this article are those of the individual author and may not be representative of Vanguard Asset Management, Ltd.

Issued by Vanguard Asset Management, Ltd, which is authorised and regulated in the UK by the Financial Conduct Authority.

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