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How realistic is a £1m pension pot?

Significant retirement savings are not as impossible as some commentators suggest but it does help to start early – and also to adopt a long-term, value-oriented approach to investment

01/05/2018

Roberta Barr

Roberta Barr

Research Analyst, Equity Value

It takes a brave millennial even to glance at the personal finance media these days.

Barely a week seems to pass without those born between the early 1980s and the mid-1990s being told of their vanishing chances of ever enjoying a comfortable retirement, say, or even owning a house.

Still, here on the Value Perspective, we always prefer to do our own analysis so let’s crunch a few numbers relating to that first possibility. 

As someone at the younger end of the millennial generation, I certainly have an interest in doing so and the exercise really brought home the profound effect of compounding – what Albert Einstein is often said to have called “the eighth wonder of the world” and “the most powerful force in the universe”, even if in reality he probably never said any such thing.

Compounding

Compounding – the interest or growth earned not only on a loan or investment but also on the interest or growth previously earned – may indeed be a wonder but it is a deeply underappreciated one.

We once illustrated the power of compounding, here on The Value Perspective, by posing the question: “Given the choice, would you rather have £500,000 upfront or 1p doubled every day for 30 days?”

“Most people would instinctively take the half a million but compound interest does not work on instinct but maths,” we continued.

“Doubling up from 1p on day one, it would be day eight before you had more than £1. After three weeks, however, you would have just shy of £10,500 and, on day 30, your 1p would have become the best part of £5.5m – or £5,368,709.12, to be exact.”

However realistic the financial media’s exhortations for millennials to start saving for their retirement – ‘NOW!’ – may actually be, they stem from this basic idea that compounding is an extremely powerful thing, especially if you can harness it over time.

Building up a £1m pot by 70

To put some numbers around that idea, then, let’s think about the monthly contributions it would take from different ages to build up a £1m pension pot by the age of 70.

What we have done is to calculate how much money someone aged 20, 25, 30 and so on up to 65 would have to save each month to reach that £1m target at different rates of annual growth – from 2% up to 10% a year.

And while some might view that latter figure as hopeful at best, value-oriented investors have solid grounds for believing it is by no means unrealistic.

We have discussed before the so-called ‘value premium’ investors could enjoy if they follow a value-based strategy over the longer term – and clearly the longer term is what we are looking at here.

As we noted, for example, in our 2017 anti-forecast: “From 130 years of history, not only do we know the market tends to make 6% or 7% a year on average, we also know value tends to make around 2% a year on top of that.”  

Of course, that level of performance cannot be guaranteed in future but it is reasonable grounds for considering the spread of annual returns we have.

And, as you can see from the table below, the ranges are quite extraordinary – if, for example, you start at 25, then 7% average annual growth will see you needing to save £262 a month to hit the £1m target. Procrastinate 15 years, however, and that more than triples to £815.

Amount required to save per month in £

Age to start saving

/return needed

Age 20 Age 25 Age 30 Age 35 Age 40 Age 45 Age 50 Age 55 Age 60 Age 65
2% 970 1141 1359 1643 2026 2568 3387 4760 7522 15835
3% 718 875 1077 1345 1712 2237 3038 4395 7138 15430
4% 522 660 843 1091 1436 1939 2717 4050 6769 15033
5% 373 491 653 877 1197 1672 2423 3726 6413 14644
6% 263 361 500 698 991 1436 2154 3421 6072 14261
7% 182 262 379 552 815 1227 1909 3137 5744 13887
8% 125 188 285 433 667 1045 1686 2871 5430 13520
9% 85 134 212 337 542 885 1486 2623 5129 13160
10% 57 95 157 261 439 747 1306 2393 4841 12807

Source: Schroders April 2018

The difference an early start to saving can make is even more starkly illustrated if we shift the numbers into graph form, as we have below with the 2%, 4%, 6%, 8% and 10% growth rates. 

One final caveat, of course, is that the erosive effects of inflation mean £1m will buy you a lot more today than it will in 10 years’ time – let alone 40 or 50.

Still that does not change the underlying message of the following graph, those scary press articles and possibly even your own parents – start as early and put away as much as you can.

 

Amount required to save per month in £

Source: Schroders April 2018

Author

Roberta Barr

Roberta Barr

Research Analyst, Equity Value

I am an investment analyst for the Global Value Team, having joined Schroders in 2016 as part of the graduate programme. After spending a year as an investment analyst for the Quantitative Equity Products team, I realised my affinity for the deep value investment mindset and joined the Global Value Team in 2017. Prior to working for Schroders I studied mathematics at Oxford University.

 

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