Monday, October 21, 2013

The Need to Start Planning for the Future Now

This statement is one that you have probably heard hundreds of times; from the first time you encounter money you are told to ‘put some away for a rainy day’ and from then on you have most likely been told to put some money away for the future on countless occasions. However, have you ever actually sat down and weighed up how much you can benefit from offsetting some consumption today in return for a firmer financial footing later in life?

The main benefit of saving earlier rather than later is Compound Interest, dubbed the ‘8th Wonder of the World’ by the great Albert Einstein. This is where the interest you earn in the first period can earn interest in the second period as well as the initial deposit, and then all the interest earned in the first two periods can earn interest in the third period and so on and so forth. This can have a profound difference on the final value of savings down the line when compared with simple interest, as an example, savings of £10,000 over 20 years with a 5% interest rate would return £20,000 under simple interest, whereas the same sum would return over £26,000, no small difference when worked out as a percentage and the effects are amplified when you increase the rate offered or the time the savings are left for.

I think one of the best ways to show the benefits of saving earlier rather than later is to do a direct comparison of two people that save the same amount of money but over different time periods. I will take the case of two people that are saving for retirement, one saver starts at 20 years old and the other is a bit late to the party (but not later than a lot of people actually start saving for their retirement) and starts at 40 years old. They were both aiming to retire at age 60 and so the organised saver put £100 away per month for 40 years and the late saver put £200 away for the 20 years he had left before retirement, meaning they have both put away £48,000 apiece. If they both invest their money and get an average return of 7% per year (the amount Warren Buffett says the stock market should return), the person who invested for 40 years would end up with £265,000 compared with the second person who would end up with just £105,000! This is a staggering difference and again highlights the benefits of getting money invested early in your career rather than leaving it until later.

There are other benefits to saving early as well as financial, the additional peace of mind it gives you to have something tucked away for when life throws an unexpected incident your way is hard to put a price on. It doesn’t have to be difficult to save either, even a small amount per month adds up quickly over the course of a year or two, it’s a good idea to have a savings target that you can build up to, first putting away a small amount per month then building up until you reach the target.

Hopefully this article will encourage people to start early.            


Author: This article was written by Thomas Nash, a graduate in Economics from the University of Manchester, now working at PensionReviews.com raising awareness of the need for people to be adequately prepared for their retirement financially.