plonkee money an english-er's thoughts on personal finance

May 28, 2009

pensions are investments

Filed under: retirement — Tags: , , , — plonkee @ 7:23 pm

You shouldn’t take financial advice from a Baptist minister.

I was listening to Radio 4’s Thought for the Day earlier on, where a Baptist minister was talking about the sensible, risk averse people having to bail out the more foolish, risk takers. Bail outs are not universally popular, but one thing in particular that he said stuck out to me. He said that he has his whole fortune safely in a building society.

are building societies safe?

Of course, you’ll all be aware that building societies are not intrinsically safe. Your money is only as safe as either the institution you’ve put the money in, or if that fails, the extent to which it’s guaranteed by a government scheme such as the Financial Services Compensation Scheme.

When you hold money in a building society, you hold it in cash, and cash has its own risks. There’s the risk of inflation eating away at your money, and the opportunity cost – the chance that you could have done better with your money elsewhere.

do you have money elsewhere that you forget about?

I suspect that the Baptist minister in question doesn’t have his whole fortune safely in a building society. I can’t be certain but it’s likely that he expects to enjoy a ministers’ pension when he retires, he’s probably contributing to one right now.

what do pensions have to do with anything?

Well, work and personal pensions are part of your fortune. Especially if you are planning on retiring one day on more than the state pension. Final salary pensions are much sought after, because they offer great benefits to retirees. But those benefits need to be paid for.

You might think that if you have a final salary pension, it comes with some sort of cast iron guarantee. But it doesn’t. There’s only one place that the money that you pay in can grow into enough to pay out, and that’s in investments. Regardless of the type of pension that you have, there’s no secret money cupboard.

If you have a final salary pension, then the trustees and the scheme actuaries decide where how the money should be invested – usually in stocks, bonds, cash and property – and try to ensure that there will be enough money to cover everyone’s pension. That’s why a lot of schemes are asking members to contribute more, for the same or lower pension when they retire. If they don’t, there isn’t going to be enough money to pay everyone’s pension, because money doesn’t grow on trees.

If you work in the public sector, the taxpayer could be forced to pick up the tab if there’s a shortfall, but don’t count on everyone else voting for that.

If you have a money purchase or defined contribution pension, then you can directly control your investments. You should take the opportunity to learn about risk and investing, but there’s probably a default set-up that is at least vaguely appropriate.

maybe I shouldn’t invest?

There is always the risk that your pension might not be worth as much as you hope, but it’ll  be better than nothing, and it’s very likely to be better than just sticking the money in a building society, as there are tax breaks, (and often employer contributions) for using a pension wrapper.

Nearly everyone is invested in risky things and it’ll probably turn out ok. In the long run. Don’t use the current economic climate as an excuse for delaying your investing.

January 8, 2009

the best return you’re likely to make

Filed under: retirement — Tags: , , , , — plonkee @ 12:00 pm

Have you ever tried to make your way across a crowded bar? Usually, the easiest way is to find a line of people already moving and tack on the end of them. Although this works a lot of the time, sometimes when you’re aiming for the dancefloor, you find yourself at the door instead because the line of people moving wasn’t headed in the right direction.

It’s similar with investing. It’s basically a given that stock markets act irrationally. When the stock market is rising, everyone thinks that buying is the right thing to do, and prices go up – beyond the point at which things are reasonable. When the stock market is falling, everyone thinks that selling is the right thing to do and prices plunge further. The typical novice investor intends to buy low and sell high, but in reality does the exact opposite; buying when everyone else does (when prices are high) and selling when everyone else does (when prices are low). Not really the way to get where you’re planning on going.

fear of investing is all around us

The stockmarket took a huge dive in 2008. I’ve (on paper) lost all the money I invested last year, and another 10%. It would be easy to let recent losses cloud my judgment and for me to lose confidence in the underlying basics. I’m certainly naturally inclined to retrench slightly and pull back from dangerous positions. After all, no one wants lose, and we certainly don’t want to throw good money after bad.

If you’ve looked at your pension recently, it’s certainly tempting to think that your future contributions would have better spent your wallet, or even in your emergency fund. But don’t lose out on one of the best returns you’re ever likely to make.

employer matching contributions

If you have a retirement account or pension through work where your employer contributes money if you do, then this should always be taken advantage of wherever possible.

At my place, if I contribute 2% of my earnings to a pension, then my employer will add 4% of my earnings. What’s more, this is all pre-tax. There’s no other investment where I get an instant 200% return. What’s more, it’s taken directly out of my pay so I never even miss the money.

Maybe your job isn’t quite as generous, but if there’s any contribution match at all on offer in your retirement account or pension, always take advantage of it if you can. Your future self will be really and truly grateful.

September 22, 2008

and what do you have to show for it?

Filed under: retirement — Tags: , , , , — plonkee @ 8:34 pm

I don’t know if any of you have read Your Money or Your Life, but there’s an exercise at the beginning where you have to add up all the income you’ve ever had, and then calculate your net worth. I was a little bored on the train the other week, so I had a go at this in rough.

I ended up with approximate figures of £150k in income after tax since the age of 18 (including wages, bonuses and major gifts) and a net worth of about £12k (depends on share prices so could well be less, but good enough for an approximation). This means that of all the money that has come into my hands as an adult, I have about 8% of it left.

That’s not a lot, especially when you consider that since I graduated, I’ve saved about 20% or more of each pay cheque. To be fair, I assumed that house prices have gone down, and my house is now worth as much as my mortgage, whereas I had a £10k deposit. Also, although I save quite a bit of money each month, some of that is planned savings for specific things like travel, or home maintenance.

Still, to see how I’m doing in the great scheme of things, I calculated my anticipated earnings across my lifetime (assuming only that I get a cost of living increase each year). This came out as £2.6M, but the pot of money that I need to retire on is nearly £1.7M. I need a net worth to total life income ratio of approaching 65% in order to retire.

I’m not panicking yet though. One of the key factors in becoming wealthy is allowing time for the magic of compounding to take place in a good way. A lot of the planned for growth in my net worth is going to be caused by earning interest on the interest rather than me saving three quarters of my income. Although saving more probably wouldn’t hurt.

Anyway, has anyone else done this exercise or something similar? And if so how did your numbers come out?

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