David Prosser explains how regularly saving small amounts can pay off in the long run.
If your new year’s resolution for 2017 is to spend less and save more, it’s worth taking a look at the Pension Village website maintained by financial services company LV. Its calculators allow you to work out the long-term impact of making even very small savings today – and the figures are remarkable. Give up your daily cup of high street coffee, for example, and invest the money instead, and you could generate a pot of cash worth more than £100,000 over the next 35 years, assuming an annual investment return of 5 per cent. Cut down on one restaurant meal a week and the long-term dividend could be £96,000.
These numbers are realistic for two reasons. First, what seem like trivial sums of money in isolation add up to very substantial sums over long periods of time, as long as you’re disciplined enough to keep putting them aside, week-in, week-out. Second, you get the benefit of compound interest – the fact that you’re continually earning returns on the returns you’ve already earned as well as the savings you’re making; again, over the long term, the effect is dramatic.
Regular saving in practice
How, then, do you turn theory into practice? That is, what’s the best way to put, say, your £2 daily saving on coffee towards long-term savings?
Well, the first point to make is that this idea isn’t going to work unless you’re consistent, so you need some form of regular savings vehicle into which you can sweep your savings – on a monthly basis, say. Ideally, the sweep should be automatic, so that you don’t have to remember to do it.
At the same time, you’ll also need to think about where this money is invested. The safest option is a bank or building savings account, but the returns on such accounts look unattractive in the current low interest rate environment. Moreover, over very long term periods, stock market investments have in the past outperformed cash savings. In the short term, these investments can fall in value as well as rise, but if you’re investing to produce a return over many years, or even decades, you can afford to take this risk.
Investment companies offer a solution
Investment companies are collective investment vehicles that pool savers’ money to invest in particular assets – some funds offer a broad exposure to the UK stock market or to global markets, while others are more specialist. Many funds offer regular savings schemes that allow you to contribute as little as £25 a month via a direct debit. You also have the option of holding your funds within a tax-free individual savings account.
Investing in the stock market this way has another advantage too: you get to benefit from a statistical quirk known as pound-cost averaging. Very simply, the idea is that in months when the value of the fund has fallen, your fixed cash sum investment buys more shares in it – so when the price recovers, you’ve got a larger holding. This can help smooth out some of the ups and downs of stock market investment.
Investment company regular savings plans aren’t for everyone – you must be prepared to take a long-term view and be comfortable with your money falling in value as well as rising. But if you’re looking for a disciplined way to channel even small amounts of cash into a long-term savings plan, they offer a convenient and attractive option.