6th May 2019
This week I am sharing some thinking and insights about building a substantial pension pot. We’ll explore the impact of time, fees and your ‘asset allocation’ on the potential pot you can enjoy in years to come……so buckle in!
It’s been mentioned by a handful of people that the topics of the Blog tend to be focused on the ‘upper end’ of things, and that for most ‘ordinary people’ the figures I talk about here are out of reach. To be fair the figures I sometimes talk about are aspirational, I get that. At the same time I fell that irrespective of the level you are aiming for the principles are the same, the ideas are the same. So whether the figures are 2x or 5x what you are aiming for, go with it and hopefully you’ll gain some insights that’ll help you get to where you want to get. Also, we gotta surely aim big….or as a friend of mine says ‘keep your eyes on the stars and your feet on the ground’!
I covered ‘can a couple retire with €1m‘ last year, and this week I will explore how to actually get to that level of a pension pot! In this relatively short piece I will explore the impact of different ages and different strategies in retirement planning, and we’ll see how they each impact. The strategies differ in regards the duration of ‘accumulation phase’, asset allocation and fee structure…..
How Long Does It Take To Build A Pension Pot Of €1m?
We can forecast fairly simply how long and at what level of contribution it will take to get a pension pot of €1m. Please note that this €1m is not increased in line with inflation, it is €1m in your fund at that date in future, which obviously won’t buy what €1m will do today – we are doing on this basis in order to keep things clear, and to highlight some important insights!
So, if we assume a relatively modest long term annual average return of 6%, and a typical annual management fee of 1.5% the following will hold true:
If you are 30 now and want €1m in 36 years, by 66, you’ need to save €950 per month
If you are 40 now and want €1m in 26 years, by 66, you’d need to save €1,700 per month
If you are 40 now and want €1m in 20 years, by 60, you’d need to save €2,600 per month
If you are 50 now and want €1m in 16 years, by 66, you’d need to save €3,600 per month
If you are 50 now and want €1m in 10 years, by 60, you’d need to save €6,600 per month
Couple of things I’d like to note about these figures. Firstly, it obviously takes considerable commitment to build a pot of €1m, no matter how long you have to do it! Secondly, the 6% annual return is what is typically used in the industry when running investment growth and retirement fund projections, but they don’t usually include the management fees, the omission of which makes it more ‘rosy’ looking! The impact of the 1.5% fee may not seem like much but it obviously has the impact of reducing that 6% to 4.5% actual average growth, which is fairly significant.
Speaking of significant, it keeps cropping up; whereby people are led to believing they are paying say 1.2% on their investment funds but when they go looking at the Key Investors Documents they see that that 1.2% fee is actually 1.8% or indeed above 2%….and we know what fees do to your long term returns.
What Investment Portfolio Stands The Best Chance Of Delivering €1m Pension Fund?
In the above sample we assumed 6% Gross return before fees. We’ll now see the impact of 3 different portfolios, real portfolios which have performance data going back over 80 years. Portfolio A is a 100% Global Equity Index, has delivered 10.5% average over those 8 decades. Portfolio B is 60% Global Equity, 10% Emerging Markets and 30% Global Bonds, has delivered 8% per year average. While Portfolio C is 100% Global Bonds which have delivered average 5% per year growth over those same 80 years.
If you were invested in one of these 3 how would it have benefited you or not? We will take the scenario whereby you have 20 years to get to €1m pot, that you are paying the same 1.5% in fees, and observe how the different average return rates impact.
Portfolio A: 10.5%, or 9% Net average annual return, you’d need to save €1,600 per month
Portfolio B: 8%, or 6.5% Net average annual return, you’d need to save €2,100
Portfolio C: 5%, or 3.5% Net average annual return, you’d need to save €2,900
Looking at Portfolio B, for example what is really striking is that you yourself have invested €500k, and the annual growth has delivered the other €500k of your final pot. The magical power of compounding yet again!
What is also interesting is that a couple of percentage points per year have such a really significant impact over that period of time. To look at it another way, if you were saving €2,900 per month as per Portfolio C, but instead of 5% Gross return you were getting the 10.5% Gross, after fees you’d have a pot of €1.9m, right up at the Standard Fund Threshold of €2m!
What Do Fees Do To My Long Term Returns?
Well it should be pretty obvious at this stage, but there is a seriously inverse correlation between your fees and your long term investment success! Fees are unavoidable, no doubt. If you want a fund or pension structure or advisor to guide you you’ll pay for it, but high fees don’t always mean better returns/service/probability of success. And yes, poor investor behaviour and decisions can and do cost far more in returns than fees, however fees are something that you can control, or at least do something about!
In the above Portfolio B scenario, we assumed a 1.5% fee, if your fee was actually 1% you’d have €60,000 above the €1m target in your pot after the 20 years. If you fee was 2% you’d have €50,000 less than the €1m target. That’s a swing of €110,000, or 11% of your final pot value due to the difference of 1% in annual fee……..you’d buy an apartment (in some parts of the country!) for that. And if you think, ‘surely’ nobody is paying 2% in fees then think again, it is far more common that many believe it to be. It is an extreme example but in the interests of potentially savings some people from such disasters, somebody sent me a KID a few weeks back that showed separate costs on one product of 0.71% + 2.88% + 0.43%, which equates to 4.03% per year in fees. Mind-blowing.
I guess there is no denying that the magic of compounding, that it can be a really helpful ally if you let it. Yes, fees need to be kept to as sensible a level as possible, and you’ll need to figure out which asset allocation will best suit you but please don’t ever overlook the beauty of simply allowing compounding to do it’s thing and let it help you deliver the result you seek.
When you need help mapping out your financial future, and want a strategy for making those plans a reality please check out the work with paddy section of the website.
Thanks for listening!
QFA | RPA | APA
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