How To Use The Calculators
June 23, 2010
We have two calculators to help you work out:
However, there are a number of points to note. First of all neither calculator takes taxation into account. As everyone has a different tax situation and the tax regime alters over time, it would be hard to model this into the calculator. If you invest in an ISA then your investments have the opportunity to grow free from tax. You also get tax-protection in a pension plan but, currently, you are taxed on your pension when you start to draw from it.
What rate of return should you use?
There’s no correct figure to use -- the future is unknowable after all -- but it's important to be realistic about the rate of return you expect from your investments.
Historical returns can give you a steer. Since 1869, the UK stock market has returned an average of around 9% a year. However, returns over shorter periods have been much more variable. For example, average annual 20-year returns during this period have varied from as low as 3% to as high as 20%. Even over 50-year periods, returns have varied from around 5% to 14%.
And don't forget you need to consider the costs of investing, too. In a plain-vanilla index tracker these could be as little as 0.25% a year. In other types of investments, charges could knock 1%-2%, or even more, off your annual returns.
What about inflation?
The stock market returns quoted above are what is known as the nominal rate. Adjusting for the effects of inflation, the average annual real rate of return since 1869 has been 6% (as inflation over this time has averaged around 3%). If you want to use the calculators to compare like with like, i.e. spending power now versus spending power in the future, you should use a real rate. Again you might need to reduce the rate to allow for the cost of investing.
Real rates of shorter periods have also been quite varied. Over 20 years, average real returns range between -2% and 13%. Over 50 years, the range is a lot narrower, at 4% to 9%.