FOOL'S EYE VIEW
When, Where And How Much To Invest

By Stuart Watson (TMFTiger)
October 9, 2001

Great Titchfield Street, London -- We are constantly being told that, as a nation, we do not save enough money for our retirement. A recent report from the Association of British Insurers said that the gap between what we need to save and what we are actually saving is £27b a year. If we assume that there are around 30m people saving for their retirement in the UK this means an average shortfall of almost £1,000 a year. Yikes!

That's all very well you might say. I know that I can't rely on the State to provide for my retirement, if I want to continue with a similar standard of living. But when should I invest, where should I put it and how much should I put in? Let's examine these three common questions. Although we can only give the briefest of answers in one article, we can still provide a sensible framework.

When Should I Invest?

Easy one. All the time. Put in a regular amount each and every month. It's just not worth the effort of trying to outguess the market's short-term movements. If someone thinks they can beat the market like this, well good luck to them. It is also much easier to get into the habit of investing if it is on a regular basis. You'll also have more spare time and less grey hairs.

Where Should I Invest?

There is only one thing we can truly control or predict as an investor. That is the charges we pay. Therefore the most sensible thing we can do is to minimise them in a low-cost fund like an index tracker. Stick with major markets like the UK, US and Europe. Low cost means annual charges of 1% or less. That means all charges of every single, weird and wonderful description. Avoid investments with high or obscure charges (such as with-profits policies) like the plague. Above all, keep it simple. Ideally, never read the City or Money sections of any newspaper - ever. That way you won't feel pressurised to chop and change your plan. Reading the Motley Fool is, of course, perfectly acceptable!

You can get some shelter from tax within a pension or an ISA. To be honest, there is little to choose between the two routes. Both have their advantages and disadvantages. For example, ISAs are more flexible but pensions ensure you can't raid your fund before you retire. Put a bit in each if you like, but make sure this doesn't mean you pay more in charges.

How Much Should I Invest?

There is no simple answer to this one. The touchy-feely answer is that you should save as much as you can without unduly affecting your current lifestyle. Our compound interest calculators can give you an indication of the figures involved. Try calculator 2 on this page if you want to estimate how much to invest each month.

First of all work out how much you have now (let's assume £15,000), by looking at your current pension statement and adding in any other investments that you are setting aside for the long-term. This is your initial sum. Calculate how many years you have until you want to retire (let's assume 30).

The final two boxes are a little harder. Your final target sum will depend on how comfortable you want to be. At the moment, a final sum of £300,000 will give you a basic annuity income of around £20,000 to £25,000. We reckon that provides a reasonable sum for the average person.

What rate of return will you see on your investments? In order to keep things simple we've stripped out inflation on all these calculations, so we need to do the same with our investment returns as well. The long-run return from shares, after inflation, has been 8%. Take off a bit for charges, say 1%. Take off a bit more for the fact that not all your investments will be in shares. This leaves you with returns of, say, 6%. Put in all these assumptions, click calculate, and you'll see that in this illustration you would need to invest £218 a month.

Try a few different assumptions to see what the effect is. It is also important that you do these calculations on a regular basis, say every year, to see if you need to increase your monthly payment. If you get a nice pay rise, why not put in a little more anyway?

It's important to realise that it's impossible to be precise with these numbers. The purpose of this calculation is to make sure that you have sufficient funds for when you retire. You're not trying to hit a particular target down to the nearest £1,000. You're trying to make sure you give yourself at least a minimum level of income. If in doubt, err on the side of caution. Having more money that you know what to do with is a problem that most of us can happily live with.

More: Compound Interest Calculators | Pensions | ISAs