Read about the most Foolish funds to invest in and learn also the difference between 'saving' and 'investing' for retirement.
I wrote a piece last week that was a one-year update on my 2007 series The Four-Step Guide To A Comfortable Retirement. The guide shows you how to work out what you personally should save in order to retire with the level of comfort you want.
Now I'm going to explain how to save for retirement.
Wait, let me be more specific. We often use the phrase ‘saving for retirement' when really what most of us do is ‘invest for retirement'.
The difference between saving and investing
When you save money (for example, in a savings account) you get a safe, certain return, paid as interest. Hopefully you'll get a good return, but that'll only happen if you've chosen a decent savings account.
When you invest, your money is at risk. What's more, the value of your investments, and therefore the size of the pot of money you've invested, goes up and down. In the short term, (say, five or so years) you could quite easily lose money.
On the other hand, provided you're not reckless with your investment choices, you can expect that, over the long-term and despite the volatility, your investments will outperform money kept in savings.
Let's use some figures to expand on this. Let's say that your savings do remarkably well, earning you what would be an excellent 4% a year over 20 years. You save £100pm, so you've put away £24,000. Add on the interest and you have £37,000.
Now let's say you invest for 20 years. If you haven't been reckless with your investment decisions then you might expect to get 7% (after charges and in ‘today's prices', which is an expression I explained here). It might not sound like much more than 4%, but if you invested £100pm for 20 years you'd have £53,000. That is £16,000 more than if you'd saved at 4%.
Even if your average investment return drops to 6%, you'd beat cash savings by £10,000 (total £47,000), and a poor 5% investment return would still beat cash by £5,000 (total £42,000).
The nub of this is that, if you want to save your way to retirement, you'll need to throw a lot more money at it than if you invest.
So how should we invest for retirement?
To secure our retirement, most of us do three things:
- We invest in shares (often through pension schemes, but increasingly with ISAs).*
- We pay off our mortgages.
- We work, pay National Insurance tax, and thus get ourselves a modest state pension.
Does this work?
Yes, I think it's a good combination (although who knows what we'll get from the state in the future). What I've been building towards in this article is the top bullet point: investing in shares. So let's focus on that.
Many people invest in property and a minority invest in collectibles or other more unusual areas. However, shares have an excellent track record going back well over 100 years. It's investing sensibly in the stock market that hopefully will give you a return of around 7% over the long term.
Aside from that, shares are relatively easy to invest in. Finally, you can invest safely in shares by investing for the long term and by spreading out your investments, e.g. through different sectors like oil, banks, IT, transport, manufacturing, and even property builders and developers. This protects you from losing all your money because of one unfortunate event in a single sector.
Where to put your money
Stuart Watson helped me out with this marvellously-timed article about Foolish investment funds: Ten Top Trackers (published yesterday). UK tracker funds and exchange-traded funds (which are the types of funds that Stuart writes about) have always, for many great reasons, been a favourite of The Motley Fool.
You could do a lot worse than choosing any of those funds to invest in. If you want something more exciting then that's a whole different topic! I hope to cover that in the near future.
Use a pension or ISAs?
Finally, how do you invest for your retirement using funds like these?
Most fund providers will allow you to put a fund into an ISA (a tax-efficient wallet for your investments) or a pension (tax-efficient in a different way). You can ask each provider which they offer for a particular fund, or check out the provider's website.
Take a look at our guide -- Pensions vs ISAs -- which looks at some of the main issues you need to conside when you make this decision.
ISAs are great, but if your employer matches your contributions to a company-pension scheme then this is certainly your first place to start. I also feel that if you're not so knowledgeable about money then you shouldn't be unhappy investing in a simple pension. In particular it means you won't be able to do something silly: spend all the money!
Other choices
For this piece I've hacked at the decision tree till you've just got few branches to choose from. You can invest - or save - for retirement in so many more different ways. However, these are the first ways that you should consider.
Once you've read enough about these branches you might want to look into other options, perhaps by searching The Fool website. But, personally, I'm going to stick with trackers, pensions and ISAs.
*Alternatively, we don't invest but through our employers we have final-salary schemes (otherwise known as ‘defined-benefit' schemes). These pay out, usually, 1/2 or 2/3s of the salary we were earning just prior to retirement. (You get less if you leave the company early, but it's still generous.) These schemes are becoming less common as they've turned out to be too expensive for businesses - but very valuable for most people!
Read more about how to track down lost savings, pensions, shares and more in How To Recover Your Lost Assets
