You want to retire before you’re too old to have some fun and enjoy your leisure. And you reckon you’ll need a £1m fund to make sure you can live — and spend — comfortably.
£1m sounds like an ambitious target in 20 years, but it could be easier than you think. Here’s what I think you need to do.
Is £1m enough/too much?
Although it sounds a lot, a £1m retirement pot could be a reasonable assumption for many of today’s workers.
Financial advisers use the 4% rule to calculate how much you can withdraw from a savings pot if you want it to last 30 years. If you’ve got £1m, then you should be able to pay yourself £40,000 each year, plus increases for inflation.
Although I’d argue that many people can manage with less, there’s no doubt £1m should fund a long and comfortable retirement.
How much to save each month
With such long-term planning, we can’t be sure exactly what your money will earn each year. But what we can do is rely on long-term average rates of return from the past. Over a 20-year period, there’s a good chance that historical patterns will repeat themselves.
If you want to save £1m in an ISA, then you have three basic choices — cash, bonds or stocks. Here’s how each asset class performed on average between 1899 and 2016:
|
Asset class |
Average annual return 1899 – 2016* |
|
Cash |
4.7% |
|
UK government bonds |
5.2% |
|
UK stocks |
8.9% |
*Source: Barclays Equity Gilt Study 2016
As you can see, over long periods, the UK stock market has delivered considerably greater returns than either cash or government bonds.
Using these rates of return as a guide, I’ve done the sums to work out how much you’d need to save each month to reach a million in 20 years:
|
Asset class |
Monthly ISA contribution |
Total contribution each year |
|
Cash |
£2,519 |
£30,228 |
|
UK government bonds |
£2,377 |
£28,524 |
|
UK stocks |
£1,517 |
£18,204 |
I should stress that these are estimates. No one can tell you with certainty how much you need to save today to have exactly £1m in 20 years’ time. But I do believe these numbers are a realistic guide to how much you’d need to save.
How would this work?
The annual contribution limit is currently £20,000. This is important. As you can see above, only by putting your savings into the stock market can you save enough to reach £1m and stay within the ISA contribution limit.
Although you could save in a taxable stocks and shares account instead, this could leave you liable to big tax bills in the future. In my opinion, the tax-free qualities of an ISA account give long-term investors a huge advantage.
Where should you put your cash?
You could choose to invest in individual stocks, in the hope of picking winners and beating the market. But doing this successfully over 20 years would require a lot of work and some luck.
In my opinion, it makes much more sense to put your cash into a cheap FTSE 100 tracker fund inside an ISA. Use the accumulation option to reinvest all dividends automatically, and setup your monthly payment with a direct debit. Then forget about investing and get on with enjoying life!
