Are you saving too much? It may sound unlikely, but today I want to explain why saving too much and not investing your cash could make it hard to hit your retirement goals. Here, I’ll explain the steps I’m taking towards my goal of a £1m ISA.
Do you have too much cash?
It’s tempting to think that by stashing all of your spare money in Cash ISAs you’re building a nest egg to help you retire.
Unfortunately, low interest rates mean this plan is unlikely to work. Top Cash ISA rates today are about 1.5%. At that rate, the value of your cash isn’t even keeping pace with inflation, which currently stands at 1.9%.
By contrast, the FTSE 100 currently offers a dividend yield of 4.4%. And the long-term average return from the UK stock market (including capital gains) is about 8%.
I’ve crunched the numbers to see how much you might end up with after 20 years, based on monthly savings of £200 with all interest reinvested:
Value after 20 years
1.5% (Cash ISA)
4.4% (FTSE 100 dividend yield)
8% (long-term average return from UK stocks)
These figures are only approximate. But you can see the stock market could provide double the money in 20 years, compared to cash savings.
My aim is to try and take advantage of superior stock market returns, while still protecting myself from life’s unknowns. Here’s how I’m doing it.
1. You still need some cash
Stock market investing isn’t a substitute for short-term cash. To protect yourself from everyday risks, I believe you should have three-six months’ living expenses saved in cash before you start investing.
I’d also suggest paying off your credit cards before starting to invest, as the interest rates on most of them are higher than the annual return you can expect from the stock market.
2. Stocks and Shares ISA (and a 25% bonus!)
The next step is to set up a tax-free Stocks and Shares ISA as a home for your investments. Like Cash ISAs, these accounts have an annual allowance of £20k.
If you’re under 40, you may also want to consider a Lifetime ISA. The government provides a 25p bonus for every £1 you pay into these accounts — more info here.
3. Start investing your cash
The final stage is to decide on your investments and put your cash to work. In my view, the top priority here is to focus on low-cost investments that should provide regular income and steady long-term gains.
If you’re comfortable buying shares, I’d aim for a diversified portfolio of 15-20 stocks from the FTSE 100 and FTSE 250. If you’d prefer the simplicity of a fund, then I think the best option is to go for a FTSE 100 tracker fund. (If you do this, make sure you choose accumulation units for maximum gains).
You can invest via a lump sum, but I’d recommend using a direct debit to make monthly deposits and investing your cash gradually.
Will I hit £1m?
I estimate that over 20 years, monthly savings of £1,700 would be required to hit £1m. That’s more than many of us can afford. But it doesn’t matter — you can start saving into a tracker fund today with as little as £25 per month.
Every little really does help. And the sooner you start, the more you should have when you retire.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.