Living within your means and using a savings account to plan for retirement may seem like a good idea. After all, the State Pension is unlikely to be sufficient to fund most people’s retirement plans, with it currently amounting to just £8,767 per year.
However, the return potential of savings accounts means that they may fail to improve your retirement plans to the extent that many people anticipate. In fact, their returns are currently below inflation. This could lead to a reduction in your spending power over the long run.
Therefore, instead of saving for retirement, investing in FTSE 100 shares could be a better idea. They have a strong track record of growth, and appear to offer good value for money at the present time.
With savings accounts offering interest rates of less than 1.5% at the present time, capital held in them is losing its spending power. In other words, it can buy fewer goods and services as time goes by due to inflation being around 2%. This means that in the long run, your retirement savings may not be able to provide the level of financial freedom that you had hoped for.
This situation could remain in place over the coming years. Interest rates are not expected to move significantly higher due to fears surrounding the outlook for the UK economy. This may encourage policymakers to maintain a low interest rate to try and boost the UK’s economic performance.
FTSE 100 growth potential
While the interest rate on cash savings may be just 1.5%, the FTSE 100 offers a dividend yield of around 4.4%. However, many of its members have even higher income returns expected in the current year. Therefore, it may be possible to obtain a portfolio yield that is in excess of 5%, while also diversifying across a variety of industries and geographies.
As well as its income appeal, the FTSE 100 has growth potential. Its performance since inception has been strong, with it rising from 1,000 points almost 36 years ago to trade above 7,000 points today. That’s an annualised return of around 6% plus dividends. Therefore, the spending power of your capital that is invested in FTSE 100 shares could rise significantly over the long run. This may help to make your retirement more financially comfortable, and suggests that investing could be a better means of overcoming the low State Pension than relying on cash savings.
Of course, having some cash savings is always a good idea. They provide peace of mind and the capital required in case of unexpected costs being incurred, such as a car repair bill. However, relying on cash to build a retirement nest egg could end with disappointment. Buying a diverse range of FTSE 100 shares may produce higher returns in the long run.
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Peter Stephens 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.