There’s a rule of thumb that say you should invest your age. If you’re 30 you should invest 30% of your net income. 50% when you hit the half century and a whopping 60% when you reach 60 (if you’re still in gainful employment then). That’s a good plan. Let’s look at how that works
If you start deferred spending (aka saving) at 30 you need to tuck away 30% of your net income (i.e. after tax). At your next birthday you need to increase the amount you are saving by either of these TWO amounts, whichever is the biggest
- 1% Now you are one year older. The rule is: save your age. That’s 30% when you’re 30 but 31% when you’re 31.
- Inflation Inflation has increased the cost of everything over the last year. If you don’t increase your contributions by inflation you are actually saving less in real terms. Compound this over 30 years and ignoring the impact of inflation on your savings can be devastating.
Here’s an example. Tanya is 30 and her net income is £30,000. She should be saving £9,000 per annum. Inflation is 5%.
On her 31st birthday Tanya’s salary is unchanged so she should increase her contribution to £9,300 using the age rule (31% of £30,000).
But checking inflation, her £9,000 contribution should have increased by at least 5% to maintain its purchasing power. i.e. £9,450.
Tanya will actually need to contribute £9,450 to ensure her contribution matches the purchasing power of £9,000 last year.
Imagine that at Tanya’s 31st birthday her net pay has increased to £31,000. So using the age rule she should be saving 31% of £31,000 = £9,610. This is more than the inflation adjusted amount so she should stick with the age rule.
The inflation underpin is to ensure that once you start, you never put in less (in real terms) than you are when you start.
Hardly anyone knows what they want, but everyone knows what they don’t want. And what they don’t want is less than they have now. Keeping place with inflation is the only way to achieve this basic minimum.
By far the biggest risk you will face in retirement is inflation. Essential to guard against it.