simple retirement planning trick can add over £300k to your pension pot

What if I told you today that there is a way you can increase your pension pot by over £300,000? Would that be something that would get you excited? Would that make you consider to look into retirement planning a bit more serious?

This article continues what I’ve started in my previous post on retirement planning. If you haven’t seen it, you can read the article here. In short summary, I showed you a way how while earning an average UK salary of £33,000 a year you could sacrifice £36 a month and increase your retirement pot by over £90,000.

Today I want to take it a step further. I want to start looking into the same problem but start including the fees you could be charged as well. While earning the same £33,000 a year – there is a way you could boost your pension pot by over £300,000. The cherry on top is the fact that you don’t have to do much to achieve this.

what happens with your pension contributions?

Let’s assume that the previous post made sense to you and you decided to increase your pension contributions by 2% and your employer matched it (this is above the minimum required – your total contributions would equal 7% and your employer pays 5%). This is going to be our starting point.

What happens next is the company deducts the money from your monthly salary. Next, it adds its own contributions and pays it into a financial institution that holds your pension for you.

What they were also kind enough to do is the following. The agreement between your employer and the financial institution is to pick a fairly safe investment fund for you. All the money goes into this selected safe fund every month.

The problem I see with the above is following. Safe and actively managed investment funds mostly underperform the market. When I say market I mean a diversified total market index. Something like S&P 500 is a great example of this. It tracks the performance of the 500 biggest US companies and gives you a return based on how all of them perform jointly.

how to choose who should hold your money?

One thing I’ve mentioned in a previous post is the fact that you can consolidate all your pension pots into one. This makes it a lot easier to manage your pension as well as easier to get your money out when you retire.

One suggestion I would give you – pick a platform that makes the most sense. A better platform will give you more options to invest in different funds and indexes. You will be surprised that many platforms have only a couple of options and none of them are actually good. Not all the platforms offer market wide indexes.

The next thing I would look into are the fees that the platform charges for holding your money. This is normally a percentage of your total holdings. You obviously want to pick the one that charges you the least.

how much fees do you actually pay?

What does a rather safe investment fund look like? The returns on it might look something like 6% a year. This isn’t actually bad you would say. Well, the reality is slightly worse. The 6% return doesn’t include the fees you have to pay.

Actively managed investment funds and the expensive investment platform could end up costing you something like 1.5% a year. This would pretty much drop your returns from 6% to 4.5%. The worst part is – you have to pay these fees even in the years the market is down.

It is fairly realistic to assume that you could reduce these fees to something more like 0.5%. So, an improvement of only one percentage point.

This however already makes a massive difference to your pension pot. If you were to be contributing into this for the next 30 years without changing anything – your overall pension would be £203,500. 

The 1% reduced fees would boost your pension pot by over £40,000. This would make your total pension pot just under £245,000. This is absolutely crazy! You can actually add the £40,000 to your pension simply by switching the platform and the product you are invested into. There is absolutely nothing else to be done. 

smart ways to invest for your retirement

I hope the above got you hooked up. I am guessing, however, you are wondering – where is the £300,000 I was talking about earlier? You will find the answer to this in the paragraph below.

For your pension to go up by over £300,000 you would actually need to switch the investment type you are using. Rather than a safe actively managed fund I would suggest using a wide diversified market index. Here I am referring to the S&P 500 once again.

S&P 500 has proven to be a great investment vehicle for the past 150 or so years. On average it would deliver just over 10% returns a year. The past performance however can’t be seen as a given. The future isn’t given purely based on the past performance. I am however fairly confident that the returns are still going to be solid and above what the actively managed funds can deliver.

So now, I will assume that for the same contributions you were making above you will switch into the S&P 500. I will assume 10% returns per year for the next 30 years that you will be contributing to your pension pot.

As this is index, the fees will come really low. I will assume 0.5% to be a combination of the index itself and the platform fees. This will mean that your overall returns after the fees are going to be 9.5% a year.

By keeping the same contributions and switching to S&P 500 your new pension pot after 30 years would be just under £545,000. I am sure you prefer it this way rather than the £200,000 we were looking at earlier.

And the best part to the above, you don’t need to be spending tons more money on your pension contributions. You just simply need to make wiser decisions where to invest your hard earned money. And the compounding effect is going to do the rest for you.

summary

I have looked through a fair amount of data in the past myself. And the returns I’ve seen from many actively invested funds over long-term were always below the S&P 500.

This makes it a great investment vehicle for you and your retirement pot. And the longer you give it to mature the less likely you are to lose money. There was no period of 25 years in the past where you would lose money if you were to be invested in S&P 500. This makes it the perfect solution to invest into in your early days and stay invested for a long term.

Below is a table summarising the three scenarios. The first one is the 6% return from a safe but actively managed fund. The second is the scenario where you manage to reduce the fees by one percentage point. The last one is the scenario when you move your pension into the S&P 500.

I am no financial advisor however the history seems solid enough for me. That’s exactly what I’ve done with my personal pension and strongly encourage you to walk away from actively managed funds. These mostly underperform the market. On top of that, they have enough courage to charge you a high fee for providing you this “service”.