The 5 Minute Money Guide: The Pension Prize
Audio Version
The Pension Prize
What exactly is the ‘prize’? Put simply - more money for you, in your retirement.
To highlight the impact returns can make we will start by running through a couple of hypothetical or theoretical examples, somewhere in amongst this there may well be something which closely relates to your situation.
In each case we will show you comparisons between what we describe as ‘below par’ returns and ‘above par’ returns. These are not meant to illustrate what we suggest might happen or will happen, but merely to outline the difference future returns, when stretched over time, make to the eventual pot size.
Example 1
Two savers both age 35 with £30,000 in a pension fund today.
Saver #1 invests and gets a below par return of 3% per year (1) Saver #2 invests and gets an above par return of 6% per year (1)
How much does saver #1 have at age 60?
£62,813
How much does saver #2 have at age 60?
£128,756
Saver # 2 has simply invested ‘better’ and got a better return, as a result he/she has around £66,000 MORE in their pot at age 60. That’s the prize!
Stretch this forward a little and imagine that they actually invested for another 5 years, to age 65 (instead of age 60) – what’s the difference now?
How much does saver #1 have at age 65?
£72,818
How much does saver #2 have at age 65?
£172,305
Nearly £100,000 MORE.
Finally at age 70
How much does saver #1 have at age 70?
£84,416
How much does saver #2 have at age 60?
£230,583
By age 70 the above par investor has £146,000 MORE than the below par investor, on a starting pot of £30,000.
(Note (1) – 3% per year and 6% per year are compounded figures, assuming this is the net return per year after all charges have been taken into account. This is not a formal illustration of a pension plan. It is an illustrative basis for showing the value of a £30,000 pot at those future points, to stress the compounding effect and differences that build up)
Example 2
In this example we consider two investors age 55, who have both built up £150,000 in pension plans, where they have radically different experiences in the ten years until they aim to start taking their benefits. One pursues a strategy which produces 2% growth per year, the other gets 7% per year, so the difference is now stretched to 5% per year in the returns they receive:
Saver #1 invests and gets a below par return of 2% per year (2) Saver #2 invests and gets an above par return of 7% per year (2)
How much does saver #1 have at age 65?
£182,849
How much does saver #2 have at age 65?
£295,072
Saver #2 has simply invested ‘better’ and got a better return, as a result he/she has around £112,000 MORE in their pot at age 65.
(Note (2) – 2% per year and 7% per year are compounded figures, assuming this is the net return per year after all charges have been taken into account. This is not a formal illustration of a pension plan. It is an illustrative basis for showing the value of a £150,000 pot at those future points, to stress the compounding effect and differences that build up) Don’t believe that 5% per year difference in returns is realistic? Then you need to read on...
There is nothing here which is revealing. All we have attempted to do, using these basic examples is show how much difference being above par makes to
being below par. It is obvious that higher returns will make more difference and this difference is seriously accentuated over time, but even in the relatively shorter periods the differences still stack up.
Research shows that the swing in returns from funds in the same sectors can be easily around 5% per year.
For example, the average past performance of the best performers is that much higher than the worst performers, based on historic returns. The level of difference can vary from sector to sector, higher risks sectors (such as equities) tend to vary more than lower risk sectors (such as bonds) but the principle point remains – fund performance really does vary, surprisingly so based on past returns.