If you’re reading this, you’ve likely already decided that you want to put money away to help secure your future. You’re also likely pondering important questions, such as “How much do I need?” and “How can I be sure to save enough?”.
At Vanguard, we consider clear goals to be one of the key success factors for all investors. They help you map out a path and find the right balance between risks and potential rewards. That said, you may not have concrete goals at this point in life, which may make the question of how much to save even more difficult to answer. But there is a starting point for everyone, and we’ll try to help you find it – in three steps.
1. Set a detailed goal
People may save for many reasons, like retirement, a house or their children’s education. Those are all great aims, but you’ll need to think about more specifics to set a savings goal.
If you’re saving to buy a home, think about the location, size and other features you’re looking for. If you’re putting money aside for retirement, ask yourself how much income you’d like to have relative to what you made before. You likely won’t be commuting or buying business suits, but your expenses for healthcare, travel and leisure may increase.
If retirement seems like a long way off and you just don’t feel ready to pinpoint any other goal, you can still get started. Time is your friend when you’re building wealth. The compounding effect can help your money grow faster the longer you are invested. (That’s because, as time goes by, you’ll not only be earning returns on the money you paid into your portfolio, but also on the returns you’ve already earned). And any savings you build now will help you later as your plans take shape.
The more detail you can add to your goals today, the easier it is to develop a strategy to meet them successfully. But that doesn’t mean your goals are set in stone. In fact, it’s a good idea to check your goals every year or so as circumstances and your own plans are likely to evolve over time.
2. Take your best guess at a number
Once you have a better sense of what you’d like to achieve with your savings, it’s time to put a price tag on your plans. Research prices for the type of property you’re interested in, the costs of a university education for your children, typical healthcare costs and other living expenses in later life as well as the expected length of your retirement, or any other aspect of your personal goals. Then estimate a number as best you can. As you get closer to your goal, prices and your own plans may evolve, so you can adjust this number as needed.
The good news is you often don’t need to cover this entire sum with your savings. State and employer pensions as well as other sources of income may cover some of your expenses during retirement. Student loans and your children’s own income may cover a part of their higher education costs. There may also be some flexibility in the size of the down payment for a home.
One last note on this topic: If your goal is a long way out, make sure to adjust your target sum for inflation. Otherwise, you risk falling well short of your goal. Say your goal is to save £100,000 within 20 years. At a steady inflation rate of 2% per year, you would need almost £150,000 by the end of this period to have the same purchasing power. Your goal may then seem much more difficult to achieve, but it’s likely your income – and thus your ability to increase your monthly contributions – will also increase over time.
3. Break it down
The next step is to break your goal down into monthly savings amounts that will get you there. For many, dividing their goal amount by the number of months until their target date gives them a somewhat eye-popping figure. Earning a return on your savings means you don’t need to do all the heavy lifting yourself. That’s why many people invest their money into shares and bonds.
The more time you have until your goal, the more the markets may be able to help you achieve it. You can typically earn higher returns with investments like shares that fluctuate more in value. If you invest for the long term, you can wait out any market turbulence and allow your investments to recover. But if you’re close to your goal, it may be better to play it safe with a low-return, low-risk investment like bonds. The last thing you want is to suffer losses on your savings just as you’re looking to draw on them.
There are many tools online – like our pension calculator – that can help guide you to determine which monthly savings amount and level of returns will allow you to reach your goal. You may also want to consult a financial adviser.
In the absence of a concrete goal, look at your current disposable income and regularly put a portion of it toward your financial future. Starting early is so important. Also consider setting your regular contributions to increase automatically by a certain percentage every year. This strategy can help you adjust for inflation and future pay increases. Over time, you’ll gain more clarity over what your financial future should look like, and a clearer goal will emerge.
A concrete goal allows you to break down long-term plans into smaller, manageable portions. When you know which (possibly daunting) sum you need, you also know roughly which (much more manageable) amount in monthly savings and investments has a good chance of getting you there.
In the next part of our four-part series, we explain how funds work and give you some guidance on how to choose one.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
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