Young failing to grasp how much early saving can benefit them in later life

Young people understand they could be better off by saving early but are failing to grasp how much it could boost their retirement pot, according to research from Fidelity International.

In a survey of people aged 25 to 35, more than two thirds identified that their savings at retirement at age 65 would be higher if they started saving £100 a month from the age of 25 rather than £300 a month from the age 45, based on growth of 5% per year.

However, more work needs to be done to educate this group about how beneficial the decision to start early can be, it says.

When Fidelity went further and asked this group how much larger their retirement pot could be if they started saving £100 per month at the age of 25 rather than at the age of 30, it found most of them significantly underestimated the impact.

Fidelity has calculated that someone who saves £100 per month from the age of 25 and achieves 5% growth until they turn 65 could build an extra £39,000 by the time they retire compared to someone starting five years later.

Only 13% of those surveyed thought they would be this much better off with the majority, 42%, believing starting early would leave them just £13,000 ahead, and 35% estimating they would have an extra £26,000 in their retirement pot.

Fidelity also found almost two thirds believe cash or property is the best place for their retirement savings, with just 16% recognising the benefits over the long term of investing in the stock market.

‘We need to show young people that, while it may be easier to put off saving for retirement until tomorrow, starting today could have a much bigger impact than they think. An understanding of the magic of compounding should underpin everyone's retirement plans and the younger people can grasp its phenomenal power the better,’ said Tom Stevenson, Investment Director at Fidelity International.

Fidelity says people should start saving as early as possible, save as much as they can afford and keep hold of returns. ‘The earlier people start planning for their retirement, the better outcomes they are likely to experience because catching up after early inaction can be a hugely expensive, and in many cases simply unaffordable, exercise. Albert Einstein called compounding the eighth wonder of the world. He was right to do so. Compounding is a remarkably powerful force and the foundation of investment success,’ it says in its advice for young people.

‘Compounding is a very simple concept. Increase a sum of money by the same percentage each year and the monetary value of each annual increase becomes progressively greater. If, for example, you start with £1,000 and grow your money by 10% a year, the first's year's increase will amount to £100. The following year, however, the same 10% rise will be worth £110 because the starting capital is greater,’ it explains.

‘The most important aspect of compounding is, however, time. Continue these annual increases at 10% a year for 20 years and the 10% increase in the final year will amount to £600, six times the first year's increase.’

It also adds that just as building capital early is a key element in successful retirement saving, the amount of money that is put aside is obviously very important. ‘Someone who saves £150 a month for 30 years compared to £100 month over the same period could end up over £40,000 better off,’ it adds. ‘By increasing the amount that is put aside each year from £100 a month to £200 a month, the retirement pot could increase from £83,125.86 to £166,251.73.’

Then increasing the amount that is put aside each month can make a significant difference to the size of a final retirement pot. ‘Even more important, however, is the rate of return on the savings. Assuming the same monthly savings of £100, the difference between a saver's final retirement pot on the basis of a 5% return and a 7% return is substantial,’ it says.

‘Two percentage points difference may not sound much but over a savings lifetime it is very significant. At 7% a year, a saver could amass a retirement pot of £182,846 by saving £150 per month over a 30 year period. However, if the annual return falls to 5% a year, all else being equal, the final retirement pot will be worth just £124,689,’ it adds.