Paying the bills and putting some money aside for your retirement isnt always easy.
Unfortunately, recent government figures suggest many of us are making a costly mistake with our savings that could delay our retirement. In this article Ill explain what the problem is and how you can fix it.
All cashed up
Id always suggest trying to keep a rainy day fund of between three and six months living costs saved in cash in case of unexpected bills. Id also save in cash for big purchases like holidays.
But todays low interest rates mean that saving in cash wont really make any money for you.
Ive recently switched my ISA to an account offering 1.5%, which was the best easy access interest rate I could find. Unfortunately, with inflation running at 2.1% at the moment, my money will still be losing value in real terms each year.
This is the mistake I mentioned earlier 72% of ISA subscriptions last year were made to Cash ISAs. Just 26% were to Stocks and Shares ISAs. Although saving in cash makes sense for money you may need in the next few years, in my view its not a very effective way to save for your retirement.
There is a better way
As you might guess, I think that the stock market is a much better way to save for retirement. Although the market tends to rise and fall unpredictably over short periods, history suggests that over the long term it usually goes up.
The average return from the UK stock market has been about 8% per year over the last century, or roughly 5% after inflation.
Using an 8% annual return as an example, saving 100 per month for 20 years would leave you with a lump sum of 58,902.
Of this, just 24,000 would be the money youd invested the remaining 34,902 would be accumulated dividend income, or interest.
By contrast, saving 100 into a Cash ISA paying 1.5% for 20 years would leave you with just 27,968 only 3,968 of accumulated interest.
The secret here is whats known as compounding. This means earning interest on previously paid interest. Its a powerful way to build wealth.
How to invest in stocks and shares
How should you put your money to work in the stock market?
The simplest option is probably to put money into a FTSE 100 tracker fund inside a Stocks and Shares ISA. This is cheap, simple and allows contributions from as little as 25 per month. The FTSE 100 offers an income yield of about 4.5% at the moment, so youll enjoy a decent income as well as any long-term gains in the market.
A second option is to gradually invest cash in good quality FTSE 100 dividend stocks. This gives you an opportunity to enjoy higher rates of income and growth than the market average. But it also means youre far more exposed to company-specific problems which could leave you sitting on losses.
Whatever you choose, its important to invest money that you wont need for at least five years, preferably longer.
Youll also need to hold your nerve and keep paying in if the market falls. Selling after a market crash is usually the wrong decision. Historically, markets have always bounced back over time. In fact, buying when markets are down tends to be quite profitable over long periods.
