How realistic is a £1m pension?

It takes a brave millennial even to glance at the personal finance media these days.

Barely a week seems to pass without those born between the early 1980s and the mid-1990s being told of their vanishing chances of ever enjoying a comfortable retirement, say, or even owning a house.

Still, on our Value Perspective blog, we always prefer to do our own analysis so lets crunch a few numbers relating to that first possibility.

As someone at the younger end of the millennial generation, I certainly have an interest in doing so and the exercise really brought home the profound effect of compounding – what Albert Einstein is often said to have called “the eighth wonder of the world” and “the most powerful force in the universe”, even if in reality he probably never said any such thing.

How Einstein's wonder works: 1p to £5.5m in 30 days

Compounding – the interest or growth earned not only on a loan or investment but also on the interest or growth previously earned – may indeed be a wonder but it is a deeply underappreciated one.

We once illustrated the power of compounding, by posing the question: “Given the choice, would you rather have £500,000 upfront or 1p doubled every day for 30 days?”

“Most people would instinctively take the half a million but compound interest does not work on instinct but maths,” we continued.

“Doubling up from 1p on day one, it would be day eight before you had more than £1. After three weeks, however, you would have just shy of £10,500 and, on day 30, your 1p would have become the best part of £5.5m – or £5,368,709.12, to be exact.”

However realistic the financial medias exhortations for millennials to start saving for their retirement – NOW! – may actually be, they stem from this basic idea that compounding is an extremely powerful thing, especially if you can harness it over time.

How much might you need to save?

To put some numbers around that idea, then, lets think about the monthly contributions it would take from different ages to build up a £1m pension pot by the age of 70.

What we have done is to calculate how much money someone aged 20, 25, 30 and so on up to 65 would have to save each month to reach that £1m target at different rates of annual growth – from 2 per cent up to 10 per cent a year.

And while some might view that latter figure as hopeful at best, value-oriented investors have solid grounds for believing it is by no means unrealistic.

We have discussed before the so-called value premium investors could enjoy if they follow a value-based strategy over the longer term – and clearly the longer term is what we are looking at here.

As we noted, for example, in our 2017 anti-forecast: “From 130 years of history, not only do we know the market tends to make 6 per cent or 7 per cent a year on average, we also know value tends to make around 2 per cent a year on top of that."

Of course, that level of performance cannot be guaranteed in future but it is reasonable grounds for considering the spread of annual returns we have.

And, as you can see from the table below, the ranges are quite extraordinary – if, for example, you start at 25, then 7 per cent average annual growth will see you needing to save £262 a month to hit the £1m target. Procrastinate 15 years, however, and that more than triples to £815.

Amount required to save per month in £

Source: Schroders April 2018

The difference an early start to saving can make is even more starkly illustrated if we shift the numbers into graph form, as we have below with the 2%, 4%, 6%, 8% and 10% growth rates.

One final caveat, of course, is that the erosive effects of inflation mean £1m will buy you a lot more today than it will in 10 years time – let alone 40 or 50.

Still that does not change the underlying message of the following graph, those scary press articles and possibly even your own parents – start as early and put away as much as you can.

Amount required to save per month in £

Source: Schroders April 2018

• Roberta Barr is an author on The Value Perspective, a blog about value investing. It is a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction.

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