LondonFinance1
New member
- Dec
- 64
- 49
Management Consulting
Congratulations - you have landed your first job and are just settling into the job world. One part of this is obviously pensions and savings for retirement. Booooring as the great Homer Simpson might say and retirement for you might seem 50 years away or so, but there are some valuable lessons to be learned.
The most important lesson: whatever you do, start early – as early as possible. Albert Einstein apparently said once that “compound interest is the most powerful force in the universe”. Play around with a calculator https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator or on excel and you can see the difference a couple of years can make. Just to give you an example: for an investment of $10.000 and an interest rate of 5%, the difference of a 30- and a 40-year period is a whopping £2,718. If you only invest a regular sum per month (let’s say £100, same interest rate), the difference will be a whopping £46,884.
So, when and where to start? By all means reward yourself after receiving your first salary, be it going on a nice trip, buying that gadget you always wanted, having a big night out with your friends, inviting your loved ones for a nice meal out. After that, you should build up a rainy day fund of 2-3 monthly salaries and put this sum into a separate (sub)account from the account you use for daily expenses to avoid any temptation to use this sum for regular payments. This rainy day fund is strictly for emergencies (e.g. a broken washing machine or fridge). Should you take money out of this account, pay in the same sum back before spending money on anything else.
10-15% of your gross income should go into pensions and savings for retirements – this is not exclusively your active investments, but will also include (mandatory) state pensions, quite often some sort of voluntary pension contributions offered by your employer and last, but not least savings/investments of your own. The details are different from country to country – quite often there are tax incentives either for payments/contributions or when receiving your penion later on. The HR department of your company will be able to give you more information. In some countries, this information is mandatory. I will give an overview on the situation in the UK a little later (see below).
As a fresh graduate, you might carry a student loan with you, so there is a valid question whether you should pay off this loan first or start investing in a pension. This depends on the interest rates, the tax situation and the payment terms – it is usually better to pay off debt before starting to save or invest. However, the situation is slightly more complex. You want to benefit from compound interest, so start investing early, even if there is still some debt outstanding. Repaying a student loan is sometimes coupled to your income or tax payments, so you might not have much choice. I would encourage you to pay back student debt as quickly as possible (the faster you reduce the principal, the less interest rate you will be charged) with the only exception being your pension payments/retirement savings. Should your loan have lower interest rate than the expected rate of your investment, the answer to the question above is clear: you can invest more. If there is a favourable tax position of repaying your student loan compared or for pension contributions, go for this. Have a look at payment terms for student debt: is there the option to pay lump sums (if so, how often?), when (and how) are interest payments calculated.
State pension: in most countries, there are mandatory payments towards a state pension, often by both employer and employee. In some countries, the payments you can expect can be quite generous, in other, e.g. the UK they only cover a basic standard of living. The payments you can expect to receive will definitely be less than your last income. Educate yourself on the payments (what goes in) and potential payments (what you can get out of it). Demographic shifts (fewer active employers supporting more pensioners) will mean a lot of pressure on these pensions, so you should not only rely on them. On the plus side, payments are usually guaranteed by the state and there is some protection against inflation.
Company pension: in some countries (like the UK), this is mandatory, in other countries (like Germany) it is a voluntary benefit as part of a payment package. These pensions are quite interesting because there is usually a tax benefit either when paying in or taking money out. Should there be an option to top up payments voluntarily, I would strongly recommend to look into it, not least because having your regular contribution deducted from your pay cheque helps to be disciplined about regular contributions.
Own investments: first of all, this is about your retirement savings, so be risk adverse and look at an investment horizon of decades. If you want to
If you want to invest and engage in picking companies (it is a lot of fun), you are free to do this as well, but do this from a separate budget and ringfence your longer-term investments here. While working in a demanding job, you might not have time to do much research or react quickly should the share price fall. I would thus recommend monthly payments in very broad ETFs like the MSCI World, Eurostoxx 50, FTSE 100 and so on. Less bragging rights at parties, but this approach gives you peace of mind. Compare the cost for ETFs and for regular investments as you might be able to save some money. For the UK (see also below), a stocks and shares ISA will be the best option. Granted, you might forego some exciting upside returns, but you will also have to worry a lot less about downside risks.
In your first couple of years in the job world, I would now recommend thinking in monthly budgets (this will also help with a mortgage application in a couple of years- I have worked in mortgages, so roughly know what budgets these banks will look at):
Everything that is left in your monthly budget, split it between long-term-savings and the fun budget. Should you regularly spend more than you have, adjust your spending, but never saving. It might seem a lot of saving as a share of your income, but as long as you are young, have very limited regular spending and no dependants, build up funds. You might need them later in life and then thank your younger self.
As promised, some more details on the UK, especially for those planning to come from abroad. The state pension is comparatively low compared to other countries https://www.citizensadvice.org.uk/debt-and-money/pensions/types-of-pension/state-pension/ - - not more than £ 600/week after full contribution (on the other, these contributions are also lower), so there are workplace pension schemes to top this up https://www.citizensadvice.org.uk/debt-and-money/pensions/types-of-pension/workplace-pensions/ You will be automatically enrolled by your employer, usually cooperating with a large fund company, and they will guid you through the process. You are free to choose funds, but have an eye out on risk profile and cost of individual funds. Last, but not least, your own investment which you are free to choose, unless your employer has compliance rules (which they will tell you about), so you are not betting against clients, use insider knowledge etc. Use a stocks and shares ISA https://www.moneysavingexpert.com/savings/stocks-shares-isas/ which allows you to pay in up to £20,000 per year and enjoy any gains tax free. There are also cash ISAs for savings – the annual contributions over all ISAs should not exceed £20,000 per year. And to bust the jargon – ISA stands for Individual Savings Account.
A lot to take in, so feel free to ask any questions.
The most important lesson: whatever you do, start early – as early as possible. Albert Einstein apparently said once that “compound interest is the most powerful force in the universe”. Play around with a calculator https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator or on excel and you can see the difference a couple of years can make. Just to give you an example: for an investment of $10.000 and an interest rate of 5%, the difference of a 30- and a 40-year period is a whopping £2,718. If you only invest a regular sum per month (let’s say £100, same interest rate), the difference will be a whopping £46,884.
So, when and where to start? By all means reward yourself after receiving your first salary, be it going on a nice trip, buying that gadget you always wanted, having a big night out with your friends, inviting your loved ones for a nice meal out. After that, you should build up a rainy day fund of 2-3 monthly salaries and put this sum into a separate (sub)account from the account you use for daily expenses to avoid any temptation to use this sum for regular payments. This rainy day fund is strictly for emergencies (e.g. a broken washing machine or fridge). Should you take money out of this account, pay in the same sum back before spending money on anything else.
10-15% of your gross income should go into pensions and savings for retirements – this is not exclusively your active investments, but will also include (mandatory) state pensions, quite often some sort of voluntary pension contributions offered by your employer and last, but not least savings/investments of your own. The details are different from country to country – quite often there are tax incentives either for payments/contributions or when receiving your penion later on. The HR department of your company will be able to give you more information. In some countries, this information is mandatory. I will give an overview on the situation in the UK a little later (see below).
As a fresh graduate, you might carry a student loan with you, so there is a valid question whether you should pay off this loan first or start investing in a pension. This depends on the interest rates, the tax situation and the payment terms – it is usually better to pay off debt before starting to save or invest. However, the situation is slightly more complex. You want to benefit from compound interest, so start investing early, even if there is still some debt outstanding. Repaying a student loan is sometimes coupled to your income or tax payments, so you might not have much choice. I would encourage you to pay back student debt as quickly as possible (the faster you reduce the principal, the less interest rate you will be charged) with the only exception being your pension payments/retirement savings. Should your loan have lower interest rate than the expected rate of your investment, the answer to the question above is clear: you can invest more. If there is a favourable tax position of repaying your student loan compared or for pension contributions, go for this. Have a look at payment terms for student debt: is there the option to pay lump sums (if so, how often?), when (and how) are interest payments calculated.
State pension: in most countries, there are mandatory payments towards a state pension, often by both employer and employee. In some countries, the payments you can expect can be quite generous, in other, e.g. the UK they only cover a basic standard of living. The payments you can expect to receive will definitely be less than your last income. Educate yourself on the payments (what goes in) and potential payments (what you can get out of it). Demographic shifts (fewer active employers supporting more pensioners) will mean a lot of pressure on these pensions, so you should not only rely on them. On the plus side, payments are usually guaranteed by the state and there is some protection against inflation.
Company pension: in some countries (like the UK), this is mandatory, in other countries (like Germany) it is a voluntary benefit as part of a payment package. These pensions are quite interesting because there is usually a tax benefit either when paying in or taking money out. Should there be an option to top up payments voluntarily, I would strongly recommend to look into it, not least because having your regular contribution deducted from your pay cheque helps to be disciplined about regular contributions.
Own investments: first of all, this is about your retirement savings, so be risk adverse and look at an investment horizon of decades. If you want to
If you want to invest and engage in picking companies (it is a lot of fun), you are free to do this as well, but do this from a separate budget and ringfence your longer-term investments here. While working in a demanding job, you might not have time to do much research or react quickly should the share price fall. I would thus recommend monthly payments in very broad ETFs like the MSCI World, Eurostoxx 50, FTSE 100 and so on. Less bragging rights at parties, but this approach gives you peace of mind. Compare the cost for ETFs and for regular investments as you might be able to save some money. For the UK (see also below), a stocks and shares ISA will be the best option. Granted, you might forego some exciting upside returns, but you will also have to worry a lot less about downside risks.
In your first couple of years in the job world, I would now recommend thinking in monthly budgets (this will also help with a mortgage application in a couple of years- I have worked in mortgages, so roughly know what budgets these banks will look at):
- Max 30% of your income should go towards your rent - this is probably your biggest regular spend, so do not overspend on it; if you want to spend more on a nicer/more central etc. place, take the money out of the fun budget
- 10-15% of your gross income overall should go into retirement savings/investments - this is all three parts combined
- 5-10% on long-term savings, e.g. to build up capital to buy property in a couple of years; you can make very safe investments with a half of that (e.g. a broad ETF), but nothing risky. If you get close to spending this money, e.g. for a mortgage downpayment, hold it as cash
- 5% - invest in yourself (or rather career progress): this could be books, newspaper subscriptopns, trainings or certifications like a CFA; your employer will quite often have a budget for this as long as it is relevant for your job
- Rainy day fund – every now and then, top it up, e.g. if you got a salary increase or a promotion
Everything that is left in your monthly budget, split it between long-term-savings and the fun budget. Should you regularly spend more than you have, adjust your spending, but never saving. It might seem a lot of saving as a share of your income, but as long as you are young, have very limited regular spending and no dependants, build up funds. You might need them later in life and then thank your younger self.
As promised, some more details on the UK, especially for those planning to come from abroad. The state pension is comparatively low compared to other countries https://www.citizensadvice.org.uk/debt-and-money/pensions/types-of-pension/state-pension/ - - not more than £ 600/week after full contribution (on the other, these contributions are also lower), so there are workplace pension schemes to top this up https://www.citizensadvice.org.uk/debt-and-money/pensions/types-of-pension/workplace-pensions/ You will be automatically enrolled by your employer, usually cooperating with a large fund company, and they will guid you through the process. You are free to choose funds, but have an eye out on risk profile and cost of individual funds. Last, but not least, your own investment which you are free to choose, unless your employer has compliance rules (which they will tell you about), so you are not betting against clients, use insider knowledge etc. Use a stocks and shares ISA https://www.moneysavingexpert.com/savings/stocks-shares-isas/ which allows you to pay in up to £20,000 per year and enjoy any gains tax free. There are also cash ISAs for savings – the annual contributions over all ISAs should not exceed £20,000 per year. And to bust the jargon – ISA stands for Individual Savings Account.
A lot to take in, so feel free to ask any questions.
. Because yet again, in early stage of ones career, its not that we have a lot to distribute around in every direction and you correctly highlight that we need to save some because who knows what lies ahead.