30 May 2014, 3:18pm
personal finance
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  • Why Compound Interest won’t help you retire early

    I’m always the bad guy when it comes to the compound interest myth, but really, it’s not powerful enough to help you retire early. I’ve picked up the challenge, but the tl;dr reasons why are

    1. the real-inflation adjusted return on equities is too low and
    2. you don’t live long enough and
    3. you don’t work long enough (sort of related to #2)

    None of these are within your control.

    Wealth warning – nothing in this should be construed as saying that you don’t need to save into a pension in your 20s. All I am saying is one of the common stories about early pension savings is overrated to mythical extremes. Saving enough money to stop working is a tough job and takes the whole of your working life. The sooner you start, the sooner you can check out, provided you balance pension savings with the rest of the calls on your finances.

    What is compound interest?

    There’s a much more positive account of it not written by a cynical old git available here, but the definition is easy:

    Paddington Bear takes his money to the bank, and deposits a nice five pound note. A year later he gets £5.10. That’s because he gets paid interest on his money, of 2%p.a. Next year he gets 2% on £5.10. And so on until he is rich beyond his wildest dreams, apparently. The mathematically astute will observe that the future value of his investment is basically

    Present value × (1.02) ^years in the bank

    where ^ means raised to the power of. Now I’m going to cheat and raise Paddington’s interest rate to 5% for reasons that’ll be clearer later on.

     

    The Magic of Compound Interest

    The Magic of Compound Interest – 45x gains after 40 years, Whoopee-do

    And show you this chart. You will observe that if Paddington puts in £1 in 1974 and becomes a Retired Bear this year then he’ll get 45 times as much out. Fantastic. People use that sort of thing to give you bullshit like “when saving for 10 years is better than saving for 40” along with the obligatory wacky picture of Einstein, who is supposed to have said compounding is the eighth wonder of the world

    Fabulous story. But it’s fiction. I’m not contesting the maths – after 30 years as an engineer I’ve learned you don’t fight the laws of maths or physics. It’s incontrovertible that if Paddington got a real interest rate of 10% every year, his first year’s saving will punch 45 times the weight of his last year’s saving. Note this graph shows only what happens to the value of his first £1, not the cumulative value of his pension!

    That’s the story, but the devil is in the detail

    Detail #1: Whoa, boy, you said 5%!

    The sharp-eyed will, of course, spot that I said 5% at the start, in which case lower your gaze from the lofty value of 45 to the pedestrian boost of 7 times.

    That’s the first problem. As I described in an earlier rant on this topic, Warren Buffett, the most successful investor the world has ever known , has managed 13% annual return in real terms. So he’s doing better than 10%.

    You aren’t going to do that. You’ll get about 5% provided you can avoid screwing up, which is challenge enough in itself. Follow these ideas on passive investing and you stand a decent chance.

    That’s the trouble – to make the compound interest story interesting you have to sex it up with unrealistic values of return. And it’s gotta be the real rate of return, ie subtract the long-run rate of inflation from your nominal investment return as well as any fees. The FCA regulator doesn’t even allow people to use 10% for their optimistic projection rates for equity based pension investments. Repeat after me – you are not Warren Buffet.

    Detail #2: Most people earn more as they get older

    at least compared to the start. If they save as a percentage of salary they will save more as they get older. I deliberately selected a chart that made a dramatic entrance, because it’s all about that first £1. You save to a pension across your entire working life. A lot of the UK PF community seem to work in finance, where this may not hold because burnout is rife in that industry; it’s a young man’s game. But most people pick up some knowledge, skills and contacts so they can command a higher salary in their 30s and 40s than in their 20s. It’s much harder to save 10% of your salary when it’s £25,000 than when it’s £50,000, because the fixed costs of living are a larger proportion of your income. There are other pressures on people in their 20s that I didn’t have in my 20s, so it’s even harder, but even I found the cost of rent, house deposits and all that stuff hard in my 20s and early 30s

    Cumulative chart of all years contributions to total, zero real value career progression

    Cumulative chart of all years contributions to total, zero real value career progression

     

    cumulative total, 3 times career progression

    cumulative total, 3 times career progression

    These charts show you the total as a sum of all the contributions, growing. You can track how each of the contributions grew if you have the patience and clarity of eyesight. In the top one there is no career progression at all, in the second one over 40 years  the Ermine achieves a 3× real times value career progression (this happened to me over 30 years, which would make the later contributions even more equal with the early ones :) In the first chart £1 is contributed each and every year, and compounds at 5%. In the second chart I start off contributing £1 and then each year  it is increased by linearly interpolating to a final salary of 3× initial salary (ie adding £3)

    You can see in the first example the early contributions punch way over their weight, but in the second this effect is deflated by the increase in salary. The favouring of later contributions is in fact much heavier due to tax breaks  benefiting the better off more because –

    Detail #2a: It’s easier for the rich to save and they get more bang for their buck in a pension

    because they are saving 40% tax instead of 20% tax. So to save £100 in his pension a rich saver only needs to go without £60, whereas a basic rate taxpayer needs to reduce his post-tax income by £80. The fixed costs of living are usually still a lower proportion of income, so they get a win from that too

    Detail #3: Can you stick working for 40 years?

    Look around your office. How many 60-65-year olds are there?  If people start in your company at 25 then one in 8 should be old gits between 60 and 65. If there aren’t that many it says something about the likelihood of you working there that long. Now generalise that to your industry. Note how all the compound interest action happens at the end of the chart… 1

    I’m perfectly capable of engineering, still. It was the stupid gamification of the workplace and nutty management that I tired of and made me want out. Yes, maybe I was more mentally unstable or weaker than the average Brit. I don’t think it’s that huge – in my last year at work I had to rugby tackle one dude in the office who had just hurled a laptop computer at the wall, over a few colleagues’ heads because he was pissed off by something it was or wasn’t doing.

    I took his car keys, drove him home, stuck him in a chair and told him to get on the horn to his doctor. ASAP. The official story was that he tripped and dropped his laptop on the stairs. Mental health wasn’t good at The Firm. There are a few cracked paving slabs under some of the stairwells. You can’t open the windows in those stairwells any more…

    And it’s not good in a lot of places. We have people talking cock like this

    You need Emotional Resilience.

    For many people the workplace is becoming a worse experience. Some of the problems are fundamental. There is a power-shift from labour to capital which is particularly noticeable in developed economies because globalisation and improved communications dramatically increases the global workforce that can be brought to bear on solving business needs.

    So about that 40 years you need to work for compound interest to give you a leg-up, well, it’s time to roll out Clint again

    I didn’t bloody well make it to the modest normal retirement age of The Firm at 60. Will you? And I was lucky – after I got a job I never lost it 2  until I took voluntary redundancy at the end of my working life.

    Detail #4: if your workplace is no place for old men, compound interest ain’t going to help you much

    ‘Cos early retirees are drawing down their savings earlier, and so they have less time in pure accumulation mode

    Compound interest is oversold

    I’m not saying compound interest does diddly-squat for you – in that previous rant I came to the conclusion that it would give you about a 50%-100% uplift on what you pay in over a typical working life, less if you experienced career progression and saved more towards the end, more if you very given a pension at birth by your parents. But don’t get the impression it’s going to do a lot for you, and the Telegraph article was absolute bollocks – the 10 year saving beating out 40 years only applies at unrealistic rates of return.

    You can test this out yourself on Monevator’s Compound Interest calculator. An Ermine saving £100 a year for ten years at 5%p.a. gets £1500 at the end of that 10 years. The lazy tyke then sits back for the next 30, ending up with £6500 after 30 years of 5%. The Johnny-come-lately variant steadily saves £100 a year for 30 years and ends up with £7000. Who knows – the Johnny-come-lately variant might have put the £100 a year for ten years into a house deposit or starting a business, in which case it would benefit his finances in other ways. In my case the Johnny-come lately fellow earned twice to three times in real terms as the young pup, so he probably ended up with £14,000. The old boy was a 40% taxpayer too, so each £100 saved cost him £60 rather than £80. It’s just not a fair fight.

    become a long-lived vampire to get the magic of compound interest working for you

    become a long-lived vampire to get the magic of compound interest working for you

    You ain’t gonna get the rates of return that the Telegraph used, and unless you’re a vampire you ain’t getting to live long enough to have compound interest do the heavy lifting for you. If you get an employer match in your 20s that will probably do as much for your early contributions than compound interest will. The Telegraph had you working for 50 years FFS – life is much too short to donate 50 years of it the The Man. Life is not all about work. My earnings, for what it’s worth, although respectable and well above the UK average were low compared to what I’d estimate to be the majority of the UK PF community – I never earned anywhere near £100,000

    There’s a converse part of the story. If you are an old git in your late 40s and you suddenly find all four engines flame out in the second half of your career for some reason then compound interest does not mean you are doomed automatically. I saved a quarter of the HMRC nominal capital of my final salary pension in the last three years of working and filled ISAs and saved cash with NS&I. I was lucky enough to be standing next to an open goal in the form of the stock market when I started. And I was fortunate enough to have enough mental capacity left to seize the day.

    Compound interest will do something for you. But it won’t be earth-shattering, and it’s not worth flogging yourself into the ground in your 20s for. Try and take the employer match, because it’s rude to leave part of your salary behind. But before you believe the stories about the 25-35 making more difference than the 35-65 years do the maths. With realistic, not fictional values for the rate of return.

    Compound interest is particularly not going to help early retirees. I am a normal early retiree (less than 10 years to normal retirement age for my company). Very early retirement (40s) or extreme early retirement (30s) means your money only has 10-20 years to grow. Compound interest at 5% just ain’t gonna cut it, you’re own your own, which is why ERE’s logic ignores it totally.

     

    Notes:

    1. this is in fact a property of any autoscaled charts of that sort plotted on linear scales. If I were to extend it to a thousand years all the action would look like it happened at the end
    2. I did switch jobs a few times. But without gaps – when I left the BBC in London on Friday I came to Suffolk and started at The Firm on Monday

    > None of these are within your control.

    Rubbish.

    1) Rate of return cannot directly be controlled, true, but younger people with time on their side can opt for a more aggressive portfolio mix, increasing their expected rate of return.
    2) Lifestyle factors have a significant impact on lifespan, although I grant you not many people would make significant changes for their finances alone!
    3) Provided one remains in good health, I see no reason why retirement age should not be flexible. Your later point about “you’ll never last 40 years of work” seems even more reason in favour to get started early — aim to retire early, but be prepared to delay if setbacks occur.

    The main objection I have, though, is that you paint an either/or picture. Personally, as a late 20-something, I just pile as much cash as I can in to an ISA at the end of the month. If my spending power increases later in life then all the better, and I’ll switch to a pension if I hit higher rate tax. Higher rate relief might be abolished by then, but if not — bonus — I can move ISA savings into the pension to get the extra relief AND compound interest.

    The attitude encouraged by the article of “never mind, you can make up the difference later” is not sensible advice for young adults – they might later have kids, large mortgages, layoffs or whatever else coming there way. All of which points to getting started earlier, not later.

    Thanks for the article, sir! An interesting read. Enjoy the weekend!

    @Rob okay, you can choose when to retire, I’ll give you that ;) Assuming you are in good health. And FWIW I absolutely agree with BR taxpayers using ISAs in the early days, though it increases your risk to drawdown in redundancy

    The 5% real rate of return is that of passive investing in equities. There’s nothing legal that gives you a better return, though if you are one of the few with talent then you may get a better reward in return for more risk.

    > “never mind, you can make up the difference later” is not sensible advice for young adults

    I absolutely agree, which is why there’s a wealth warning to specifically counter that :) I am saying compound interest will not give you the amount of benefit it’s normally claimed because you may get career progression, the tax breaks are better if you do. Show me where I am saying people shouldn’t start early and I’ll gladly correct it. I do counter the myth that your early contributions are that much more valuable that your later ones, but you need ‘em all!

    Excellent article!

    I’m sick of hearing that young people should live like ascetics and become dragons, simply accumulating wealth.

    Unfortunately, while bang on, this article is dangerous for the many who really have little concept of future-them. The fact that Wonga even exist is testament to that!

    It’s for this reason I don’t get too wound up about the finance industry’s “make sure you save as much of your money as possible and let us look after it, for a fee of course”!

    I do get the impression that there is much rote learning of mantras & herd following in the PFA world. I think I could do a better job than pretty much any of them…

    Naturally, the people that read these sorts of blogs are not a normal cross-section of society and should probably be encouraged to actually save less, not more!

    A worthy riposte, sir, with lots of food for though. (Caveat: I still think I’m right! ;) ).

    One thing I’d note is there’s a bit of a contradiction in saying your later years are the most valuable, while then going into the Logan’s Run In The Workplace Rant.

    If I don’t think I’m going to have many years mining the great salary at the fag end of my career for ultra-hard core saving and investing, then surely it’s even more important to put money away early?

    @Greg – Feel free to start a blog. :) I am very happy with the results of compound interest on my investing and my net wealth, while still in my very early 40s. People saving too much is not a problem in our society.

    31 May 2014, 10:17am
    by Grumpy Old Paul


    You can’t choose when you retire unless a) you are healthy and b) either you’re able to find someone to employ you – age discrimination is still rife – or are able to earn a crust working for yourself.

    @Ermine,
    I agree with your points about the practicalities of benefiting from compound interest. In the days of ‘jobs for life’, the compound interest argument was perhaps more convincing. In practice, for the better-off and, it is only they who can afford to save, the benefits from 40% tax relief on pension contributions, employers’ matching contributions and employee share purchase schemes of various kinds trump compound interest.

    @Greg,
    My parents always told me to enjoy myself when you were young and they were right. I didn’t benefit from as much parental wisdom as Ermine but they were right about that and also about the value of education. I don’t mean monetary value either. Too many people know ‘the price of everything and the value of nothing’.

    Also agree about mantras and rote-learning in the IFA world. I use the phrase ‘mindless mantras’. An example is the split of one’s portfolio between equities and bonds which has been quoted for many decades and takes no account of increased longevity, whether the portfolio is to be used to purchase an annuity or to generate enhanced spending power in retirement or other individual factors.

    On an unrelated point, I never hear the argument that one should spend money on enjoyable experiences in the early decades of retirement because one can derive much more pleasure from them than when one is old and infirm. I don’t want to be an infirm 95 year- old sitting alone with substantial investments incapable of deriving enjoyment from from my wealth.

    @Greg – indeed, balance is one of the keys to living life well, and the Western world is making it harder to achieve, not easier.

    > this article is dangerous for the many who really have little concept of future-them.

    They aren’t going to read it, not enough pictures, not enough pretty girls/boys (apart from the Twilight pic which is a long way down). I have no trouble sleeping at night!

    > I do get the impression that there is much rote learning of mantras & herd following in the PFA world. I think I could do a better job than pretty much any of them…

    In all fairness the entry criteria for an IFA are probably a little bit beneath you, so this is hardly surprising. But yes, it’s a bizarre world, and a lot of CYA and nobody lost their job buying IBM sort of thinking. I wonder if our coming robot IFA overlords are going to do any better!

    @Monevator – there is right on both sides. I’ve had to take an extreme position to lean against an in practice factually erroneous shibboleth IMO, but the issue is degree. I’m perfectly happy to acknowledge compound interest roughly doubles your retirement savings over a working life so it’s not to be sneezed at. But the simplistic analysis that ends up overrating it and that 10 years of saving and stop story needs to be arrested.

    Realistically all your years of saving to a pension count. If you experience no career progression then the early ones do count much more. I got career progression so I’ve seen the difference the 40% tax vs 20% tax makes, and people’s attitudes change as they get closer to retirement. In my case I had discharged my mortgage, what else was I going to do with the money once I’d filled my ISA? The young just don’t have these options, though I do take the point that some will never have them so you shouldn’t rely on them. And I expressly put the wealth warning up top as a hat tip to your reservations about saying that compound interest isn’t all it’s cracked up to be.

    @GOP also in the days of jobs for life people’s working lives were longer. Mine has been 30 years, my Dad worked from <16 to 65

    One of the very tragic things we seem to be doing to the young is saddling them with debt right off the bat, or things that look like debt and are called debt. This binds them into The System early on. Some people left my school at 16 and were earning money and living the life of Riley. And I'm absolutely with the philosophy that they should enjoy life. Stuff and Work is overrated IMO!

    > one should spend money on enjoyable experiences in the early decades of retirement

    I think that’s because there aren’t that many tales from the front line, at least that I’m aware of. Once I get a hold of my AVCs and get to draw my pension I intend to do just that. Initially I had to screw my costs down to eliminate work so that I have a decent chance to get to that stage. But that phase won’t last that much longer :)

    @Rob:
    >Provided one remains in good health, I see no reason why retirement age should not be flexible.

    Being able to work requires both physical and mental health. The post focused on mental health.

    >Personally, as a late 20-something

    Says it all right there.

    Another thing that never seems to be taken into account is that people tend to reduce their volatility as they age. This brings the overall return down, particularly as new money is likely to still be going in. (This does increase the relative value of earlier contributions though!)

    The main issue for me is simply one of marginal utility. When you are young, there really isn’t much left after typical fixed costs, which are astronomically high compared to the ones the previous generations had. This makes the money left over more valuable. Furthermore, the money goes further when young – e.g. bumming around Europe is cheap when young, before one starts to desire a bit more in the way of creature comforts… Both of these, as well as the tax break for pensions when hitting high rate, make it seem daft to save for a pension until middle age.

    Of course, saving a reasonable amount into an ISA is sound, but don’t get carried away. “No I can’t have a go at the Mongol Rally with you all as I want to have a shag-pile carpet in my lounge in 25 years’ time”

    As for my own blog – I’ve found two I like which are substantially better than any others I’ve found, so see little I could improve. I like to think I add to the conversation when I comment, but that doesn’t mean I could regularly produce the inspiration in the first place!

    I suppose I might do so if ever I decide to get a bigger presence for the career enhancement becoming a self-style expert would give, but I’m working hard to “gain expertise in my core abilities” (which are not related to finance) first!

    Right! I’m off to enjoy the (free) sunshine!

    1 Jun 2014, 12:05pm
    by Never land


    I dunno compounded investment returns have practically worked out very well for me in the last 25 years

    The linear earning progression experienced by the baby boomers in their one company careers has not been replicated by the succeeding Gen X (there is a Joseph Rowntree paper on the subject I can’t be bothered to link). All the more reason to save when you can

    The other argument I would put forward for starring now is that all the juicy tax incentives for savings now (ISAs, SIPPs, VCTs, etc) are likely to get reduced in the future

    We’ve already seen personal pension savings reduced from an unlimited amount to £1.25m, with further falls to come, and inflation proofed N&SI certificates have been all but abolished

    @Greg at the risk of being shot by others again for apparently suggesting young’uns shouldn’t bother saving early, the paper referenced indirectly in this post said pretty much what you’ve just said.

    I also found money terribly short in my 20s – okay so I stupidly lived in London, which is/was a fantastic place to be young, and it was only when the lack of the shag-pile became more important that I moved out.

    So the trajectory you’ve outlined worked well for me.

    @Neverland it’s the 10 years and stop myth I want to shoot – C.I. just ain’t that powerful. I’m not saying it doesn’t exist. It’s already faintly detectable in my own ISA. And doubling what people save over a working life is worth having, but saving for retirement is still mainly about saving, particularly for early retirees.

    Agreed about the tax bungs – if people in their 20s did as well as to get into HRT then they definitely should be pension saving in their 20s. However, the average household income in the UK is ~£27,000. The value of the tax incentives is a lot less at that level of income.

    1 Jun 2014, 1:30pm
    by Never land


    Funnily enough saving *a lot* is the argument I keep making over at the original monevator thread

    A responsible government would be banging into people’s heads that they should be saving c 20% of their income a year

    Instead we have Chas ‘n Dave trying to get shop takings up to boost their reelection chances

    @Greg, Never land
    At the risk of sounding like Methuselah, I do feel it incumbent upon me to point out to any unfeasibly gilded youths here present that most boomers did not have one job for life (the longest I worked in a single company was three years; moving on was mostly how we obtained career progression). That was OUR GRANDPARENTS, and to a lesser extent our parents, so your great-grandparents, maybe.

    Out of the tiny salaries that we earned mortgages were way more expensive than now, at up to 25% interest rates (mercifully only very briefly, but mostly nearer 17.5 than 2.5%) and the only choice, with a mandatory minimum 10% deposit, was for a period of 20 years, no fixes, just straight repayment or an endowment, for a maximum of 2.5 times single or 3.5 times a couple’s earnings. A lone female had to have a male guarantor, too – it really was the Dark Ages, until (I think 1966) female civil servants had had to resign if they married.

    Apart from the public sector only the banks and huge corporates which traditionally employ a small minority of the workforce offered final-salary pensions, although when smaller firms did introduce them commonly they fell prey to takeover by the likes of the Bouncing Czech and his many imitators, when the funds mysteriously and usually quite promptly disappeared, soon to be followed by jobs. In any event for some years these pensions could not be moved from one employer to the next (or frozen) but had to be paid out if that employment ended; useful enough at the time although the sums involved were negligible, but not many of us were able to save anything else and consequently many have no pension other than the State’s now.

    Personal pensions are a relatively recent introduction; for years there were very strict limits (as far as I hazily recall, starting at 12.5%, increasing to 15% at age 50, then 17.5% at 55) of salary that could be used as contributions, and tax-free savings were introduced only by John Major, in the guise of PEPS and TESSAs, the forerunners of ISAs. During the span of my working life, the financial possibilities now open to all have increased immeasurably.

    In the dark days of pre-decimal coinage, there were 240 pennies to the pound rather than 100, so it has been pointed out that the old eight-sided threepenny bit then had the purchasing power of the new eight-sided pound coin shortly to be introduced, which may offer you some perspective on inflation since that time. I don’t suppose it will average out any better over the next 40 or 50 years; far more likely to increase (so you’ll need more, we’d had no QE officially then, so Never land’s right there).

    My father insisted that investment in education (in which I would include travel) is never wasted, and looking back down the years I have to admit that he was right. Despite all the above, by dint of borrowing extra deposit from the previous two generations, we bought our first house in our mid-20s, and by shovelling everything into the repayments including my inheritance were mortgage-free at 38, just one house later, and have stayed that way although a lot has happened since then as it does in most lives. We had plenty of fun along the way, too. I’ve no idea what will happen in the years ahead, or even how many of them there may be, but would suggest that it’s possible to focus too much on specific goals (a pension pot of £x) for that very reason; flexibility in how it can be used is far more valuable if only because we can’t know the circumstances (divorce, accidental injury, death/bereavement, taxation, illness, late remarriage, unexpected offspring in subsequent generations, the economy stupid) in which it might be needed.

    Despite every prospective purchase having been subjected to strict cost-benefit analysis during a quite ascetic life, I seem to have amassed a truly astonishing amount of stuff (as well as memories) which is now being decluttered or downsized. I’m now concentrating on keeping as high a proportion of my assets as liquid as is consistent with earning a reasonable return, because as has been usual, the latest pension reforms are coming at a good time for me. A few years ago I “retired” for the third time, and now can’t imagine returning to wage slavery again. Once again my circumstances have changed so keeping the gleanings away from the tax man may involve investment in officially wasting assets which will further enhance these golden years. That is rather the point of this long effort, after all.

    2 Jun 2014, 4:00pm
    by Grumpy Old Paul


    @Caz,
    I’m of the same generation as you and should like to point out a few other facts:
    1. The public sector was a much larger employer than today since it included all of the now privatised industries.
    2. Final salary pension schemes were the norm for blue chip companies.
    3. Maxwell was the exception not the norm.
    4. Tax relief on the interest on the first £30000 of a mortgage (a huge sum in the 1960s and 1970s) was given at one’s highest rate.
    5. The combination of high inflation and rising real earnings meant that the real cost of servicing a mortgage tended to fall very quickly, especially for those in the early years of work when rapid promotion was the norm.
    6. The standard term for mortgages was 25 years but it was definitely possible to get a 20 year term too.
    7. I don’t remember mortgage rates ever reaching 25%. Inflation reached that level in the early 1970s after the Barber boom but some groups of workers negotiated pay rises of 33% or more.
    8. Real incomes were probably lower for most people 30-40 years ago but were only “tiny” when compared to today in money terms.
    9. No-one has claimed that everybody stayed in the same job for their whole career; I can’t think of one acquaintance that did. However, it was reasonably safe to assume that one would be able to stay in work, if one so chose to do, until normal retirement age.
    10. TESSAs, PEPs and ISAs were not available but tax relief against one’s highest rate was given on life assurance premiums and on endowment policies.
    11. Many of us did not have the fortune to be assisted in house purchase by two previous generations and nor did we benefit from any inheritance apart from one’s genes. This is also true today. Furthermore, longer life expectancy means that even those fortunate enough to inherit wealth may not do so until they are themselves senior citizens.
    12. In those days, 2.5 or 3 times the salary of graduate in their mid 20’s would typically buy a house in the south-east of England. I understand things are a little different today.
    13. Most graduates finished university without much debt or a ‘been to university tax’.
    14. The employment market was far more favourable to employees than today; the old cliché was that ‘you could walk out of one job on a Friday and walk into another the following Monday morning’.

    Baby boomers as a generation didn’t create the economic mess we have today and don’t deserve to be blamed en masse. But as a baby boomer, I’d say that as a generation we had it far easier than subsequent generations and that was especially true for those who did not come from privileged backgrounds.

    I do not agree that compound investing does not work. Kindly run a calculation whereby you invest say £20k for 30 years and you have invested in companies that consistently raise their dividend by between 5% and 10% year on year from an initial yield of about 3.5%. You do not add fresh capital, you simply reinvest those dividends as you go along.

    This is what I have done since 2008/9 when I bought about £20k worth of quality stocks with high current yields because stocks had been smacked down and have since consistently raised their dividends by above 5%/a.

    By my calculations, my dividends alone will be coming in at a rate of abvove £75k/a in 30 years i.e. I am not even taking into account stock splits and spin offs and capital appreciation. I can live on about £25k/a comfortably now and at an inflation rate of 4%/a, I would need more than £70k/a in 25-30 years.

    I like this method because the dividends will keep up with inflation and I do not have to touch the capital…:)

    @sasa I do not say compound interest does not work. It is misused in the finance world to give people a false hope, particularly that dire start in your twenties and stop at thirty and you’re better off that somebody starting at 30 and going on to 60 story – it’s just plain wrong. The devil is in the detail which is why I spent God knows how many words on outlining the issues, but even then I acknowledge it roughly doubles peoples retirement savings over 30-40 years. Note that just taking a company match does that too!

    FWIW I use exactly the same philosophy as you, in that a HYP I will use the dividend income. I also started in 2009, however you are inferring the general from the particular. Also note that HYP shares often do not show the amount of capital appreciation other sectors of the market show. Simply spending the dividends is not necessarily not touching your capital if the company is not growing

    March 2009 was a low-water mark, and you will have done well because you bought cheaply and the improving economy has improved company earnings. However, the annualised long-run trend for equity performance is about 5.3%, you’ll probably eat the .3% in fees and rebalancing costs. Which is why I used 5%. If you are saving over 30-40 years and retiring over the same period then it’s the long-run rate of return you need to take into account. You can’t just take a ruler and stretch from a bear market to a bull market and say that will hold for the next 40 years.

    @GOP and caz – thank you for making me feel young, though it sounds like I missed a hell of a great ride ;)

    @ermine — “It’s the 10 years and stop myth I want to shoot”

    But this is a straw man IMHO, yet you keep focusing on it.

    The ’10 years and stop’ illustration is specifically chosen to show the combined power of early savings and compound interest. Nobody has ever advanced it as a sound plan for financial freedom (although ironically extreme early retirees may come the closest…)

    To appeal to the engineer in you, f I told you a Harrier Jump Jet worked via a VTOL engine, I don’t think you’d come back and say “it’s a myth because as soon as that engine is switched off it falls to the ground — there’s more to it, it needs to keep going”.

    Sure, and so do savings after 10 years. But they are massively boosted by the early lift. :)

    It’s a very persistent story – the same tale was sold as such to me at the start of my career, though not in terms of pensions, but in terms of endowment investing. It was possibly more true then – interest rates and inflation were higher.

    We need to save steadily and persistently for retirement. For instance, CI doubles your money, as long as rates of return stay at least as good as 5% and you work 30-40 years.

    Now that employer match does just the same – guaranteed and right off the bat. That is something we should be firing our young people up about, go get that and make sure you get all of it!

     

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