You have a steady income, you haven’t much debt, you control your spending and you don’t gamble. But are you still taking a huge risk? Becky Sugden, chartered financial planner at Gresham Wealth Management, reveals the invisible threat to your long-term financial security.
Whenever we talk to a new client at Gresham Wealth Management, risk is always a key topic of discussion. A person’s attitude to risk – be it cautious, moderate, balanced or adventurous – will have a direct impact on the investment strategies we implement on their behalf.
In financial planning, there’s a special relationship between risk and reward. Broadly speaking, the higher the risk of an investment, the greater potential it has for rewards in the long run (but also the higher the likelihood of volatility in your portfolio). Investing is about trying to get this balance right for your personal circumstances. But there’s another, hidden risk involved in financial planning, which affects many people because they fail to spot it.
The hidden risk in everyone’s finances
Though people talk about the risk of investing, very few ever talk about the risks of not doing so – that is, the risk of failing to plan properly for the long term. Although young people are being actively encouraged to plan for retirement via pension auto-enrolment, many still aren’t saving enough and some are still opting out. Recent stats from the ONS show that although pension enrolment is at an all-time high (73 per cent of employees), nearly half of private sector employers are paying in under 2 per cent of employees’ pensionable earnings. In most cases, this won’t be anywhere near enough for a decent retirement income.
Of course, for many younger people saddled with student debt or trying to get onto the property ladder, making pension contributions may be the last thing on their mind. Can it really be such a risk to delay pension saving until next year? Well yes, it is.
Pension planning – the cost of delay
It might seem counter-intuitive, but if you want your pension saving to be more affordable, you need to start earlier – even if you aren’t earning as much. Simple arithmetic shows that delaying pension contributions by as little as 10 years (e.g. starting in your 30s instead of your 20s) will mean you need to contribute a much greater percentage of your salary to build the same size pension pot. Thanks to the power of compound interest, the amount of time you spend saving up your pension may be even more important than the size of your contributions.
The government has set out some proposals to encourage younger people to start saving into pensions sooner, such as scrapping the minimum qualifying threshold for auto-enrolment schemes, and is also increasing the minimum contribution levels for both employees and employers (to 5% and 3% respectively) by the start of the next financial year (2019-20). Unfortunately this also courts the risk that more people will opt out as their contribution levels increase.
Self-employed – the most at-risk group?
Of course, auto-enrolment only covers those who are employed by someone else. Self-employed people still need to take sole responsibility for their pension planning – and it’s clear that many are still neglecting to do this. The number of self-employed in the UK is rapidly growing – up from 3.3 million in 2001 to 4.8 million in 2017 – but according to the ONS just a quarter of them are now actively building their pension. If this trend continues, it could see several million self-employed people eventually entering retirement with little to support them except the State Pension and any private savings they may have.
How to overcome the risks of pension planning
The lessons from all this are clear-cut:
Start paying into a pension as early as possible
Do not opt out of a workplace pension scheme
Contribute as much as you can afford to your workplace pension scheme (this will also boost your employer’s contributions, so it’s a double benefit)
If you’re self-employed, find out about personal pensions and talk to a financial adviser about starting one.
Just as every investment carries an inherent level of risk, so too does the failure to invest at all. Even if you are self-employed, there will come a time when you will have to stop working, either through choice or necessity. Where pensions are concerned, the highest-risk options are always failing to save enough to support you in retirement – or not having a pension at all.
Becky Sugden is a chartered financial planner at Gresham Wealth Management, a firm of independent financial advisers based in Greater Manchester.