I have just read a great post over at Plonkee. Plonkee talks about the need to effectively put your investment strategy on “auto-pilot” – with money being dripped into stakeholder pensions and Stocks and Shares ISA’s on a regular basis.

They key with any long-term investment strategy is to start as soon as possible – tomorrow is too late!

This reminded me of an article I wrote on the Rule of 72 and the Time Value of Money. The rule of 72 simply states that whatever rate of interest your money is enjoying, divide that rate into the number 72 and that is the number of years it will take your money to double in value.

For example, at 6% per annum, your money invested today will double in value after (the maths bit! – 72/6) 12 years.

So the sooner you start investing the more of these “12 year bits” you can accumulate in your lifetime.

The other benefit of starting as soon as possible is the benefit of “compound interest” – this effectively is where “money makes money”. If I invest £100 today, at a rate of interest of 5% I will have £105 at the end of the current tax year – in year 2 my amount invested is now £105 – I will earn 5% on this total amount – so in effect my £5 interest received in year 1 is now earning interest in its own right – “money making money”.

Present day investment environment

Most of you will be aware of the recent falls in world stock markets – it would be strange if you hadn’t heard about them!

Well it’s not all bad news – the only people who lose money in a falling stockmarket are those who need or have to cash in their investments. Everyone else has simply made what is known as a “paper loss” – in reality you haven’t lost anything – it’s just on paper – the only time you have made a real loss is when you cash it in.

Why is this of interest to the shrewd investor?

The shrewd investor will be the one who has continued to invest over the last year or so – on a regular basis to benefit from “pound cost averaging” – as they have been able to buy more and more shares at a lower price.

Any investment in the stock market should be viewed as a long-term strategy and I personal am looking at a minimum 10 year timeframe for each investment I make – I only invest the money if I am willing to hold that investment for 10 years.

At the start of 2009 I made a pact with myself that this year I would make as much effort as possible to change my lifestyle for the benefit of the environment as well as putting more money in my pocket.

Here’s what I have managed to do so far:-

1. Walk to work instead of drive

Since relocating to Bristol about 4 years ago I had been in a position where I was commuting to work, in my car, for 2-3 hours each and every day. It wasn’t a long trip – about 8 miles each way – it was simply a case of the congestion in and around Bristol holding me up.

The benefits to me of moving away from this “daily commute” were several – saved petrol and wear and tear on my car, saving the environment and natural resources, saving me time (my favourite savings by the way!) not sitting in the car for such periods of time as well as the health benefits of moving away from the stress of the daily commute.

In order to make this change I decided to move to a new company closer to home – and am I glad I did – I know have a fantastic 10 minute walk to work through some of the most beautiful streets in Bristol. The car rarely moves off the drive in the week now and I have extra money in the bank each and every month!

2. Give up pre-packed sandwiches and bottled water

Not only are they expensive (how can bottled water, in some instances, be more expensive than petrol?!) I used to buy a sandwich on a daily basis, as well as a bottle of water for work. Not only were these expensive (when compared to the alternatives of drinking tap water and making my own lunch) but stopping buying them also did a little bit for the environment as there is no rubbish (plastic wrappers and bottles) thrown away each day.

3. Taking the Train to Visit Parents

I was surprised when I looked into it that I can get a train from Bristol to my folk’s house, and back, at the weekend for less than the cost of the petrol I would burn to drive there.

OK, it takes a little planning and I have to walk a couple of miles to the stations, but this is one less car on the road, I have three hours of my life back for doing more productive stuff – especially if I am lucky enough to get a seat with a table on the train – and the train is going there anyway so the environmental impact is considerably reduced.

The result is I arrive fresher and less stressed than I used to and I see some fantastic countryside on the way there!

4. Unplug – not standby

Like most people, my TV/DVD player, radio, microwave, etc had all been left on standby for years. I was aware that this was using electricity but not to the extent that in reality it is.

I now turn off at the wall all my electrical items when they are no longer in use.

5. Holiday in the UK this year

Having been abroad most years for the last decade I decided that this year I would not fly abroad and would holiday at home. My goal was to minimise the total cost of the holiday and to this end we went camping! This was a great adventure and bought back a lot of childhood memories.

I’ll admit it takes a bit to get used to having to get out in the middle of the night to go to the toilet in the middle of a field and waking up to a cold tent, with lots of condensation, even in the middle of summer.

But it was more than just a holiday – it was an adventure – money was saved – and a great time was had by all of us – it just proved to us that we don’t need to jet off abroad and spend lots of money in fine restaurants to have a great time. We will certainly be doing it again next year.

6. Use email instead of posting stuff

Another concern I had to address was the amount of paper being wasted in running my investments, bank accounts, pensions, bills etc and the almost daily fall of half a rain forest through my letter box.

I registered with the Mailing Preference Service – which stopped most of the junk mail coming through the letter box in a couple of weeks. I moved all bank accounts to paperless statements – I don’t need paper ones – they have historically been filed away and never looked at again until destroyed after 7 years as I am self-employed.

7. Stopped buying newspapers and magazines.

Whilst having a clear out a few months back I was shocked at the amount of newspapers and magazines I had accumulated. I noticed that these were not cheap with the average magazine costing £3 – £4. The majority of the pages are adverts which I am not interested in anyway.

So I have not bought a newspaper or magazine at all this year – a great savings – I get my news and current affairs fix from the internet and TV now.

And the next 7………….?

I am sure there are many more changes I can make to put more money in my pocket as well as doing my bit for the environment – please let me know by leaving a comment below what hints and tips you would like to share with us.

The following is a list of the top 10 read articles in August.

1. Pay Yourself First – the first step in wealth creation

This article discusses the need to save from income before spending it! This is a form of deferred consumption and by saving first and then spending what is left you can build a solid foundation to your financial future.

Tip – aim to start saving 10% of net income each and every month – it won’t be easy at first but your budget and lifestyle will adapt over time.

2. Get Money for your Old Mobile Phone

Many of us have old mobile handsets lying around – did you know you can sell yours online – here is an article discussing this – I recently sold my old Sony Ericsson K800i and received £28.00.

3. New Tax New ISA Allowance – ISA 2009/2010

In just over a months time the ISA allowance for over 50’s increases to £10,200, with the allowance increasing for the remainder of the population on 6th April 2010.

4. Cashflow forecasting – income and expenditure spreadsheet

Our free income and expenditure spreadsheet remains as popular as ever and we are receiving some great feedback from people who are using it – thanks!

5. Investment Bonds – an introduction

An investment bond can be a shrewd financial planning tool as well as an investment vehicle.

6. It’s not how much you save but how long

This article discusses how, over time, money make money – with interest earned on a savings account itself earning interest. The longer you can save for the more money you will build up – start saving as young as possible.

7. Non-taxpayers – ensure you receive your bank and building society interest without tax deducted

Completing a simple form can ensure that non-taxpayers, both young and old don’t pay unnecessary income tax on the interest they receive on their savings accounts. With interest rates as low as they are at present every penny counts so ensure you’re registered to receive your interest gross if applicable.

8. Personal Finance Blogroll

A list of the other personal finance blogs I visit on a regular basis – makes for some interesting reading!

9. Retirement is an Income not an Age

Many have fallen into the trap that retirement occurs at a particular age. Unfortunately for most of the population this occurs simply because they haven’t secured sufficient income to retire earlier. By targeting a specific income and going for that it is possible to retire early. In a forthcoming article on “goal setting” we will discuss how this can be achieved.

10. Buy a Financial Calculator

If you’re serious about planning your own finances I strongly recommend buying a good financial calculator – ideal for calculating rates of return, how much to save on a regular basis to build a certain sized fund etc.

And finally……

Be sure to subscribe to our newsletter – it’s free and you can cancel it at any time.

Also – did you know you can receive our blog posts via RSS.

Anyone who is committed to increasing their personal wealth would be strongly recommended to buy a financial calculator.

I bought my first financial calculator when I was at University some 18 years ago, it was a Hewlett Packlard 10B Business Calculator, and I still use it today. The model has been updated now – Hewlett Packard 10BII – but the new model still offers the same great facilities I have come to know and love.

It carries out all the normal calculations you would expect of a scientific calculator, but also provides the ability to calculate the following:

Growth of a set level of regular savings, given amount, rate of interest and term in years is known
Net Present Value (of a range of regular inflows of cash)
Internal Rate of Return
Compound Interest Calculations
Time Value of Money

For example, if I save £100 per month, for 25 years, at 6% interest this calculator will calculate the future value of my savings (the answer is £69,299!). If I change this to 26 years, the answer is now £74,807 – an additional £5,508 for investing for another 12 months!!!

For retirement planning, say I have identified that I need a pot of £360,000 in 23 years time to retire on the income I need to live in retirement, I can calculate how much I need to invest on an annual or monthly basis, assuming any rate of return, to hit the target.

The third calculation I like to use the calculator for is calculating how long money will last for, for example, I have £10,000 today and I wish to draw £250 per month from it. Based on an interest rate of 4%, my calculator shows me that my money will last for 43 months.

Here’s the manual (4.0MB) for my Hewlett Packard calculator – it shows all the different calculations you can do with a financial calculator.

Buy a financial calculator from Amazon.

Related articles:

Rule of 72 – Time Value of Money

It’s Not How Much you Save, But How Long

The following is a list of the top ten articles visited in June 2009.

1. Pay Yourself First – the first step in wealth creation

Those who save first then spend invariably end up better off than those who spend first and save what is left.

2. New Tax Year – New ISA Allowance

Increase in ISA allowance following the start of the new 2009/2010 tax year on 6th April 2009.

3. Changes in ISA Allowance – Budget 2009

How the ISA allowance will increase to £10,200 for those aged over 50 on 6th October 2009 and for the rest of the population on 6th April 2010.

4. Cashflow Forecasting – Planning Income and Expenditure

A budget and cashflow planning article with a useful Excel spreadsheet to download and share with friends and family.

5. Investment Bonds – An Introduction

The various ways in which this life assurance based investment vehicle can help with your financial planning.

6. Non-taxpayers – earn interest without income tax deducted

How completing a simple form can stop non-taxpayers paying unnecessary tax on their bank and building society interest to the taxman!

7. Critical illness cover v income protection

How these two different types of protection product can be used to compliment each other.

8. Will writing – an introduction

What is a will and why are they important?

9. 10 Great Reasons for Writing a Will

A must-read article for all those serious about financial planning and protecting their families and loved ones.

And, finally…………..

10. The Rule of 72 – The Time Value of Money

A great little rule for making quick calculations

In this new feature we will answer some of the many questions we have been receiving from visitors to shrewdcookie.com. It is often said that if you ask a question chances are that many other people also want to ask that very same question.

Although we receive a large number of personal questions we have to remind you that we do not give financial advice on this website – we encourage you to visit an independent financial adviser, solicitor or accountant if you wish to discuss any particular course of action which may be prompted by an article you read on our site.

1. What are the new ISA allowances announced in the recent Budget?

The ISA limit is increasing from £7,200 to £10,200. The change comes into effect for the over 50’s from 6th October 2009 and from 6th April 2010 for the rest of the population. Of the new £10,200 limit, upto £5,100 will be allowed for Cash ISA investment, with any surplus between the amount you place in a Cash ISA up to £10,200 being available to invest in a stocks and shares ISA.

2. Inheritance Tax – who pays?

The liability for paying inheritance tax lies in the hands of the executors/administrators of the deceased’s estate. Inheritance tax is payable within 6 months after the end of the month in which the person passed away. It is possible to pay Inheritance Tax in instalments over up to 10 years – this is the case in circumstances where say the estate includes a house. There is an interest charge if you pursue this method of paying Inheritance Tax – http://www.hmrc.gov.uk/ for more details.

3. I am married to someone who was not born in this country – how does this affect our Inheritance Tax position.

Where a spouse is deemed to be non-Uk domciled then the Interspousal transfer is limited to £55,000, there in no limit to the Interspousal transfer where both partners are UK domiciled – no liability to inheritance tax on first death if you leave all your assets to your marital partner. Consult a solicitor or accountant about your own particular situation.

4. How do I get a State Pension Forecast?

To obtain a forecast of your state pension entitlement, based on your national insurance record you need to fill out and submit a form BR19 – this article – “How Much State Pension will YOU get” gives more details.

5. If I invest a lump sum now how can I easily calculate how it will grow between now and retirement?

Using the Rule of 72 – by assuming an interest rate and dividing this into 72 will tell you how long that money will take to double in value. For example, at 6% your money will double in value every (72/6) 12 years. If you had say 36 years to retirement, at 6% growth your money would effectively double 3 times. See this article for more details.

6. Can I back-date my ISA investment to use last years allowance?

No – your money needs to be invested by midnight between 5th and 6th April each year to use the ISA allowance for that tax year – there is no way to backdate an ISA investment. A case of “use it or lose it”!

7. I am a female born in 1954 – when do I get my State pension?

State retirement age for men and women is being equalised to 65 for both sexes. See this article . There is also a State Pension Age calculator provided by The Pension Service – enter some basic details and it will tell you exactly when you qualify for your State Pension.

8. Can I hold Cash in a Stocks and Shares ISA? What is the tax liability?

Yes – many providers offer a “cash park” facility whereby you can invest temporarily in cash and then switch into stocks/funds over the short term. There is the facility to receive interest on this cash held but the interest is subject to tax and a non-taxpayer cannot reclaim this tax either. See this article for more details.

9. What is the minimum deposit on a mortgage for first-time buyers?

There is no legal minimum deposit, the minimum is set by market forces – we are currently suffering from the “credit crunch” whereby lenders are being cautious about lending to people particularly with the housing market currently falling. Therefore, more and more people are being expected to make a deposit when buying their first homes – typically 10% or more is required to obtain a good interest rate product – see “5 tips for first-time buyers” for more details.

10. What is the “deferred period” on my income protection plan for?

The deferred period is the time between notifying the claim to the life office and the benefit being paid out. The plan is designed to provider a replacement income in the event of long-term absense due to illness or accident. The longer the deferred period, the lower the risk to the insurance company of having to meet a claim which therefore means a lower premium. See these article on “income protection” for more information – “Income Protection – an introduction” and “Critical Illness Cover versus Income Protection”.

These are just some of the areas we have received enquiries on in the past month. Although we cannot reply directly please ask a question and we will try to feature it in the next FAQ article next month. Add a comment below or complete this short form to contact us.

Simon

Long Term Savings – the need to start early

Saving for income in retirement can be a daunting thought for most people – the problem they face is that they simply don’t know how much they need to save between now and retirement.

In this article we consider the time value of money, and in particular, the benefits to be enjoyed from “compound growth”. In later articles we consider just how you go about working out how much you need to invest to plan for your own retirement income.

The Rule of 72

In the article “The Rule of 72 – the Time Value of Money” we discussed a simple technique for calculating how your money grows over time whereby dividing the rate of growth you are enjoying on your money into 72 shows the number of years it takes for your money to double in value.

For example – if you were lucky enough to receive 6% annual interest on your money in a savings account then this would double in value every 12 years (72/6=12).

Compound Interest

The principle of compound interest is simply one of “money makes money”. An example of this would be investing £100 in a savings account at 10% interest – after one year your money would have grown to £110 – after two years, £121 – you have earned an extra £1 interest in year two as not only have you earned 10% on your original investment of £100 but you have also earned 10% interest on the £10 interest you made in year one and this continues for as long as you leave that money invested.

Over time, as the proportion of “interest earned” grows then the rate at which your overall investment grows also increases – it’s like a snowball effect – when you roll a small snowball down a hill at first it grows slowly – the more it rolls, the more snow it picks up on each rotation and the faster it moves…….

The following chart shows how £500 per month, enjoying a simple return of 5% per annum, grows over a 30 year period –

Demonstrating compound interest on regular savings over time

The above chart shows that in the earlier years the rate of growth on the funds invested is relatively low, and as the benefits of compound growth accumulate over time the curve of the graph becomes steeper as each and every £1 of interest earned subsequently earns its own interest!

It’s not how much you save, but how long….

The principle of compound interest therefore brings us nicely into the subject of pension planning, saving for retirement or any other form of long-term saving.

For the sake of this example we will consider that you wish to retire at age 60 and you are now aged 30.

You have calculated that to provide income in retirement of £20,000 per year, ignoring inflation for the time being, and assuming a return of 5% after charges for both the growth on your money being invested BEFORE retirement and for the annuity income you receive AFTER retirement, that to provide £20,000 per annum you need a fund of £400,000 (£20,000 per annum divided by 0.05).

So to achieve this income goal you need to build up a fund between now and retirement of £400,000. Logic says that we simply divide the fund needed between the number of years to retirement and this tells us how much we need to save each year – in this example £400,000 over 30 years requires a saving of £13,333.33 per year (£1,111.11 per month)

This however doesn’t take into account the growth that you would enjoy on each contribution being paid into the investment vehicle – the contribution made in month 1 would have the longest time to grow – 29 years and 11 months, the contribution made in month 2 – 29 years and 10 months and so on…….

Compound Growth and Regular Savings

Saving on a regular basis into an asset-backed investment, such as a pension fund, or a unit trust held under an ISA umbrella, can benefit from “pound cost averaging”. In a volatile stock market, such as the one we are currently in, investing on a regular monthly basis means that you effectively have 12 chances each year to invest some of your money into the stock market on a day when the market is lower than on other days. The benefit of this is that it brings down the average cost of the units you hold, and ultimately leads to a larger potential profit at the end.

In our example above we calculated the monthly contribution required to build a fund of £400,000 assuming no growth

If we add in say net annual growth of 5% after charges (which should be achievable over the medium to long term) then the monthly investment actually falls to £480.62 per month.

If the rate of growth increases to say 6% per year, the monthly investment falls to £398.20 per month.

If the rate of growth again increases to say 9%, the monthly investment required to hit £400,000 falls to £218.49.

The Cost of Delay

Above we calculated that £480.62 invested at 5% net per annum will grow to £400,000 over a 30 year period. If we reduce the term to 29 years, then to achieve the same fund value, the monthly investment needs to be £512.77 per month – an additional monthly investment of £32.15 or an additional total investment of £11,188.20 over the life of the investment. This shows the cost of delay.

So by waiting one year, an additional £32.15 per month needs to be invested, each and every month for the whole 29 year period, to provide the same £400,000 fund at age 60.

If the individual were to delay their regular savings by 2 years then a monthly investment of £547.63 would be needed – delay by just 5 years and the monthly contribution rises to £671.69 which is probably beyond the means of most families with average income and outgoings.

Starting Early

We have now calculated that the regular saving to build a fund of £400,000 over 30 years, at 5% net return per annum, would be £480.62 per month – but what if you were to start earlier?

If you had the foresight to have started last year, and therefore have a period of 31 years over which to make this investment then this monthly investment would fall to £450.90 – start 5 years earlier and the monthly investment would need to be £352.08……………….

Conclusion

In conclusion then it is vitally important that you start saving as soon as possible for retirement income – whether that be through a personal pension, stocks and shares ISA, a deposit account…….

Start as soon as possible!

Ask yourself this question – how many more paydays until retirement? – 30 years – another 360 payslips – it’s later than you think!

Related Article:

Buy a Financial Calculator

Introduction

The Rule of 72 is a great way to help plan for the future. It is a quick and easy method for calculating the impact that growth and inflation can have on your money and other investments.

Compound Growth/Interest

The rule can be applied to investments where the investor is enjoying compound growth. Compound growth, in its simplest terms applies in cases were “money makes money”.

For example, with a savings account you receive an annual interest rate (return) and for the sake of this article we will consider the scenario where you invest £1000 into a savings account and leave it for a number of years with it enjoying an interest rate of say 5% net (those were the days!)

After year 1 your money will have grown to £105.00 (£100 plus 5%) – at the end of year 2 your money will have grown to £110.25 (£105 at the start of year 2 plus another 5% interest. This is COMPOUND INTEREST – your money has earned money – the £5.00 interest received at the end of year 1 has itself earned 5% interest; in this case the £5 has earned 25 pence interest.

The Rule of 72 – how to use it

To work out roughly how long it will take for a given investment to double in value, simply divide the interest rate being received into 72 – this will give you the length of time required for money to double in value.

For example, of you are receiving 6% net interest per annum your money will double in value in 12 years (72/6 = 12 years).

Likewise, the same principle can also be used to calculate the effect of inflation (increase in the cost of living) to halve the value of your money – e.g. if inflation is running at 3% per annum then your money will halve in real value (it’s purchasing power) in 24 years.

Why is this Principle important?

When planning your finances for the future you need to make a number of assumptions about how finances will change over time. Retiring today on £20,000 per annum pension may be comfortable for many people – but if you retire on £20,000 per annum in say 50 years time then the purchasing power of this income will be considerably less if the cost of living rises steadily over the next 50 years.

If you were to make an assumption that say inflation was to run at an average of 4% per annum then the real cost of living doubles every 18 years.

This is important for anyone planning to build a portfolio of assets over the longer term. In this example, consider someone age 29 – if we assume inflation of 4% per annum the cost of living will have quadrupled between now and retirement at age 65.

If the 29 year-old considers they can comfortable live on £25,000 if they retired today with all mortgages and other debts repaid by the time they retire, then by the time they reach 65, assuming 4% inflation, their portfolio will need to provide them with £100,000 per annum to maintain the same standard of living.