For most people, the largest pension benefit will be the workplace plan. The key here is not just maximizing your contribution, but making sure your investment works as well as possible. The best way to reap the benefits of the “youth dividend” is by regular long-term savings in globally distributed tax incentives such as corporate pensions.
This allows you to multiply your profits for decades through tax relief and the miracle of compounding returns. At the same time, dollar or pound cost averaging helps in smooth returns. Cost averaging occurs when you invest a constant amount each month. This tends to happen automatically in workplace pensions. If the market is down, your monthly contribution will buy more units. If the market is strong, fewer units will be purchased. The net effect is that amateur investors tend to mindlessly buy more commodities when markets are at their weakest, something many professional fund managers fail to achieve. .
As for the investments themselves, most online investment platforms are equipped with algorithms that allow inexperienced investors to select portfolios of globally diversified low-cost funds.
The last thing a young investor should avoid is being overly cautious about retirement. Holding large amounts of cash can be a major obstacle to wealth creation.
The right amount of risk to take is largely determined by your time horizon. If you’re saving up to buy an apartment in the coming months or years, holding your down payment in stocks or bitcoin is clearly inappropriate. It may disappear before you need it. But for someone with maybe 40 years to retire, there’s plenty of time to overcome the market’s regular panics.
Even though interest rates are at levels not seen since the 2008 financial crisis, the most competitive bank deposit rates are nowhere near matching inflation. According to Moneyfacts, the most easily accessible savings rate is 4.5%, only half the UK inflation rate of 8.7%.
By contrast, the UK benchmark FTSE-100 is by no means the world’s best performing index, but has averaged an average annualized return of almost 13% over the past decade.
Over a long enough period, stock market ups and downs, especially on a global scale, tend to average out. Unfortunately, many long-term investors miss opportunities by holding too much cash in cash, especially in the immediate aftermath of market volatility. From February to March 2020, when the COVID-19 pandemic began, the S&P 500 Index fell 35% in just over a month. By August of the same year, the index had fully recovered its losses, and by the end of 2020 was up 16% from its beginning.
Emphasizing the stock market’s long-term resilience and tendency to bounce back from bad luck overlooks another advantage young investors can enjoy. People tend to focus on the value of what they have already invested in. But most investors under 40 will save more in the future. In that sense, the current sharp market correction may be stressful, but it could be a boon to long-term wealth creation.
How much equity risk you take is in many ways a matter of personal preference. Big profits mean little if you can’t sleep at night. However, traditional investment heuristics help people become accustomed to higher levels of risk. One such rule suggests that your exposure to equities must be 110 minus your age. Based on this, it makes sense for a 30-year-old to keep his 80% of retirement savings in stock funds and the balance in bonds.
So while it is understandable to be wary in the face of political, environmental and economic turmoil, it can be detrimental for young investors to let it influence their investment decisions too much. Young people have few advantages that make it impossible to ignore life’s greatest wealth: youth.
Details from Bloomberg Opinion:
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• WeWork’s predicament shows return to office is not a party: Lionel Laurent
• Should I pay my child’s college tuition or not: Merrin Somerset Webb
This column does not necessarily reflect the opinions of the editorial board or Bloomberg LP and its owners.
Stuart Trow is co-host of Switch Radio’s Money, Money, Money and author of The Bluffer’s Guide to Economy. He was previously a Strategist at the European Bank for Reconstruction and Development.
More articles like this can be found at bloomberg.com/opinion.