The Savings Equation

04 Oct 2016 | News |

In our new book “The Wealth Secret” we set out a series of principles to achieving long-term wealth creation.

The first of these principles, and the bedrock to the total concept of creating wealth, even from a standing start, is the savings habit. Drawing upon traditional values the Book explores how and why savings is such a consistent factor in any study of people who become wealthy.

The chapter on savings is really about the discipline of regularly saving 10% of “every penny you earn” and explores how this can be done regardless of earnings levels.

Of course, the 10% figure is not rigid and it is with this in mind that we look at this subject even further in this article.

Here’s a question: “what determines how much you accumulate when you save money?”

There is an equation here, somewhat hidden, but in any event real and tangible. The equation is basically (put in simple terms) a combination of:

  • How much you save;
  • For how long;
  • Compounded by the rate of return you get on the amount saved.

At Penguin we are very big proponents of making sure you invest as well as you can. This includes striving to get the best return you can. Compounded returns are a magical thing! The more you can compound any money you save, the bigger the end amount – and the effect of even a couple of extra percentage points you can eke out on your return, add up over time quite handsomely.

However, the reality is that if we return to our formula it is the first factor where you can make transformational differences to your wealth. We can illustrate this through this example –

Imagine a 40 year old deciding to save £100 per month from today. They expect to increase this by around £5 per month, every year. So next year they will increase and save £105 per month, the year after £110 per month and so on.

Let’s say they invest until 65, when they expect to use this saved-up money to help in retirement. They make a choice to save in a certain area where the investment return is likely to be 4% per year net of costs.

So they are going to save £100 per month, increasing this slowly each year (as their earnings increase) for 25 years in total and they are going to get 4% per year as an investment return on average (of course this is unknown in advance, but their investment approach suggests this level of return is expected).

The paragraph above summarises their equation. We can project what this will produce, which is around £51,318.

However much we advocate trying to improve those investment returns/gains – the harsh reality is that if we can help to get this to 6% per year it makes a reasonable difference but not a transformational one. It is worth doing regardless of this, but it is not the ‘game-changer’. The difference 6% p.a. achieves is to boost the future sum to £68,287.

We can’t help a 40 year old rewind and start their savings from age 25. We don’t want to suggest extending the period of saving beyond the desired retirement age, as our illustrated individual really wants to retire at 65, so overall we cannot stretch the ‘how long’ part of the equation.

But what happens if we can find a way to help our individual save £200 per month, not £100 per month? What happens if we work together to trim expenditure, reduce tax or simply reorganise so that instead of £100 per month our individual can increase their starting sum to £200 per month?

If we accept the 4% annual investment return then we help that individual accumulate £102,636. This is now a substantial difference, if not life changing then possibly ‘retirement changing’!

If we can help the individual find the extra sums to save and increase their return on the savings, then we can boost the pot to £136,745.

The fact is that our equation is important in every regard; the longer you can save (so start early or now!) and the bigger your return on your saved money, the better: it will make big differences to your future pot. But if you want to totally transform your future pot, then work out a way to spend less and save more because it does not take much to make transformational differences to your future wealth if you pursue this course.

Order a copy of our book, The Wealth Secret, here.

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