The Coronavirus pandemic has taken a heavy toll on many of us in terms of uncertainty, unemployment, loss of business or livelihood, and our mental health. It’s important however, that we take a step back and focus on the long term, and don’t stop our regular investments, so that we can avoid costly mistakes with our future.
Many of us may be either considering, or have been forced to cut back on expenditure during the current crisis. Whilst it’s a good thing to aim to live more minimally and reduce expenditure, it’s critical that we don’t cut back disproportionately on our regular investments for F.I.R.E.
Also, while many of us may be holding on to more cash at the current time due to uncertainty, in reality this is a bad move for anything more than smaller sums. Due to historically low interest rates, cash savings accounts and bonds are paying paltry rates of interest of less than 1%. With real rates of inflation much higher than official government figures suggest, you are effectively loosing money by holding cash.
This scenario helps explain the fast recovery we have witnessed from the steep fall in markets at the start of the Pandemic. Investors have been driven in to stocks and other assets in the search for higher yields on their capital than they can get for cash, despite the current turbulent environment.
How much could you lose out by stopping regular investments?
There are two main paths to invest in stocks for the long-term:
- In a company or private pension
- In a private stock portfolio through a broker
The following chart gives you an overall perspective of how a typical pension investment will grow over time, to demonstrate how growth is affected by the level of contributions made. It is based on two £20,000 pensions growing at 5% p.a over a 30 year period, exclusive of fees and compounded.
The £300/month is obviously growing larger due to the contribution size, but it is also growing faster due to the power of compounding which results in a steeper growth line. This demonstrates that any additional funds you put into or omit from an investment can make a significant difference to the final outcome over a long period of time.
Analysis by Vanguard has shown that for a typical professional of 35 who pays £300/month into a self-invested personal pension (SIPP), they would lose £15,000 in capital growth over 30 years by simply deferring their monthly contributions for one year.
Even though their one year of deferred payments amounts to £3,600 (12x £300), they would lose out on tax relief from the government at their prevailing rate, plus an assumed growth of 5% on their investments and the growth in compounding. The loss of £15k overall would mean losing a typical £760 in annual income.
Deferring regular contributions to a company pension will amplify losses
If you are currently contributing to a company pension, your long-term loss as a result of deferring payments will be even greater. This is because as well as your contributions and tax relief, the company also makes a significant and sometimes very large contribution. This results in overall growth, particularly once combined with compounding, to be significantly greater. Ceasing contributions will therefore make a considerable difference to your final pot’s value.
Additionally, contributions and capital appreciation in a company pension or SIPP are tax free. Compounding will hence have a greater effect on overall return compared to stocks or funds that are held in a brokerage account that will be subject to tax, hindering growth.
What if I can’t afford contributions?
During the Pandemic, some people have actually benefitted financially. Those who work for companies that have instructed them to work from home but have been kept on full pay, are actually better off. This is due to savings made on commuting, lunch expenses, childcare costs and more. For those in this situation and pursuing F.I.R.E, this is a great opportunity to put those extra savings to work.
For others that have had their incomes reduced due to furlough, or a reduction in hours, it would be prudent to try and maintain your existing regular investments where possible. If this is not achievable, then try to only reduce them in proportion to the reduction in your income.
If you have found yourself out of work and unemployed then the best way forward is to live as frugally as possible until you can find new employment and attempt to save something each month even if it is a small amount. See how I save 50% of my income.