Saving for the future is not always front of mind for most people which is understandable given the cost-of-living crisis and the need to balance household budgets.

This is a shame because the sooner an investor can get started the better their chances are of building a decent nest egg. In this article we show how you can go from a starting point of investing £200 per month, building up your contributions as you progress through your working life, to achieve a £1 million pot within 30 years.

Three decades may sound like a long time but with life expectancy increasing and government finances wilting, it is likely that the retirement age will keep moving higher. This means working for 30 years may prove to be a conservative estimate over time.

Another implication is that on average Brits are probably not saving enough of their current income for retirement. Investing £200 a month or £2,400 a year is equivalent to around 9% of the average UK salary after tax based on the latest data from the Office for National Statistics.

It is not far away from the minimum workplace pension contribution which is currently 8% of salary. Employers must contribute at least 3% with the rest made up by the employee.

This article focuses on investing through the tax efficient Stock & Shares ISA (individual savings account) which offers more flexibility than a pension and can be a useful tool for building up a sum which can be used for other purposes, not just funding a comfortable retirement.

THE KEY DRIVERS OF WEALTH ACCUMULATION

The important drivers that determine the size of a retirement pot are the rate of investment return achieved, the length of time invested, and the total amount of cash invested.

Everyone’s life circumstances are different. Later we discuss three scenarios and reveal how different rates of return and the amount of money invested can affect the size of your eventual pot.

Let’s look at returns first. Over short investment horizons share prices can be volatile and are impossible to predict, but over long periods investment volatility dampens down and returns smooth out.

Share prices are closely related to earnings growth over the long term. As companies increase their earnings, share prices should eventually follow suit and provide capital gains and dividends which can be reinvested.

According to Barclays 2023 Equity Gilt Study, UK shares have delivered a compound annual growth rate of 8.9% a year over the last 123 years.

Over the long run dividends contribute around half of the total shareholder return which underscores why it is crucial for investors to reinvest dividends to maximise growth.

Not reinvesting dividends really handicaps returns. The Barclays study shows that annualised returns drop to 4.3% a year if dividends are not reinvested.

The roughly 9% annual total shareholder return seems a fair target for investors to aim for over long investment periods. However, they can probably do better than that if they widen their investment horizons to overseas markets.

For example, the US is home to some of the largest and most dominant growth companies in the world. Emerging markets like China, India and Brazil have better growth prospects than old world economies like the UK and Europe.

Therefore, taking the long-term average as a starting point and adding some ‘juice’ from faster growing overseas markets, Shares believes investors can arguably shoot for total returns of closer to 11% a year.

As mentioned, starting the investment journey earlier is a big advantage because the effects of compounding have longer to work their magic. For our scenarios we have assumed an 8% increase in contributions each year to reflect the increased financial capability associated with career progression, at least until they hit the current £20,000 limit on contributions. We have not factored in the impact of any charges or costs.

Scenario 1

Julie's £1 million ambition

Julie finished university and landed a job as a trainee mechanical engineer at BAE Systems (BA.). The job pays relatively well and if Julie is successful there are many career path opportunities for her to progress through the corporate ranks.

Julie initially lived at home with her parents which provided he with more disposable income. She saves £200 a month to invest in a Stocks & Shares ISA in addition to her workplace pension.

Fast forward a few years and Julie eventually moves into a flat with her partner. Three promotions and a job move permit Julie to increase her annual investment contributions.

Julie has taken on more risk to maximise her returns and take advantage of her early commitment to investing.

For its growth potential Julie owns the Xtrackers MSCI Emerging Markets ETF (XMMS) which is invested in almost 1,500 companies and has an annual total expense ratio of 0.18%.

In addition, given her interest in technology Julie owns the Polar Capital Global Technology Trust (PCT) which has an ongoing charge of 0.8% a year.

Julie reasons that most of the time there are companies somewhere in the world doing well and with that in mind she owns the popular iShares Core MSCI World ETF (SWDA).

This £47 billion fund is invested in more than 1,500 shares spread across the globe. Julie considers this a good choice given it provides such a broad exposure to shares for a cost of 0.2% a year.

These investment decisions turned out well over the years and Julie managed to grow the value of her portfolio by just over 10% a year.

In total Julie has invested just over a quarter of a million pounds spread across 30 years which is equivalent to just under £10,000 a year on average.

As the table illustrates Julie’s portfolio grows to just over a million pounds in her early 50s. She is still healthy, married with one child and doesn’t plan to retire anytime soon.

Scenario 2

Greg – the cautious accumulator

Greg has enjoyed a successful career in marketing over many years and is happily married with three children. He stuck with his investment plan and kept adding to his ISA year after year.

Like Julie he invested over a quarter of a million pounds into an ISA over a span of thirty years.

Greg isn’t as comfortable as Julie in taking on risk. For global shares exposure he owns the Vanguard FTSE All World ETF (VWRP).

The £6.7 billion fund gives Greg access to developed and developing markets and almost 5,000 stocks for an annual fee of 0.22% a year.

Greg has also built a stock portfolio mainly comprising UK blue chip names such as BP (BP.), HSBC (HSBA), AstraZeneca (AZN) and Tesco (TSCO).

He is aware that smaller companies tend to perform better over time, but they are riskier. For this reason and to get a global diversified exposure Greg owns the Global Smaller Companies Trust (GSCT) which has an ongoing charge of 0.79% a year.

This Columbia Threadneedle managed fund invests in high quality, profitable global smaller companies. It currently trades at a 13% discount to net asset value.

The trust is a member of the prestigious Association of Investment Companies’ ‘dividend heroes’ list and has delivered 52 unbroken years of dividend growth.

Greg’s investment decisions have not been quite as successful, but he still managed to grow his portfolio by around 7% a year. Greg isn’t complaining though. After all, he is sitting on an ISA pot value of around £650,000.

Three percent (the difference between Greg’s average return and Julie’s) doesn’t seem like much but compounded over 30-years it means Greg has around £400,000 less than Julie which is close to 40% in percentage terms.

We have discussed how achieving different investment returns can affect the relative size of future pension pots. Not everyone is lucky enough to be able to continually feed their ISA. The next scenario looks at the impact of taking a break on future returns.

Scenario 3

Ann – pausing contributions with a young family

Ann enjoyed a good career in teaching but when she settled down with her partner and started a family their household disposable income dropped.

Having fed her ISA for a decade Ann decided to take a break while her children grew up and the couple had paid off more of their mortgage.

Ann still made time to manage her portfolio despite a hectic work and home life. As well as an individual share portfolio Ann owns the iShares Core MSCI World ETF.

She likes the idea of investing in technology and gets passive exposure through her holding in iShares S&P 500 Information Technology (IITU).

This provides access to companies such as Apple (APPL:NASDAQ), Nvidia (NVDA:NASDAQ) and Microsoft (MSFT:NASDAQ).

The £3.6 billion fund has an annual expense ratio of 0.15% a year and is invested in 66 companies.

In her 40s Ann can restart investing into her ISA once again. In total Ann has invested just over £86,000. Overall, Ann’s portfolio has achieved good growth averaging 7% a year.

The lower amount she invested due to the break in the middle means Ann’s ISA is worth about £270,000.

CAVEATS TO CONSIDER

The scenarios presented above are for illustrative purposes only and are not intended to be projections. In addition, we have made a big assumption that ISAs remain available throughout the next 30 years.

Government desire to encourage higher levels of savings into retirement products suggests they are here to stay, but politicians are always capable of changing their minds.

It is important to note that ISAs do not attract income or capital gains tax and money can be withdrawn without paying tax.

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