Why young people should think about pensions

Young people face clear challenges when it comes to deciding how to manage their money. Recent graduates and those just starting out in their careers must navigate earning for the first time and start to consider long-term financial goals.

But many young people may want to use most of their monthly earnings to have fun. For them, the concept of starting to save for a pension may seem an issue for later.

But there are real advantages in contributing to a pension from a young age. For one thing, you have a greater opportunity to benefit from compound returns.

In a pension, you can make returns not only on the money you put in but also on the income from the assets the pension fund invests in. For instance, if the pension fund buys equities (shares) it will receive dividend income from these. By reinvesting this dividend income back into the pension it can produce more returns over time. This creates a snowball effect that may lead to substantial gains. But there’s no guarantee of investment returns and you may end up with less than you started with.

The earlier you start to invest in a pension, the longer the time your contributions have the potential to grow, and the greater the opportunity you have to benefit from this snowball effect. And the more your pension benefits from compounding, the better positioned you’ll be when retirement does finally come.

Another advantage of starting to save into a pension early is young people typically have a higher tolerance for risk. Young people don’t usually carry the responsibility of providing for a partner or a family. So they could be better placed to hold higher risk investments, which typically have the potential to generate higher returns, although such returns are not guaranteed.

Time on your side…

Moreover, young people have time on their side. So they have the opportunity to outlast the fluctuations in value that higher risk investments often undergo.

Young people will most likely use a defined contribution pension scheme. In this type of pension the amount you get when you retire depends on how much you put in and how much it grows.

Many of us have a pension that our employer sets up and runs. Employers often match the amount we put into our pension, up to a certain point, which increases the total investment. So if you don’t pay into a workplace pension, you’ll miss out on these matched employer contributions.

But people under 22 are not automatically signed up for their workplace pension schemes as your employer does not have to pay into your pension until you are 22. Even so, they might do it if you ask them.

...but time does not stop for anyone

Saving up for a deposit to buy a home, building up rainy day savings or paying off student debts are financial concerns that may be at the front of a young person’s mind. Pensions may be seen as something to sort out at a later stage.

However time does not stop for anyone and there are real benefits to contributing to a pension from early on. At Schroders Personal Wealth, one of our key principles is to invest for the long term. This can help ensure you outlast the ups and downs that markets inevitably undergo, and can enable you to benefit from compounding.