How to invest, workplace pension or ISA

[franceshalladay]

Hi MMM community,

I am 26, and am very new to investing so would appreciate any advice on how I should approach my investment strategy long term.

I am on a tax code 783T on a work visa and to avoid paying tax, I currently contribute 58% and my employer matches 12.5% to my pension pot. I then have around £1000 income pay every month.

I put around £1720 every month into my pension pot and invest on the North American index fund that includes companies in S&P 500 and some mid-cap Canadian companies. This is the only fund I invest so far as I don't know which other funds I should look into.

I spend around £600 on my expenses (rent, bills, council tax) and aim to save at least another £350-£400 and invest that in Vanguard S&P 500 or LISA or to my sinking funds.

Is this a good move in general? Is this putting all my eggs in one basket (which is my pension pot) and risking myself?

My first question is, due to my low income pay, my employer is contributing less on my NI. Would this affect my benefits on state pension? Is the state pension based on how much money I contribute?

I understand that this will not sound sustainable as I may consider purchasing a big expense like buying a home in my 30s but I am quite happy with what I can do at the moment to save as much as I can.

My second question is, do you think it would be better if I only match my employer down to 12.5% take around £1500 every month and invest around £800-£900 into Vanguard S&P 500 and not worry about how much tax I will have to pay in the future?

I would like to know what would be more profitable long term.

[daverobev]

You'r fine on NI (check your record on gov.uk).

I'd say you're way overweight on a subset of American stocks. These things go in cycles, and US valuations are historically high. I would switch the lot to a global tracker, personally, but that's up to you.

Bear in mind unless you buy a house the LISA is locked just like the pension. Do you have anything in a normal ISA?

Do you have a student loan? If so, pushing into the pension also avoids/defers repaying that. If you can afford to, pension is great. If you want to FIRE you will need a bridge to pension unlock date from whenever you stop work, so it isn't that easy. There is also an argument to say don't go overboard on the pension while you're in the 20% band. Once you're a higher rate earner it's even better. However, compounding is magic...

For a long time it wasn't really worth putting money into bonds ('return free risk') but that's no longer the case. Even at your age you may want 20% bonds. Vanguard do a LifeStrategy fund to fit that, though it is a little overweight UK.

But yeah IMHO going full on USA is unwise.

[franceshalladay]

Hi,

Thanks so much for taking the time to read my post and for the financial advice I appreciate it!

I was on a default lifetime strategy and all my contributions were invest in a global index fund, and for over a year, from May 2022 until June 2023, it returned about 1%. I was not satisfied with the return therefore switched to a North American index fund. I can see that this might be a gamble for me. Which other funds would you suggest for my age apart from bonds? I am currently enrolled on the L&G workplace pension.

I currently have £11k in the workplace pension and about £5 in Vanguard S&P 500. No emergency funds which is something I need to look into.

Apart from my workplace pension, the only other savings account I prioritize is the Vanguard S&P 500. I see the benefits of LISA but yes like you said, it is locked up money until I reach 60 for retirement.

Also, thanks so much for pointing out the bridge gap, this is also I should bear in mind. Would you be able to elaborate more on this? 'There is also an argument to say don't go overboard on the pension while you're in the 20% band. Once you're a higher rate earner it's even better. However, compounding is magic...'

I have a student loan that I pay £70 every month 'interest-free'. I have about 20K debt. Would you suggest to pay this off as soon as I can?

[daverobev]

Your terminology is a bit off.

S&P500 is an index. FTSE100 is an index.

Workplace pension and SIPP are 'pension' accounts, locked til you're 68 or whatever date the govt has it at by the time you get there. Inside this, you can buy funds and ETFs - which can be S&P500 tracker (ie, they track the index - usually by holding the items in the index, but sometimes synthetically for various reasons... well, let's not get too deep here I guess).

A LISA and an ISA are also both tax shelters like the pension accounts above, except they are 'after tax, never taxed again' instead of 'tax refunded or avoided on entry, but payable on exit' (bearing in mind the 25% tax free lump sum... etc).

£70 'interest free'... um are you sure about that? It's a UK loan through the Student Loans Company..? I don't know the ins and outs of it but generally if you're not going to pay it off across your working life - before it gets written off - then no you don't want to pay it off more than you have to. Putting money into your pension avoids this.

If you put money into your pension now, you start it compounding today (say 40 years at 6% growth, but the tax you avoid is lower).

If you put the money in in ten years while you're a higher rate taxpayer you only get 30 years of 6% growth, but you avoided more tax. I'm sure there is a calculator somewhere which will say if one option is better than the other.

IMHO it is quite easy to overfill the pension. If you get to 40 and want to retire, have a cool million in your pension and £200k in your ISA you're kind of screwed because you don't have enough to get you to pension unlock. Vs say having £400k in your ISA and £600k in your pension - 'enough is enough', having more in the pension doesn't help if you can't actually get at it when you need it (ditto the LISA).

[PhilB]

I'll second all of daverobev's points.  I'd add though that, as long as the rules don't change, you get the same compounding effect by putting the money into an ISA now and then moving it to a pension later, so that's what I would look to do in your position to maximise flexibility.


I'm also somewhat worried by your stated reasons for moving to US equities.  12 months is way too short a period to base any investment decision on. The fact that US prices went up more can be just as good an argument for avoiding them as for buying them.  Like daverobev I use a global tracker as I know that I don't know enough to beat it by cherry picking stocks or indices.

[franceshalladay]

Hi PhilB and daverobev,

Thanks so much for your detailed advice, I appreciate it -

After some careful inspection of my current pension pot, I decided to invest on 4 more funds and divide what I put solely into my North American index. I am now investing in both corporate and government bonds, a mixed asset, and index funds outside US such as UK, Europe, Japan (the FTSE developed index fund) etc. I think I am at the 80/20 ratio for stocks and bonds, just as what daverobev suggested, and even though I am quite heavily invested in the North American index fund, I think I will take the risk for now as I have a long time ahead before I retire. I do want to ask you all again why it is not wise to invest all in the S&P 500? Yes it is volatile and has ups and downs, but for myself who have 40 years left until retirement or to receive the pension allowance, wouldn't it be worth given the historic higher returns?

And yes, I do understand what you mean by its worthless not having any money as the pension money is locked. I think I will motivate myself to increase my income and look for side hustle jobs where I can maximize my ISA allowance. Currently, I try to put all my side hustle income to my HYSA and to my ISA.

My 20k debt is not from the UK loan agency, I failed to pay my tuition fee during university and has been tagged to the debt collection agency. My initial debt was around 18k then they added 10% interest fee/ service fee adding in total of 20k. I plan to pay this off for the next 30 years, interest free, as this is what I can only afford at the moment. Do you think it is better to pay them asap?

And as always, thanks again for the constructive feedback!

BW

[PhilB]

If the student loan is interest free, then I definitely wouldn't be paying it off any sooner than normal so you are fine there.

S&P500 is not a bad investment strategy in itself - indeed it makes up a large percentage of any global index fund.  What worried me were your stated reasons for making the change, as chasing returns based on short term performance generally leads to you buying things after they have gone up in price rather than before.  If your S&P funds only gave a 1% return in the next year vs 4% for a global fund would you swap back again?  That's the kind of short term thinking I was worried about.

I would also be nervous of any argument that looked at historic returns without also looking at current valuations.  That approach could easily have led an investor in 1989 to sell all their global funds and go all in on Japanese stocks - and we all know how that ended up.

When you are starting out in this game there is often a real desire to do something to improve your investment performance.  To learn the secrets of investing and find a plan to beat the market.  It's very understandable, but the research shows that it doesn't generally work. 

[Brit71]

This is an idea to consider as you are so young. 

Dividend aristocrats are shares that increase their payout over the long term.  Off the top of my head there is Scottish Mortgage and Diageo in the UK and more in the US including McDonalds and Coca Cola.  The yields on them tend to be quite low (as the market priced in future dividend growth) but your time horizon - which if you include the whole of your retirement is around 70 years, and longer if you have kids - is longer than most market participants.  So if you have anything within an ISA or a SIPP then look to buying these - over time you can add and diversify - for example if you change job and move your workplace pension balance to a SIPP.  As there are no low cost funds that I know of who follow this strategy it's a DIY job and diversification is important as a single company may stop that practice, as Shell did on me a few years ago.

If these dividends are reinvested they will compound twice, once through the dividend growth and once through dividend reinvestment.  The capital growth is unlikely to be spectacular - although these shares do tend to keep their value - and the initial income yield will be nothing to write home about.  But the payout when your looking to retire will be very good and it can all be tax sheltered.