Operating as a sole trader can make retirement planning difficult because the lifestyle itself can be very unpredictable.
Most contractors, freelancers and professionals make one single pension contribution each year right before the tax deadline in October.
The problem with this is that the contribution tends to be a transactional event rather than a consistently worked retirement plan.
And therein lies the conflict.
But, the good news is that you can make one small change which can help you to invest more effectively.
It introduces an element of consistency by adjusting the way you invest rather than the amount you invest.
There is nothing inherently wrong with making standalone, lump sum contributions except for the fact that it’s a considerable financial investment whose timing is based on nothing more than a calendar date.
By default, little consideration is given to the unit prices being paid or the point in the market cycle.
Because of this, you just end up paying whatever the prevailing price happens to be on that particular day.
And this can go one of three ways.
Either you get lucky and buy at a lower rate than the yearly average, buy at a higher than the average or buy right on the average.
It’s not such a concern when you look at the consequences over one year in isolation.
However, the real problem starts to emerge if you happen to consistently pay above the average as a result of making fewer transactions.
Consistently overpaying it could cost you a very considerable amount over the longer term.
So much so that your contribution frequency can be just as important as the investments you pick.
Adjusting your numbers
By increasing the frequency, you get to take advantage of an investment principle known as Euro Cost Averaging.
Averaging helps you to avoid purchasing at marginal price points by investing lower amounts on a more frequent basis. Investing this way means you can get closer to the average price rather than buying at extreme highs or extreme lows.
So, for example, instead of investing €12,000 as one lump sum in a single year, you could divide it into 2 x €6,000 sums.
One of these gets invested at a regular monthly rate of €500 leaving the other €6,000 as a discretionary investment at some point later in the year, be it the tax deadline or something else.
This way, your €500 a month gets to utilise the averaging principle leaving you free to assess your cashflow situation at the end of the year.
The point is that, by simply changing the way you invest, your contribution frequency jumps 1,300% using the very same amount of money.
- 1 x €12,000 standalone contribution
- 12 x €500 regular contributions
- 1 x €6,000 elective contribution = 13 contributions in total.
i.e. from 1 to 13.
If you have 30 years to retirement then, rather than making just 30 annual contributions, you could be making up to 390 contributions instead.
The higher your investment frequency the more you average out the price you pay and the less affected you are by market swings.
Other Benefits to Regular Investing
This isn’t the only advantage to regular investing.
Here are some of the other ancillary benefits…
Investing on autopilot: When you don’t have to make investment decisions you remove the element of emotional decision making that could otherwise cause you to stop investing. This helps you to be disciplined without actually having to be.
Cash flow management: Working to a budget gives you the freedom to contribute more effectively without compromising cashflow. Committing to a smaller monthly amount lets you invest consistently leaving you free to make a discretionary decision with the balance, if and when the cash is available.
Momentum: The energy gained from motion is incredibly valuable so regularly investing keeps you more involved with your retirement planning.
Volatility: Making one single contribution in a year means the quality of your financial decision rests entirely on that price point. Timing the markets is not a strength for most people, including professional investors. Buying different amounts when markets move means you can use volatility to your advantage.
Compounding: Compounding returns are the magic ingredient to growth but its effects take a long time to shine through. The higher your contribution frequency the more compounding returns can work in your favour.
If you’re self employed and would like to discuss your situation, then get in touch today by calling me on 01 442 3929 or emailing me at email@example.com
2019 Business All-Star for Pensions and Retirement Planning in Ireland.