On paper, the earlier an individual starts contributing to a pension, the better. It allows more time for compounding to have a positive impact and generally means there is a better chance of a higher value pension at retirement age.
However, for someone in the earlier part of their career, there may be a more pragmatic option than investing in a pension at the moment. Buying a first home could be a better idea, since the prospects for the housing market appear to be bright as a result of an accommodative monetary policy and a continuation of Help to Buy. In contrast, the stock market may lack value over the medium term.
Housing market strength
Clearly, if an individual can afford to buy their first home as well as contribute to a pension, then that would be the most appealing option. However, the reality for many first-time buyers is that house prices have become so detached from their earning power that a relatively high deposit and large mortgage are required in order to buy even a modest first property. For instance, the house price to earnings ratio in London is 10x, but could move higher. This could make houses even less affordable in future.
There may be two reasons for further growth in house prices. The first is government policy through a continuation of the Help to Buy scheme. Theresa May recently stated that she is aiming to spend around £10 billion through the scheme, with 135,000 first-time buyers set to benefit from the interest-free loan made available by the government. This could create continued high demand for properties and make housing affordability even more challenging.
The second reason for further growth potential in house prices is a continued accommodative monetary policy. Although interest rates increased recently, the Bank of England was clear that it was not intended to be the start of a fast-paced tightening of monetary policy. Rather, the MPC looks set to keep rates close to historic lows over the medium term.
In contrast, the stock market may lack value appeal at the moment. Certainly, there are stocks which may offer relatively appealing investment opportunities. But with the FTSE 100 at a record high and other indices across the globe rising significantly in recent months, it may pay for investors of all ages to hold back cash to invest at a later date. For example, the S&P 500 has a P/E of 23. It has only been higher in five distinct periods in the last 90 years.
This could mean that it is prudent for younger investors to focus on buying their first home, rather than investing in their pension. This could be viewed as the ‘least-worst decision’, since there may be an opportunity cost of missing out on dividends, potential capital returns and their compounding in the near term.
However, for those people who know they want to buy a house at some point in their lives, taking advantage of low interest rates, the Help to Buy scheme and avoiding a potentially expensive stock market may be the most pragmatic decision at the moment. After all, share prices may offer better value for money further down the line, but the dream of buying a house may move further out of reach for many younger people.
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