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We all remember that heart-breaking story about the ugly duckling not being accepted by the others in the pond only to later turn into the most beautiful swan, don’t we? What’s that got to do with finance though? Well, apparently a lot.

The article @ savingadvice.com tells you a neat little story about how people saving money aren’t really “cool” or sit in the pub together and discuss their latest achievements. But the numbers will still speak in their favour in the long run (i.e. the ugly duckling turns into the beautiful swan).

Here’s the example quoted in the article: Person A starts off with £10,000 and wants to make his money grow. But since he’s more keen to find out how to save (more) money than to learn how to maximise his return on the stock market, he chooses the easy option and puts the whole amount in an index fund tracking the (say) FTSE 100. By spending his spare time on finding ways to save money though, he is able to add another £100 a month to this fund.

Person B wants to be one of the cool guys and spents all his spare time learning about stock-picking, i.e. how to find shares that will give him an exceptional return and thus make his money work as hard as possible. He starts off investing the same £10,000 but since he doesn’t really care where his money ends up every day, there’s nothing left over to be added to his investments. All he has are the initial £10,000.

Now guess what? Assuming a steady 10% annual return from the FTSE, person A will end up with £47,555 after 10 years. If person B was good enough to beat the FTSE by 5% (a goal almost any ordinary investor would be more than happy to achieve), his £10,000 will have turned into £44,402 - more than £3,000 less than person A.

And the morale of the story? Leave the fancy shares to people who do this sort of thing professionally, look after your money and make the most of compound interest over the years. Ideally you want to save and beat the market in the long run, but very few investors actually manage to do that. Between you and me - 85% of mutual funds (who are actively managed by someone who understands the market and picks shares for a living!) underperform the market.

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A few days ago, I read a blog entry @ The Simple Dollar reviewing an article on retirement benchmarks that appeared in the April issue of Money Magazine. According to this article, at the age of 35 you need at least 1.6 times your annual salary tucked away in savings in order to retire at the age of 60 and have the financial resources to pay yourself 80% of your last annual salary for the coming 35 years.

Obviously compound interest will work in your favour the sooner you start. That is why I decided to have a closer look into the pension contributions my (soon-to-be) employer is making on my behalf to establish whether or not I would need to worry about reaching this target. With a little bit of help from Excel I established that I don’t - assuming the pension fund has an average return of at least 6.6% over the next 14 years.

This interest rate / growth rate seems definitely feasible and not only compound interest is working in my favour, but also the fact that my employer will increase the pension contributions over time with my years of service and age. For instance, while they contribute 5% of my annual salary when I start, I will be up to 11% when I’m 32 - assuming I have been employed for the 10 years in between.

Feel free to use my template to establish whether you’ll beat the benchmark or not (all numbers in the template are in relative terms rather than absolute monetary values).

Random statistics: RPI inflation rose to 4.6% in February (from 4.2% in January) which effectively means that I’m not even beating inflation with my current savings account. As soon as I start getting a regular salary, I will have to find a savings account that will actually earn something over time.

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