Why cutting back on saving is unwise

According to the latest survey from Axa, 75% of households plan to cut back this year as the credit crunch bites. Sounds sensible until the survey then reveals that most are stuck as to whether to cut back by "going out less", or simply reducing the amount they save for their pensions. This is alarmingly muddled thinking. Cutting down on meals out and shopping for the "millions weighed down by high lifestyle costs", as Axa puts it, may feel painful. But abandoning Isas and Sipps instead, just as the property market turns, will prove far more costly.

First off, few dispute that gravity is now reasserting itself on UK house prices the IMF's latest forecast predicts a 30% drop for UK property, while March saw the largest monthly fall in UK house prices since 1992, says the Halifax. This should snap more people out of the delusion that their house will not only provide a place to live, but will also pay for their eventual retirement, when they will free up lots of capital by downsizing.

The Turner Report on pensions a few years ago exposed this logic as flawed. The latest Land Registry figures reveal why. The gap between an average detached house and a semi-detached house or flat in England and Wales is about £100,000 enough to buy an income of just over £6,000 per year using a retirement annuity while the gap between semis and flats is zero. Since we all have to live somewhere, then even assuming you can face selling the family home on retirement, the pickings from downsizing look slim unless you move to a much cheaper area, or downsize to a shoebox, or both.

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So we can't rely on bricks and mortar to fund our retirement. How about shares? Some worry that buying now, when prices might fall further, makes no sense; and yes, in an ideal world we'd all buy right at the bottom and sell exactly at the top. But that would require extraordinary amounts of luck. What most private investors actually do is to hold off buying until share prices are in an uptrend and are already expensive. They then compound the problem by delaying selling until prices are clearly falling, not realising that by then shares may be relatively cheap.

This is the main reason why, says Dalbar.com, the average investor only made 3.9% over the 20 years to 2005, when the S&P 500 averaged over 11%. The easiest way to avoid this trap is to drip-feed an affordable amount into a cheap tracking product, such as an exchange-traded fund, through a tax-effective wrapper, such as an Isa or Sipp.

If you really don't want to invest in stocks, there's always cash. Right now, there are plenty of decent savings rates out there as banks compete for custom see our compare savings accounts page for more details. Whatever you decide, the main point is that you need to save more than ever when times are hard. So if you plan to cut back, ditch the takeaways, not your piggy bank.