Retirement planning is just as important a part of your career as any. If you are in your 20s or 30s, it can seem far away. However, as we will find out, that is all the more reason to be thinking about your retirement.
Fewer and fewer employers are offering pension plans to their employees, and Social Security is expected to become insolvent in the not-too-distant future.
The result is that employees must do what they can to secure their own financial futures. That may seem like a difficult task, but if you follow these five principles, you will find it’s not as intimidating as you once thought.
1. Time is On Your Side
If retirement is in the distant future for you, then you might think you don’t have to worry about it right now. But the reality is that the reverse is true: the longer you have until retirement, the more important it is to start saving now.
Why? The reason is simple: compound interest. The more years you have to invest, the greater your possible returns.
This simple graph from the University of North Carolina illustrates the effect of compound interest:
As the years go by, interest makes up an increasingly larger portion of the money you accumulate.
But you might also notice that the curve starts relatively flat. The above graph represents 40 years of investing, and it’s not until around year 20 that the interest really starts to take off.
So if you wait until 10 or 15 years before your retirement to start investing, you will unfortunately never be able to really reap the rewards of compound interest.
This is not to say that those who are 10 years from retirement shouldn’t invest. But if you are 30 to 40 years from retirement and aren’t sure if you should start investing now, then the answer is a resounding yes!
2. Passive is Good
When it comes to your physical health, it’s a good idea to be active throughout the week. But when it comes to managing your investments, it’s better for most people to take a more passive approach.
The best way to achieve this is to choose the investment that works best for you and automatically deposit each time you get paid. This way, your investments will keep growing and you won’t even have to think about them.
Your ideal asset allocation should take into consideration important factors such as your risk tolerance and how long you have until retirement.
If you aren’t comfortable determining those things on your own, there are certainly services that can help. For example, there are robo-advisors that are specifically meant for managing retirement investments.
Robo-advisors are artificial intelligence-driven algorithms that manage investments with little to no human intervention necessary. In other words, once your goals are set, all you have to do is deposit money regularly and watch your investments grow. Or not watch them, since we’re being passive, after all.
3. Avoid Taxes & Fees
Taxes certainly have their place in society. They provide the money needed for public schools, infrastructure, public facilities, and much more.
However, that doesn’t mean you should pay more in taxes than necessary. The federal government provides several tax advantages with retirement savings, and you should take advantage.
After all, the government doesn’t do this for no reason. Of course, it understands the importance of savings for retirement and wants to incentivize people to do so.
And you should absolutely take advantage. Your primary vehicles for reducing your tax bill are an employer-sponsored retirement plan such as a 401k and an IRA.
If you can maximize your contributions to these plans, it is wise to do so. The more you contribute to them, the less you will pay in taxes. And the growth of the investments is tax-free, too, resulting in huge potential savings.
Similar reasoning applies to fees. Financial advisors can charge high fees – sometimes as much as 2%. While those advisors do use that money to pay their own bills, a 2% fee can be enormous.
While it may not sound like much, a 2% fee can result in hundreds of thousands of dollars in fees over the course of your career.
That depends on how much you invest, but high fees can cost you a huge amount of money. If you are paying anything close to 2%, you should find a cheaper advisor or even consider using a cheap robo-advisor.
4. Save for Increased Expenses
It is not an easy task to estimate how your expenses may change in retirement. For most people, the biggest increase will come in the form of higher health care costs.
And those costs can vary widely, but a 65-year-old couple retiring in 2019 needed about $285,000 to cover health care costs in retirement.
So if you want to have a comfortable retirement, expect to need around that $285,000 figure. If you end up having more money than you need, you can always bestow it upon family members or your favorite charitable cause.
5. Spend Less Than You Earn
This may sound obvious, but surprisingly few people actually practice it in reality. There are a number of reasons for that, and it may be difficult if you are not a high earner.
However, it’s more than just income. Other factors, like credit cards, play a role as well. This is not meant as a lambasting, but many people use credit cards to spend money they don’t have on things they don’t really need.
If you are always spending more than you make, you will never be able to get ahead financially. Conversely, if you spend less than you earn and invest the difference, you’ll be setting yourself for a comfortable retirement.
Again, it may seem simple, but this is a powerful concept. If you can make it a reality, you will be much more likely to have enough when you retire.
The Bottom Line
If you followed the markets at the beginning of 2021, you might think you should take an active approach to investing. You might also think it is realistic to get rich quick. Or you might think the prospect of beating the market can justify high fees.
While there are always exceptions, these things will lead to disappointment for most investors–and the opportunity cost of chasing higher returns. If you aren’t trading full-time, your best bet is likely to kick back and let compounding do the work over the years. And, indeed, avoid fees that can eat away at your returns.
That may not be as fun or interesting, but having patience will pay off in the long run. Chasing high returns? Maybe, maybe not. While it’s okay to have some “fun money” you use for speculative investments, it’s best to put the bulk of your money in tried-and-true vehicles, such as index funds.
