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Have questions about saving for retirement? Most people do. Read on to find out what everyone needs to know about planning for a fun, financially secure retirement.
Understanding Compound Interest
Most workers in all age brackets have heard their elders suggest that they should start planning for retirement early, but few actually understand how much of a difference it can make. Whether they are offered the chance to set up 401(k) accounts with employers or just want to get into IRA Investing, workers need to consider the impact that compound interest has on their investment strategies.
Compound interest can be thought of as a sort of interest-on-interest. Instead of calculating interest only on the principal balance, it calculates interest on the principal plus all accumulated interest from previous periods. It’s more important than those who aren’t well-versed in wealth management might think. Let’s take a look at an example to see why.
If two people each put aside $5,000 per year toward their retirements and each of them gets a 6% return on the investment, but one of them starts at 22 and one starts at 32, the person who started saving earlier would have almost twice as much money by the time he or she retired. That’s all thanks to the seeming magic of compound interest.
The extra 10 years of savings will amount to far more than just the $50,000 put aside in the bank. The early-bird retirement account holder will wind up with over $1 million, while the person who didn’t start investing until 32 will only have a little over $500,000. That’s a huge difference.
Assessing Risks
Those with self-directed IRAs need to learn how best to assess risk. As a general rule, high-risk investments offer better payoffs, but they’re better suited for younger workers. As workers get closer to retirement age, they should adopt more conservative investment strategies.
One way that self-directed investors get around this problem is to set aside money for required expenses in risk-free Treasury bonds, then take a less risk-averse approach to invest the rest of their retirement funds. It’s usually best to take a long view of assessing risk. Micro-managing investments in response to daily market changes is almost always a mistake when it comes to retirement planning.
Determining Spending Needs
Some consumers believe that they will spend substantially less after retirement, which leads them to earmark less of their income for retirement investing. That’s not a great idea since most retirees typically have more expenses, not less. They have more time to enjoy themselves, which means many retirees want to plan trips, see the sights closer to home, go shopping, head out to restaurants, and engage in other comparatively expensive activities.
Today’s retirees are living longer, healthier lives, as well. That means they’ll need to stretch their retirement funds further than their parents’ generations. Don’t be afraid to use tools like actuarial life tables to get an accurate estimate of how much money will be required to maintain a desirable lifestyle throughout the retirement years.
The Bottom Line
Many workers underestimate the importance of starting to invest in a retirement fund as early as possible. Today’s workers are living longer, have higher expectations in terms of lifestyle, and need to save more if they want to retire securely. Find a financial planner or learn more about retirement investment portfolios now to start planning for a long, healthy, happy future post-retirement.
