Retirement planning is the process of identifying your long-term income, determining your intended lifestyle and defining how to reach those goals. When planning for retirement, you’ll need to consider a variety of factors, such as when you’ll retire, where you’ll live and what you’ll do. Keep in mind with each additional year you hope to retire early, your investment needs greatly increase. Also consider the difference in cost of living among cities, or even among neighboring ZIP codes. Add on daily expenses, medical expenses, vacations and emergencies, and you begin to see how the costs of retirement add up.
Your retirement goals will depend largely on the income you can expect during your retirement and will likely evolve as your plans, risk tolerance and investment horizon change. While specific investing “rule of thumb” guidelines (like “You need 20 times your gross annual income to retire” or “Save and invest 10% of your pre-tax income) are helpful, it’s important to step back and look at the big picture. Consider these six essential rules for truly smart retirement investing.
1. Understand Your Retirement Investment Options
You can save for retirement in a variety of tax-deferred vehicles, some offered by your employer and others available via a brokerage firm or bank. It’s important to take advantage of all your options, including investigating what kind of retirement benefits your employer may offer; some employers still offer defined benefit pensions, which is a big bonus during a time of volatility in the stock market.
2. Start Early
No matter what you read about retirement investing, one piece of advice stays the same: Start early. Why?
- Barring a major loss, more years saving means more money by the time you retire.
- You gain more experience and develop expertise in a wider variety of investment options.
- You have more time to survive losses, which increases your ability to recover from major hits and gives you more freedom to try higher risk/higher reward investments.
- You make saving and investing a habit.
- You can take advantage ofthe power of compounding – reinvesting your earnings to create a snowball effect with your gains.
3. Do the Math
You make money, you spend money. For many, this is about as deep as their understanding of cash flow gets. Instead of making guesses about where your money goes, you can calculate your net worth. Your net worth is the difference between what you own (your assets) and what you owe (your liabilities). Assets typically include cash and cash equivalents (for example, savings accounts, Treasury blls, certficates of deposit), investments, real property (your home and any rental properties or a second home), and personal property (such as boats, collectibles, jewelry, vehicles and household furnishings). Liabilities include debts such as mortgages, automobile loans, credit card debt, medical bills and student loans. Adding up all of your assets and subtracting the sum of your liabilities leaves you with the total amount of money you truly possess (your net worth), and a clear view of how much money you’ll need to earn to reach your goals.
4. Keep Your Emotions in Check
Investments can be influenced by your emotions far more easily than you might realize. Here’s the typical pattern of emotional investment behavior:
When investments perform well
- Overconfidence takes over.
- You underestimate risk.
- You make bad decisions and lose money.
When investments perform badly
- Fear takes over.
- You put all your money into low-risk cash and bonds.
- You don’t make any money.
Emotional reactions can make it difficult to build wealth over time, as potential gains are sabotaged by overconfidence and fear makes you sell (or not buy) investments that could grow.
5. Pay Attention to Fees
While you are likely focus on returns and taxes, your gains can be drastically eroded by fees. Investment fees cause you to incur direct costs – the fees that are often taken directly out of your account – and indirect costs – the money you paid in fees that can no longer be used to generate returns.
Common fees include:
- transaction fees
- expense ratios
- administrative fees
- loads
Depending on the types of accounts you have and the investments you select, these fees can really add up. The first step is to figure out what you’re spending on fees. Your brokerage statement will indicate how much you’re paying to execute a stock trade, for example, and your fund’s prospectus (or financial news websites) will show expense ratio information. Armed with this knowledge, you can shop for alternative investments (such as a comparable lower-fee mutual fund) or switch to a broker that offers reduced transaction costs (many brokers, for example, offer commission-free ETF trading on select groups of funds).
6. Get Help When You Need It
“I don’t know what to do” is a common excuse for postponing retirement planning. Like ignorantia juris non excusat (loosely translated as ignorance is no excuse), lack of knowledge about investing is not a convincing excuse for failing to plan and invest for retirement.
There are plenty of ways to receive a basic, intermediate or even advanced “education” in retirement planning to fit every budget, and even a little time spent goes a long way, whether through your own research, or with the help of a qualified investment advisor, financial planner or other professional.
The Bottom Line
You can improve your chances of enjoying a comfortable future if you make the effort to learn about your investing choices, start planning early, keep your emotions in check and find help when you need it. While these steps may seem overly simple, a lack of action can have huge consequences for your financial future. Stay informed and engaged in your retirement planning now to reap the benefits of a well-invested retirement plan later.