How soon should you start thinking about retirement?
It’s never too soon – even if yesterday was your very first day on the job and you won’t be turning in your last time card for four decades. You’ll benefit from preparing for that last day now.
That way, says Jim Wright, a fee-only financial planner in Paoli, Pa., outside Philadelphia, “You get more time with the benefit of compounding.” The money you put aside now makes gains – and those gains can be reinvested to make more gains, and so on.
So step No. 1 is start saving. If your employer offers a 401(k) self-funded retirement plan, that’s an easy way to begin. It’s even better if the company matches part of your contributions. “It is free money,” Wright points out.
Starting small
But wait, you say – retirement isn’t just a long way off. There are so many more immediate expenses ahead – buying a house, raising a family, taking them on vacation once in a while, pursuing a hobby.
Wright is well aware of that. “We also recognize that when you are younger, you are not earning as much,” he adds. “So the important advice is just to get started. Once you get started, it would be great to try to modestly increase your savings amount each year.”
No 401(k)? Don’t let that stop you. You can still start saving now through an Individual Retirement Account or similar instruments. The point is, don’t put it off. Wright urges putting aside as little as 1 percent of your paycheck. Boost that by a percentage point every year or two; in 10 years you’ll be up to 5 or 10 percent.
The long-range objective is to end up with a significant chunk of money at retirement that can throw off income each year for you to live on, along with what you collect in Social Security.
How much?
But how big should that pot of money be? That’s a much tougher question to answer.
“If your spouse is getting a pension, your needs at retirement will be very different from someone who has no pension,” Wright says. If all you really want in retirement is a very simple lifestyle, and your projected monthly Social Security payment is adequate, “then you may not need as much saved as someone who has greater needs or lower Social Security payments.”
Of course, the younger you are, the harder it will be to be sure of what your future needs or resources will be. So the more you can save – without going into excess debt to pay your current expenses – the better off you’re likely to be.
“The key here is that life doesn’t end at retirement,” adds Patrick McGonigle, a certified financial planner at CJM Wealth Advisers Ltd. in Fairfax, Va. “A 65-year-old retiree could still be looking at a 30-plus-year retirement.”
Life cycle investment
The next question is, how do you invest those savings? With professional help is the first answer – and this column can’t offer concrete investment advice; only your professional investment adviser can.
Still, the broadest principle is pretty simple: Go for growth when you’re young – that means stocks or stock-based mutual funds. As you get older, reduce your risk. Conventional wisdom says to do that, you buy more bonds.
“A portfolio for a typical client in their 20s through 40s would primarily be invested in equities [stocks, stock-based exchange-traded funds/mutual funds] with minimal bond exposure, depending on the level of risk they are comfortable with,” says McGonigle.
“The focus on younger investors is really about making sure they are building that portfolio so the effects of compound interest can work in their favor,” he continues, while for people who expect to retire in 10 years or fewer, “the focus is typically getting growth with minimal risk. The challenge is finding the right balance between risk and return.”
Changing formulas
It was once thought that if you subtracted your age from 100, the answer was what percentage of your savings should be in equities. So if you’re 30, your portfolio should be 70 percent stocks and 30 percent bonds.
“That’s changed a little over the last 15 years,” says Jamie Hopkins, assistant professor of taxation at The American College of Financial Services in Bryn Mawr, Pa. If you still want a formula, he’d raise the starting number to 110 or 120. Using 120 as the starting point, a 30-year-old will put 90 percent in stocks (120 minus 30 equals 90), while a 50-year-old would draw that down to 70 percent (120 minus 50 equals 70).
As retirement approaches, however, it gets a lot more complicated. At least until your 60s, Hopkins recommends, you’ll want to maintain a strong equity component. “At age 60 or 65, you could still be saving 20 or 25 years,” he says. “You don’t want to get to the point where you’re too heavily invested in bonds or you’re going to run out of money.”
That’s been especially true since the 2008 market collapses and the resulting period of very low interest rates. Those low rates have been good for borrowers but for lenders – and that’s what you are when you buy bonds – not so much. Bond mutual funds may be a better choice for people who want at least some form of guaranteed return in their portfolios, Hopkins says.
McGonigle also points out that bonds aren’t necessarily as safe as the conventional wisdom implies. If inflation spikes, an all-bond portfolio risks losing value. If interest rates stay low, bond returns will be anemic. You could boost your interest rates by buying high-yield bonds, but they carry a higher risk of default.
For those reasons, McGonigle says, “we believe that equities remain a vital part of the portfolio in retirement.” Still, your age will be a factor. You can move from high-risk/high-reward stocks to safer ones, which often pay dividends. Stocks, he says, “offer a return that, historically, has outpaced inflation.”
Maximizing return
Hopkins says another traditional rule of thumb has been that you want enough money when you retire that you can take out 4 percent of your nest egg a year for the rest of your life.
Finance experts have conducted tests imagining how hypothetical portfolios would perform for a person living as long as 30 years after retirement under all the ups and downs of the market for the last 100 years.
If the assets are adequate to start with, simply keeping the mix steady at 60 percent stocks and 40 percent bonds will be enough to provide that 4 percent yearly payout going strong under virtually any historical market conditions, and regardless of how long the hypothetical investor lives after retiring. “According to the historical data, they would never run out in 30 years,” Hopkins says.
Delayed gratification
There are some other wrinkles in decision-making about retirement and how to amass your resources, he points out. When you start collecting Social Security is a big one.
You don’t have to take it the moment you retire – and if you can afford not to, there are incentives to put it off. Every year you delay collecting Social Security from the time you’re eligible until you turn 70, your monthly payment rises 8 percent. (If you start collecting it early, you get penalized, too.) And over time, the eligibility age is rising.
Suppose you’re eligible at the age of 66. If you delay collecting until you’re 68, your monthly Social Security check will be 16 percent more than it would be if you didn’t wait. Hold out until 70 and you could get 32 percent more.
Keep it simple
It’s never too soon to start saving for retirement – and never too late, either. The key is to do it step by step, and to parcel out your investments so that you focus on growth when you’re young and security as you age.
And then, when you’re ready to leave the workforce and put your feet up, you won’t just be ready – your bank account will be too.
