These five steps will help you toward a safe, secure, and fun retirement
To have a comfortable, secure—and fun—retirement, you need to build the financial cushion that will fund it all. The fun part is why it makes sense to pay attention to the serious and perhaps boring part: planning how you’ll get there.
Planning for retirement starts with thinking about your retirement goals and how long you have to meet them. Then you need to look at the types of retirement accounts that can help you raise the money to fund your future. As you save that money, you have to invest it to enable it to grow. The surprise last part is taxes: If you’ve received tax deductions over the years for the money you’ve contributed to your retirement accounts, a significant tax bill awaits when you start withdrawing those savings. There are ways to minimize the retirement tax hit while you save for the future—and to continue the process when that day arrives and you actually do retire.
We’ll get into all of these issues here. But first, start by learning the five steps everyone should take, no matter what their age, to build a solid retirement plan.
- Retirement planning should include determining time horizons, estimating expenses, calculating required after-tax returns, assessing risk tolerance, and doing estate planning.
- Start planning for retirement as soon as you can to take advantage of the power of compounding.
- Younger investors can take more risk with their investments, while investors closer to retirement should be more conservative.
- Retirement plans evolve through the years, which means portfolios should be rebalanced and estate plans updated as needed.
1. Understand Your Time Horizon
Your current age and expected retirement age create the initial groundwork of an effective retirement strategy. The longer the time between today and retirement, the higher the level of risk your portfolio can withstand. If you’re young and have 30-plus years until retirement, you should have the majority of your assets in riskier investments, such as stocks. Though there will be volatility, stocks have historically outperformed other securities, such as bonds, over long time periods. The main word here is “long,” meaning at least more than 10 years.
Additionally, you need returns that outpace inflation so you can maintain your purchasing power during retirement. “Inflation is like an acorn. It starts out small, but given enough time, can turn into a mighty oak tree. We’ve all heard—and want—compound growth on our money. Well, inflation is like ‘compound anti-growth,’ as it erodes the value of your money. A seemingly small inflation rate of 3% will erode the value of your savings by 50% over approximately 24 years. Doesn’t seem like much each year, but given enough time, it has a huge impact,” says Chris Hammond, a Savannah, Tenn., financial advisor and founder of RetirementPlanningMadeEasy.com.
You might not think saving a few bucks here and there in your 20s means much, but the power of compounding will make it worth much more by the time you need it.
In general, the older you are, the more your portfolio should be focused on income and the preservation of capital. This means a higher allocation in securities, such as bonds, that won’t give you the returns of stocks but will be less volatile and provide the income you can use to live on. You will also have less concern about inflation. A 64-year-old who is planning on retiring next year does not have the same issues about a rise in the cost of living as a much younger professional who has just entered the workforce.
You should break up your retirement plan into multiple components. Let’s say a parent wants to retire in two years, pay for a child’s education at age 18, and move to Florida. From the perspective of forming a retirement plan, the investment strategy would be broken up into three periods: two years until retirement (contributions are still made into the plan), saving and paying for college, and living in Florida (regular withdrawals to cover living expenses). A multi-stage retirement plan must integrate various time horizons, along with the corresponding liquidity needs, to determine the optimal allocation strategy. You should also be rebalancing your portfolio over time as your time horizon changes.
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