“Retirement” is probably one of the most polarizing words in the English language. We all enjoy envisioning ourselves with pina coladas on the beach, basking in the sun. That part’s fun. It’s affording your fancy retirement excursions that’s the tricky part.
“Do I know how much to save for retirement? How exactly would I go about saving that much to begin with? What do pina coladas in the tropics run nowadays?” These are all vitally important questions that need answers.
Here, we’ll do our best to answer them. Without further ado, here are five essential retirement tips that you should heed.
Retirement Tip #1: Know How Much You Need
How much do I need to save for retirement?
Depending on who you ask, the experts say you’ll need between 70% and 90% of your ending annual salary per year in retirement. Naturally, it’s better to overestimate what you’ll need than underestimate, and if we assume you’ll need 85% of your salary annually in your glory years, the kind folks at Fidelity have worked out exactly what you’ll need to save.
The general rule is this: Save eight times your ending salary in order to retire comfortably. While that sounds daunting, if you save and invest your money wisely over the course of a lifetime, the feat becomes much more feasible.
With life expectancy now at record highs — babies born in the U.S. in 2012 had an average life expectancy of about 79 years — it’s best to get a head start and start saving early. But if you’ve fallen behind, do yourself a favor and plug your numbers into a retirement calculator. The AARP has an excellent one that should help you figure out how much to save for retirement.
Retirement Tip #2: Preservation of Capital!
Sure, it’s not the most exciting maxim, but preservation of capital is a concept that should be etched into every saver’s mind. The rationale behind this idea is a cruel truth of mathematics: For every percentage of your wealth you lose, you’ll have to gain back a greater percentage to break even again.
Consider a $100,000 portfolio. Lose 15% — $15,000 — and you’ll have to make back the same dollar amount to reach break-even. But a $15,000 gain on $85,000 in capital requires a 17.6% return, not a 15% return. The more you lose, the more painfully difficult the necessary gains are to achieve: lose 20% and you’ll need 25% returns; part with 30% and it’s 43% to achieve baseline; and if half your portfolio disappears, well, you’ll have to double up just to get back to even.
Preserving capital goes hand-in-hand with taking on less risk. While the old idea to convert your age to a percentage and keep that amount of your portfolio in bonds is a bit simplistic, it illustrates well the powerful idea of decreasing risk as you age.
Retirement Tip #3: Passive Income
Let’s not gloss over the fact that while most of us are simply trying to figure out how much to save for retirement, a better strategy yet — if you can manage it — is to arrange a stream of passive income you can count on in your older years.
Bonds and treasuries represent low-risk, low-reward income streams that many retirees count on as they age, but with interest rates near record lows, be careful not to venture too far out on the yield curve in search of a return.
You can either buy bonds individually or invest in funds: iShares Barclays 1-3 Year Treasry Bnd Fd (NYSEARCA:SHY) is one of the most conservative funds out there, specializing in short-term treasuries and yielding 0.36%. A broader assortment of U.S. bonds is offered through iShares Barclays Aggregate Bond Fund (NYSEARCA:AGG), while iShares IBoxx $ Invest Grade Corp Bd Fd (NYSEARCA:LQD) gives you an assortment of investment-grade corporate bonds. AGG and LQD currently yield 2.3% and 3.3%, respectively.
Of course, the holy grail of passive income is rental income, so if you have the means then I highly suggest building a real-estate empire. Still on your way to becoming a Vanderbilt? REITs can offer nice exposure to commercial moolah. With most REITs offering fat dividends, real estate investment trusts offer exposure to apartments, office properties, and more.
Dividend stocks can also offer nice income streams.
Retirement Tip #4: Save and Match
Saving, and saving early, is a fundamental aspect of preparing for retirement. The longer you wait, the harder it gets to stack up sufficient funds. Consider this mind-blowing fact from 360 Degrees of Financial Literacy:
“The earlier you start (saving), the longer compounding can work for you. For example, a 20 year old who saves $200 a month until age 65 and earns exactly 6% on saved funds annually would have accumulated around $550,000. But a 40 year old contributing the same amount each month at the same earnings rate would have accumulated only $138,600 by age 65.”
Dollar-cost averaging — investing a set dollar amount in the market at regular intervals — is a tried-and-true technique that diversifies an investor’s risk over time. Vanguard, with its low fees, passive management, and wide variety of choices, offers investors some of the best exposure to total stock market returns.
Another thing you can do to save efficiently is always participate in your company’s 401(k) matching plan, because it’s essentially free money!
Retirement Tip #5: Pay Attention to the Little Things
As Benjamin Franklin wisely noted, “A penny saved is a penny earned.” And the guy was one of the founders of our country, so he probably knew what he was talking about. Pennies add up, and the little things matter.
In the financial world, that means investors should carefully mind fees of any sort. Pay close attention to the expense ratio, the percentage of your investment gobbled up each year by various expenses like management and trading. The Vanguard 500 Index Fund Investor Class (MUTF:VFINX) has a rock-bottom expense ratio of just 0.17%, while funds like Motley Fool Epic Voyage Fund (MUTF:TMFEX) charge a net expense ratio of 1.15% for the feat of underperforming their benchmark indices by upwards of 2% annually from inception.
On top of keeping an eye out for unctuous underachievers, minding day-to-day personal finances can pay off big in the long-run. Bringing your lunch instead of going out, paying off your credit card debt, and shopping around for flight deals are just a few of the many strategies you can employ in your quest to save for retirement.
So there you have it! Figure out how much to save for retirement, avoid losses like the plague, seek out passive income, save early and often, and mind your expenses. Easier said than done, but those pina coladas don’t make themselves.
As of this writing John Divine held no positions in any of the stocks mentioned. You can follow him on Twitter at @divinebizkid.