Saving and Investing for Retirement
While saving and investing for your retirement can be complicated, in most cases it doesn’t have to be. A simple, step-by-step approach can help you build up an impressive sum with a surprisingly small amount of effort and outlay.
The sooner you begin to set money aside for your retirement, the longer your investments have to grow. By starting early you have the most powerful force in mathematics working for you: compound interest. With it, interest is calculated not only on the deposits you make but also on the accumulated interest from prior periods.
Compound interest works best over time, which is why starting early is key. For example, if you were to put aside $100 per month beginning at age 30 you’d have about $216,000 at 65, assuming an 8 percent annual return. However, if you wait ten years, you’d have just $91,000 saved. The difference in contribution amount is small: $12,000 ($100 each month for 10 years) but the actual difference in total savings is huge: $125,000 ($216,000 minus $91,000).
Use dollar cost averaging
Dollar cost averaging is a technique designed to reduce market risk through the systematic purchase of securities (stocks, bonds, mutual funds, etc.). All you have to do is deposit the same amount of money at regular intervals into well-balanced investment accounts (typically mutual funds). If history is any indication of the future, your investments will gradually but steadily increase in value over time.
Maximize tax-deferred savings
If you have a defined contribution plan (such as a 401(k) or 403(b)) available through your employer take advantage of it! Your contributions reduce your taxable income, the earnings grow tax-deferred, and many employers match a percentage of what you put in. You also have control over the investments, and most employers offer a diverse menu of mutual funds from which to choose.
Individual Retirement Accounts (IRAs) are another way to save and invest for your future. You can open an IRA at just about any financial institution, and once you do, you can begin to invest in just about any type of security.
There are many types of IRAs, but the most common are the traditional and the Roth. Contributions to a traditional IRA are tax-deductible, and the earnings your contributions make won't be taxed until you withdraw that money at age 59.5. Deductible IRA contributions, however, may be limited based on your adjusted gross income or if you’re an active participant in a 401(k) or 403(b) plan. There is no deduction for contributions with a Roth IRA but if you meet certain requirements, all earnings are tax-free when you (or your beneficiaries) take a withdrawal.
Diversify your investments
For safety and growth, you will want to make sure that your money is diversified – some in cash, stocks, and bonds. How much you need in each depends on such factors as your personal risk tolerance, years to retirement, and overall investment goals.
You can get a good mix of cash, stocks, and bonds through mutual funds. These investment companies purchase a huge range of securities and sells shares to the public. Because fund shares represent investments in many different companies, shareholders are able to achieve diversification easily, and therefore reduce their risk. You can further diversify your nest egg by investing in funds of varying kinds.
Review your plan regularly
After you have developed a retirement plan, don’t walk away and forget about it. Monitor your plan regularly, and review carefully at least once a year. This way you’ll see if your investment strategy is working for you, and you can make adjustments as necessary.
Planning for retirement is too important to put off – which is why a simple strategy is so critical. The more complicated it is, the less likely you will take action. Once you’ve started, practice patience. For most of us, saving enough money to retire on takes many, many years.