Most everyone knows that they have to invest some portion of their earnings during their working years for retirement. What many people don’t know, however, are the nuts and bolts of how to invest and the risks versus rewards of saving your money for the future.
Some aspects of investing are entirely within your control, such as picking the type of investment to use to save for retirement. But some factors, such as the direction of the economy and your long-term healthcare needs, may be less predictable.
The most important consideration, however, when planning for retirement is to have some level of predictability as to how your money will grow and how various decisions you make can affect your investments over the long term.
1. Plan ahead.
You can alleviate much of the stress associated with retirement by planning ahead. Ideally, your investment plan should start a decade or more before retirement.
Unless you’ve been very lucky in life and expect to come into a large inheritance or similar windfall, you’ll bring unnecessary stress into your life by waiting until the last few years before retirement to start planning, only to find your savings are woefully not up to the task of lasting the duration of retirement.
2. Keep track of your short- and long-term spending.
Part of planning ahead includes budgeting in some form or another. Look into doing a cash flow analysis of money coming into and going out of your household. Be forthcoming with all your expenses, or your final numbers simply won’t be accurate and you’ll be doing yourself a disservice.
If you need help finding a template to plug your numbers into, there are resources available online1 to help get you started.
3. Be realistic about your risk profile.
Most of us are not gamblers who are willing to throw our entire retirement nest egg into risky investments such as stocks, IPOs, and REITs or other risky real estate ventures, to name a few.
Nor do you want to rely entirely on low-risk investments such as US savings bonds, certificates of deposit, and money market funds, because your rate of return, even over long periods of time, may not be enough to sustain you through retirement.
Most of us fall somewhere in the middle when it comes to risk aversion and will have an investment portfolio with a mixed basket of investments to mitigate any periodic disruptions in the economy. The most important thing is to know your level of acceptable risk before investing your money.
4. Understand your benefits as an employee.
If you’ve worked for any kind of private company, educational institution, or government entity, you likely have been offered some type of employer-sponsored retirement benefit plan.
The most popular is generally a 401(k)-type savings plan. If you’ve budgeted carefully, you’ll know how much of your paycheck you can have deducted each pay period and put into your retirement account. In some cases, your employer may match your contribution—essentially giving you the opportunity to double your contribution.
If you are enrolled in a 401(k)-type account, your money is contributed pretax, which will have tax-savings benefits when you file your return with the IRS each year.
5. Choose a retirement account that suits your situation.
Maybe you’ve heard your friends or neighbors talking about their traditional IRA (individual retirement account) or Roth IRA and have questions about how IRAs work and if they are the right investment vehicle for you.
There are many nuances to each type of account that you should know about before investing your money. For example, with a traditional IRA, you contribute money with pretax dollars while your investment grows; but once you begin withdrawing money, you are subject to paying income tax on it.
With a Roth IRA, your contributions are made after taxes, but growth on your investment and your withdrawals are not subject to taxes. Know the pros and cons of any account you plan to invest in to make sure it aligns with your retirement investing plans.
6. Be aware of tax considerations.
Most people will need roughly 70-80 percent of their preretirement income to maintain their standard of living during retirement. That’s why, given the above comparison of IRA types, it’s important to know how each of your investments will affect your bottom line.
For example, depending on how much taxable income you have from other sources, as much as 85 percent of your Social Security benefits could be taxable,2 which in turn could hurt your bottom line each year.
7. Know the pros and cons of investing in stocks and bonds.
With risk comes reward. The greater the risk, the better potential for return. But there’s a significant risk you could lose a great deal of your retirement savings by investing in stock-heavy funds.
Bonds, especially long-term bonds such as government bonds, tend to be much less risky but also yield more moderate returns. For example, between 1926 and 2008, government bonds returned about 5.7 percent per year, US Treasury bills yielded about 3.7 percent annually, but stocks yielded 9.6 percent per year.
Both types of investments have their place in your portfolio, but only you can determine the right mix. If you are uncertain about how to balance your retirement investment portfolio or have specific questions about how various types of investments work, it’s best to seek advice from a trusted financial advisor.