5 Retirement Investing Rules You Should Know by Heart
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Saving for retirement takes lifelong planning, and many people find it intimidating to try to prepare for an event that could be decades away. But retirement investing doesn't have to be complicated. In fact, by following some simple rules, you can put together a financial plan for your retirement that will get you moving toward financial security in your golden years. Below, we'll look at five retirement investing rules that can help guide you toward a richer retirement.
1. The earlier you start, the less you'll need to save. The power of compound returns is a basic tenet of investing, but it's still shocking to see how it works. The example illustrated below compares two situations. One person starts saving for retirement at age 25 and sets aside $5,000 annually for 10 years, stopping at age 35. The other waits until age 35 and saves $5,000 per year for 30 years.
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By the time both people reach age 65, you'd think that the person who invested three times as much over three decades of contributions would have caught up and surpassed the person who started earlier. Yet compound returns are powerful enough to keep the early saver ahead throughout their lifetimes. In this example, that helps the younger saver accumulate nearly $800,000, versus just over $600,000 for the later starter. That's an important incentive not to procrastinate.
2. Take full advantage of tax-favored accounts. Saving in a regular taxable account is easy, but the tax breaks that retirement accounts provide are too good to pass up. Employer plans like 401(k)s not only give you tax deferral throughout your career but often offer employer matching and profit-sharing contributions as an incentive for you to participate. IRAs come in both traditional and Roth flavors, giving you the flexibility to make pre-tax or after-tax retirement contributions and capture tax-deferred or tax-free growth. By not having to pay Uncle Sam year in and year out, the money you would have lost to taxes keeps working for you instead, and that can add considerably to your retirement nest egg over the course of your career.
3. Aim to save at least 10% of your income to put toward your retirement goals.A lot of people are intimidated by the math involved with retirement savings projections. That's why the rule of setting aside 10% of your income toward retirement savings is so popular, as it doesn't involve any complicated calculations.
The problem with saving 10% is that under most realistic investing assumptions, it only provides enough of a retirement nest egg if you start relatively early in your career and are disciplined about maintaining that savings rate throughout your working years. If you fall short on one of those two areas, you'll need to save more than 10% to reach your goals.
4. Invest more conservatively as you age -- but not too conservatively.Standard retirement investing advice has you invest heavily in stocks early in your career and then slowly adopt a more conservative strategy going forward. One simple rule involves taking your age and subtracting it from 100, and that gives you the percentage of your portfolio you should invest in stocks.
Many savers take this concept too far, however, eliminating their entire stock market exposure once they retire. Doing that leaves you ill-prepared for the challenges of making your money last for a retirement that could last 30 years or more, especially if you've had to retire earlier than you expected due to layoffs or other factors. Being willing to take some risks even during your retirement years can stretch your money further.
5. Use the 4% rule for retirement withdrawals as a guideline, not a mandate. Another often-followed rule defines how much money retirees can take from their retirement savings each year. The 4% rule has you take 4% of your nest egg when you retire and use that as your baseline annual withdrawal, and every year thereafter, you raise that withdrawal amount by the rate of inflation. Past analysis shows such a strategy would have worked even under the most adverse market conditions to make your retirement savings last for 30 years or more.
Understanding the rule is important because it can give you an opportunity to tweak it in your favor. For instance, if you can afford to cut your withdrawals somewhat during times of market stress, the analysis produces a higher figure than 4%. In reality, most retirees respond naturally to tough times by cutting back, so integrating that flexibility into your planning can leave you better prepared.
Investing for retirement is important, and these rules can help you achieve your goals. By knowing how these rules work and the assumptions behind them, you can tailor them to your personal needs and build a strategy you're comfortable with throughout your lifetime.
The article 5 Retirement Investing Rules You Should Know by Heart originally appeared on Fool.com.
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