Early Investment to reach a Comfortable Retirement
The way our lives are spread out, has become very mechanical. Not saying this to criticise the way we live but there is something about this lifestyle of ours that is mechanical in its nature.
You send your children to school , then to college and then to university and then they finally graduate. Once they graduate they get a job and start working. Many start working directly after college. In any case most people start working in their late teens or early 20s and then the 20 to 40 age bracket is one where people spend the best years of their life creating value, getting promoted, getting married and all sorts of stuff.
Enter the 50s and the sword of retirement starts looming over. Most people start saving up for their retirement quite early but with so many things happening in life it is never easy to focus on the long term goal of saving up for retirement.
If we were to divide our life into phases then the phases would look something like this
- Birth to 16 years of age – Education and fun, no worry at all. Best time of life really.
- 16 to 22 years – The age bracket may vary but during this time people are under a lot of stress. The stress maybe due to university or due to the financial pressure of getting a job.
- 22 to 40 years – This is the period when your career takes off, when most people get married and have kids. The expenditure during this phase is the highest at any point in life for most people.
- 40 to 60 years – This is the time when most people start to realise that they will be retiring in the future and they start preparing for the retired life. The career trajectory is still going upwards but the retirement can also be seen in the horizon.
- Post retirement life – This can be a bliss is you have prepared for it correctly.
This is the life cycle that most of us go through, this life cycle also corresponds with the wealth cycle. You can see that when you start your career, you are at your lowest level financially. Your job gives you a source of income and thus you can start saving for yourself at this point. Soon you enter the phase of your life where your career takes off, you start earning more and more but your expenditures also increase.
Most people get adrift in the complexities of life and forget that the early 20s is the perfect time to begin saving for their retirement. At this point your retirement is almost four decades away, isn’t it too early to be saving?
No absolutely not, unless you do not want a comfortable retired life. The thing is that the earlier you start the longer your outlay will be and the easier it will be for you to save and invest. The later you start saving the more difficult it will be for you because you will have a shorter amount of time to save more. Look at figure 1 and see how this reality is shown in the graph.
If you invest $10,000 at the age of 20, at the rate of 5% then by your retirement your $10,000 would have grown to $80,000 over four decades. If however you invest the same amount at the same rate when you are 0 years old then you’ll end up with roughly $55000 by your retirement. If you wait till the age of 40 to invest the same amount at the same rate then you’ll end up with roughly $40,000 by your retirement.
This clearly shows the important of starting early and compounding. Both things go hand in hand.
Now obviously if someone is in their 20`s they cannot really afford to invest $10,000 right away. This was just a simple example to illustrate the importance of starting early and compounding. In reality, the saving rate in your early career will be much less.
1. How to Plan for Savings?
If you are just starting your career and want to start saving for your retirement right away then you first need to carry out basic calculations. You have got approximately four decades ahead of you. You will see both good and bad times. Your income will increase but your expenditures will also increase. It is very difficult therefore to carry out calculations that will tell you exactly how much you will have when you retire.
Instead a good approach is to take the basic savings rate. An average person or family can save around 30% to 40% of their income. So if you are in your 20’s. This is what you should be aiming for. Fine, you can drop it to 15% or 20% but if you drop it to this level then make sure that over time you do take it to 30% to 40%.
Another benefit of starting early is that it will form into a habit so you won’t have to struggle later on to cut down your expenses and in addition to this you will also get rid of habit of wasting money unnecessarily because at the back of your mind you’ll always know that whatever you will save, you will be able to use in your retirement.
2. Invest and Reinvest
Saving is only one part of the equation. Next you have to invest your savings. It is better to talk to a financial advisor if you are in your 20s because a financial advisor will be able to guide you in the best possible manner. You can keep your savings in 401(K) or in a self directed IRA. You will also need to build up your portfolio over time, balance it out and then whatever returns you get you will need to reinvest them.
Remember, in the long term the goal is to go for compounding effect. Compounding will allow your investments to increase at an exponential rate and in this manner you won’t only be saving for your retirement instead you will be creating wealth from your savings.
By following these simple steps you can turn your simple savings into wealth over your lifetime. Yes this is a very long term plan but if you follow it, you will end up creating wealth to last you a lifetime. It only makes sense to start preparing for your retirement when you still have strength in your bones and when you are less likely to run into financial troubles as compared to later on in life when it will be much more difficult.