As with any long-term goal, the earlier you start planning, the better off you will be. This is no different from planning for retirement. The benefits of having a long-term horizon are that you will be able to utilize compound interest to grow your savings. The down part, however, is that your savings will be eroded by inflation. So keep in mind, that having $10 worth of goods today will cost you around $12.20 in 10 years if you take into account 2% inflation annually. To apply this to your savings, if you saved $100,000 today then you would need $122,000 10 years down the road in order to keep the same purchasing power. So if we extrapolate to a longer-term, like 40 years, then in order to have the same purchasing power of $100,000 in 40 years, you need $220,804!
Now before you give up saving and spend everything now, remember that the benefits of compound interest can also work to your benefit and not only your detriment.
So receiving 2% interest for 40 years will change your $100,000 into $220,804. The purpose of the previous example was to remind you that money today is always worth more than money in the future as inflation erodes your purchasing power.
One of the most beneficial positions available to employees is to take advantage of the company-sponsored retirement plan. The company will match your contributions up to a certain level of your contribution per year. If you do not use their matching offer, this offer disappears, so try to max out your employer’s contributions in order to start stocking up for retirement. However, after you start reaching levels above their matching contribution, it might make better sense to invest elsewhere to get higher returns.
The government offers tax-free means to save for your retirement like IRA’s, 401k plans, and Roth IRA’s and 401 plans. Utilize these vehicles to shield your investments from taxes but also realize the pros and cons of each plan and be diligent to avoid high fees and costs as this eats away at your investments and savings.
The key to your retirement plan is to earn above inflation and to keep a well-diversified portfolio in order to yield returns in both strong and weak stock market years. Retirement plans are not short-term investing solutions, this is a long-term horizon investment Warren Buffett style, where you want to have principal and yield over 20 to 30 years without substantial volatility. Trying to pick winners and losers in day to day or weekly trading atmosphere is not what you want to be doing with your retirement. A retirement portfolio requires diversification across asset classes and also within asset classes. Taking advantage of foreign markets would also be a good way to diversify away from the US stock market.
As a rule of thumb, it is said that by 35 years of age, you should have saved 1 years’ worth of your salary, by 45 you should have three years, by 55 you should have five years, and by 65 you should have eight times the value of your annual salary saved and put away for retirement. With that in mind, there’s no better time to start than today!