How you save money is crucial if you want to make your desire for an early retirement a reality.
Forty-three per cent of millennials in the US expect to retire before the age of 65, according to a recent T.Rowe Price survey, while a Bankrate survey found that millennials cited 61 as the ideal age to bid adieu to their careers.
Yet, while everyone has an idea of when they want to stop working, few are adequately prepared to finance their retirement. And with many of us living longer than our parents, ensuring a comfortable retirement is an even more challenging task.
Preparing for a future that is financially stable is undoubtedly a priority for anyone looking for a carefree and comfortable life post-retirement. Here are a few tips on how to achieve that:
Estimate your retirement years
Although it might feel unpleasant to calculate your own life expectancy, it is important to estimate how many retirement years you need to save for. By having an idea of your future needs and the expenses, and by projecting the approximate annual spend, you can derive a rough estimate of the funds you should set aside. Gratuity or corporate savings plans, economy fluctuations, inflation, food and housing costs, even future medical necessities are a few variables that should be considered to ensure an accurate projection.
To give you an idea of what you are looking at, the savings range you need to project for your retirement years is somewhere between 50 to 75 per cent of your annual income post retirement. The sooner you plan the higher the savings on the range should be.
Own income-producing assets
When determining how much you need in savings, remember to consider all future sources of income. It is critical to focus on investments that will help generate income in the long run. To find the right investment for you, first you must:
•Evaluate your attitude to risk
When determining your risk capacity, assess your investment’s time horizon. The longer the time horizon of your investment, the more risk you can afford to take. Furthermore, be mindful on how you use your discretionary income, which is the money remaining after you have paid for all your necessities. When your discretionary income level is high, you will be able to take more risks with your investments.
• Understand the relationship between risk and return
Higher expected returns are generally associated with a higher degree of risk. Hence, return expectations should be in line with the level of risk taken.
• Diversify your investments
Spread your money across a wide range of investments or different asset classes. This can be stocks, bonds, exchange traded funds and real estate across multiple geographies.
• Grasp the effect of compounding interest
Compound interest makes your savings work hard in the background as you progress through your career because it is interest calculated on the initial principal, which also includes all of the accumulated interest. You are effectively earning interest earned on interest.
To demonstrate its power, if you save Dh1,000 a year for 30 years at an interest rate of 10 per cent, this will grow to approximately Dh200,000. In reality, the actual earnings would be around Dh170,000 if you subtract your original Dh30,000 contribution of Dh1,000 for every year.
However, if you save Dh30,000 in a lump sum in the beginning of the 30-year period, the total would instead amount to about Dh525,000 because the interest starts getting calculated on the full amount from day one.
The earlier you start saving — and the more often you save — the better prepared you will be for retirement. Creating an effective savings plan and investing in a long-term, well-diversified solution are the most important steps you can take towards this.
Just remember to avoid temptation as your savings build up, such as spending on avoidable luxuries or depreciating assets.
Moukarram Atassi is the head of investment management at National Bank of Fujairah