Preparing for retirement is all about the long haul. While it’d be nice to win the lottery and never have to think about the future, the vast majority of people need to create a retirement plan that they can live with for decades. For some that may seem far away, but failing to plan is planning to fail.
The reason it is so critical to stay on track? You may need to save more money than you think. For example, having a million dollars at retirement only replaces 85% of a $70,000 household income each year.1
Best Ways to Invest for Retirement
There are a variety of retirement investment options you can utilize to prepare. Whatever tool you choose –a 401(k) or IRA – there are some standard strategies you can deploy to help you achieve the retirement of your dreams. It takes knowledge and discipline, and though there is never a guarantee, using tried-and-true tricks can help you build your nest egg.
Start Early to Benefit From Compounding
Compounding interest is like a snowball going downhill, gathering more and more snow. Simply put, compounding pays earnings on your reinvested earnings.
Here’s how earning compound interest on your retirement savings works: say you invest $100 and earn an annual return rate of 7%. At the end of the year, the $7 you earned is added to the original $100 investment. If you earn 7% again, you’re looking at 7% of $107 ($7.49). In the third year with the same return, that $114.49 becomes $122. The longer you leave your money, the greater the potential compounding value. In essence, compounding can do some of the work of building your retirement fund for you.
The longer you leave your money at work, the more exciting the numbers get. For example, imagine an investment of $10,000 at an annual rate of return of 8%. Assuming you make no withdrawals, in 20 years your $10,000 investment would grow to $46,610. In 25 years, it would grow to $68,485, a 47% gain over the 20-year figure. After 30 years, your account would total $100,627.2
Look for investments that have compound interest advantages, like employer-sponsored retirement plans. If your workplace savings plan contributions are made pretax, as most people's are, compounding really becomes a powerful force. Not having to pay taxes from year to year on either your contributions or the compounded earnings helps your savings grow even faster (though you'll owe taxes on that money when you start withdrawing).
Diversify Your Portfolio
Allocating your investments to different categories of investments (asset classes), such as stocks, bonds and cash or cash alternatives, helps you build a diversified portfolio. This is important for two reasons:
- The mix of asset classes you own is a large factor in determining your portfolio’s performance. How you divide your money between stocks, bonds, etc. can be more impactful than any specific investments you make.
- By investing in different asset classes that don’t respond to the market in the same way at the same time, you can help minimize the impacts of market volatility. Ideally, when something in your portfolio is performing poorly, you have something else performing well to help stabilize your portfolio.
Having a portfolio with investments in different asset classes and even different assets and industries within each class can help you weather the ups-and-downs of market movements.
Take Advantage of Dollar Cost Averaging
If you are putting money from each paycheck into an employer-sponsored retirement plan, congratulations, you’re already participating in dollar cost averaging. You’re investing a set amount of money at regularly scheduled intervals over time. When prices are high, your investment buys less. When prices are low, the same amount buys more shares. Over time, your regular, fixed investment should result in a lower average price per share than you would get buying a specific number of shares at each investment interval.
Here's a graph that explains how using dollar cost averaging results in a lower average cost. In this hypothetical example, ABC Company’s stock price is $30 a share in January, $10 a share in February, $20 a share in March, $15 a share in April and $25 a share in May. If you invest $300 a month for 5 months, the number of shares you would buy each month would range from 10 shares when the price is at $30, to 30 shares when the price is $10. The average market price is $20 a share ($30+$10+$20+$15+$25 = $100 divided by 5 = $20). However, because your $300 bought more shares at the lower prices, the average purchase price is $17.24 ($300 x 5 months = $1,500 invested divided by 87 shares purchased = $17.24).
Not only does utilizing dollar cost averaging potentially lower the average cost per share, automating your investing can help take emotion out of your investment decisions.
How to Manage Your Retirement Investments
Once you’ve used these retirement investment tips to get started, you’ll want to continue adding to and managing your retirement accounts. Here’s how.
Stick to Your Strategy
Investing means taking a risk by putting your money in the market, which can be volatile at times. The key is remembering that you invested on your timeline to meet your goals – market volatility shouldn’t dictate investment decisions. Likewise, hot tips from your neighbors or investment suggestions from a news headline can distract you from the real goal of building your retirement account. Timing the market is notoriously difficult, and jumping on fads can do more harm than good. Instead, stick to your well-thought-out investment strategy and adjust when you have important life changes that impact your goals or your timeline.
Review Your Portfolio Regularly
When you created your diversified portfolio, you started with a specific mix of investment types based on your risk tolerance and goals. Over time, what is actually in your portfolio can shift. For example, say 20% of your monthly investment goes toward purchasing bonds. If the cost of bonds drops, your money has more purchasing power and the asset allocation in your portfolio may drift to a higher percentage of bonds than you intended. That’s why it’s good practice to regularly review your portfolio – one to four times per year. If your portfolio has drifted more than 5% from what you originally specified – like if it’s suddenly 30% bonds – you’ll want to rebalance your portfolio to stay on track toward your goals.
Work With a Professional
A financial advisor can help you create a plan that is customized to you and help you maintain that plan so you can be confident you’re making progress toward your goals. Connect with a Farm Bureau financial advisor today.