Top Rules of Thumb For Retirement Savings

Saving for retirement

Saving for retirement can be intimidating. There are so many different plans to choose from, different investment companies to manage your plan, restrictions on who can contribute and how much, tax rules to follow, and paperwork to keep track of – not to mention investment decisions to make after you’ve gotten your plan set up. The best way to handle this complex but essential process is to break it down into small, manageable steps. With that in mind, here are the most important rules of thumb to follow when saving for retirement.

1. Start Saving Now

Ideally, you would have started saving for retirement the moment you started earning income, which for many of us was at 16 when we got that after-school job at the mall or the movie theatre or the sandwich shop. In reality, you probably needed the money for short-term expenses, like the payment on the car that got you to your job, nights out with friends, and college textbooks. It probably didn’t make sense, or even occur to you, to start saving for retirement until you got your first full-time job, had kids, celebrated a milestone birthday, or experienced some other defining event that got you thinking hard about your future. No matter what your age today, don’t lament the years you didn’t spend saving. Just start saving for retirement now. The sooner you start, the less you have to contribute each year to reach your savings goal.

2. Save 15% of Your Income 

A good rule of thumb for the percentage of your income you should save is 15%. That’s after taxes and before any matching contribution from your employer. If you can’t afford to save 15% right now, that’s OK. Saving even 1% is better than nothing. Each year when you file your taxes, you can reevaluate your financial situation and consider increasing your contribution. If you’re older and haven’t been saving throughout your working life, you have some catching up to do, and you should aim to save 20% to 25% of your income for retirement if you can. But if that’s not realistic, don’t let an all-or-nothing attitude defeat you. Just getting into the habit of saving and investing, no matter how small the amount, is a step in the right direction. See Retirement: What Percentage of Salary To Save? for detailed advice on saving.

3. Choose Low-Cost Investments

 Over the long run, one of the biggest factors in how large your nest egg becomes is the investment expenses you pay. The most common investment costs are the expense ratios charged by mutual funds and exchange-traded funds, and the commissions for buying and selling. The expense ratio is an annual percentage fee you’ll pay for as long as you hold the fund. If you have $10,000 invested in a fund whose expense ratio is 1%, your fee is $100 a year. You can find a fund’s expense ratio at an investment research website like Morningstar or on the website of any company that sells the fund. When choosing a fund, the rule of thumb to follow is the closer the expense ratio is to 0%, the better. That being said, it’s reasonable to pay closer to 1% for certain types of funds, like international funds or small-cap funds. There are two simple ways to minimize commissions. One is selecting commission-free investments. If you buy a Vanguard index fund directly through your Vanguard account or a Fidelity mutual fund directly through your Fidelity account, you probably won’t pay a commission. The other is buying and holding investments instead of making frequent trades – another good retirement strategy we’ll address momentarily. Get the lowdown on index funds and read our mutual fund tutorial if you don’t know anything about these popular investments.

 4. Don’t Put Money in Something You Don’t Understand

 If the only investment you currently understand is a savings account, park your money there while you learn about slightly more sophisticated investments like index funds and exchange-traded funds, which are the only investments most people need to understand to build a solid retirement portfolio. Don’t ever let salespeople or advisers talk you into buying something you don’t understand. They might have your best interests in mind, but they might just be trying to sell you an investment that will earn them a commission. Until you educate yourself about the different investment options, you’ll have no way of knowing. Even putting your money in a relatively simple investment like bonds can backfire if you don’t understand how bonds work. Why? Because you might make irrational, emotion-based buy-and-sell decisions based on what you hear and read in the news about how the markets are performing short term, not based on your bonds’ long-term value.

 5. Buy and Hold 

 Adopting a buy and hold investment strategy means that even if you choose investments that charge a commission, you won’t pay commissions very often. This rule of thumb also means that you won’t let your emotions dictate your investment decisions. When people follow their emotions, they tend to buy high and sell low. They hear how high a stock has gotten, and they want in because it seems like a great investment – and it is if you’ve already been holding it for years. Or, when the economy slides into a recession, people panic about how far the Dow has fallen and dumped their S&P 500 index fund at the worst possible time. Numerous studies have shown that you’re better off keeping your money in the market even during the worst of downturns. Over the long run, you’ll come out far ahead by leaving your portfolio alone through the market’s ups and downs compared to people who are always reacting to the news or trying to time the market.

 The Bottom Line 

 While there’s a lot to learn about saving for retirement, understanding how to save and invest your money is one of the most important skills you’ll ever develop. It means leveraging all the hours of research you’re doing today into years of leisure time in the future. It also means being able to take care of yourself without having to depend on another source that might not be able to provide for you, whether that’s the Social Security system or your children. Keep in mind these top five rules of thumb for saving for retirement and you’ll be well on your way to a financially comfortable future.

Source:http://www.investopedia.com/articles/personal-finance/112814/top-rules-thumb-retirement-savings.asp