What is retirement planning and why is it important?
Retirement planning involves estimating the amount of money you’ll need in retirement and saving and investing in order to achieve that goal. Many people don’t start thinking about retirement until they’re in their 40s or 50s, but waiting until then to start saving and investing will put you at a major disadvantage.
Retirement needs will vary from person to person, but most people will need a significant sum of money in order to live comfortably during their golden years. Experts often recommend saving enough to replace about 80 percent of your current income, which for some people will mean saving $1 million or more. While saving this amount of money can seem daunting, planning for it early in your career will make it more likely that you’ll reach your goal.
Retirement planning is an ongoing process that will need to be updated as your plans for the future change. Here are the key steps to retirement planning.
1. Estimate how much money you’ll need to retire
One of the most important parts of retirement planning involves estimating the amount of money you’ll need during retirement. How much you’ll need to retire depends on how much you’ll spend during retirement. You’ll want to think about key questions such as whether your house will be paid off or not, the state you plan to live in and the type of lifestyle you want to live.
Financial advisors often suggest replacing about 80 percent of your current income during retirement, but the exact amount depends on your estimated expenses. Managing healthcare costs during retirement is often overlooked, but these expenses can be a major factor as people age. Be sure to consider all expenses when determining how much you’ll need to retire.
2. Determine how much to save each month and which accounts to use
Once you have an estimated amount you’ll need to retire, you can work backwards to determine how much you’ll need to set aside each month. You’ll also want to factor in an expected investment return over the time you’re saving for retirement. Estimating a 6-8 percent return is typically a reasonable assumption, but your actual return will depend on your asset allocation, as well as other factors.
There are several retirement accounts that come with tax advantages. Making regular contributions is made simple through employer-sponsored plans such as a 401(k), and you may even get a matching contribution, which is like free money. You can also set up additional retirement accounts such as traditional or Roth IRA.
3. Choose investments
Once you’ve started saving and selected which accounts you’re going to use for your retirement planning, you’ll need to choose how to invest the money. Many investors choose stocks to invest in because they’ll have time to recover from any short-term losses. Over the long term, stocks have returned around 10 percent annually.
As you get closer to retirement age, you’ll likely shift your portfolio more towards fixed income investments such as bonds. These investments provide regular income and are less volatile than stocks, making them solid picks as you get closer to your investment goal.
Many investors use mutual funds and exchange-traded funds (ETFs) to save for retirement. These funds often invest in hundreds of different stocks and bonds, allowing you to build a diversified portfolio at a low cost. Diversification is key when building an investment portfolio and can protect you from sudden changes in the stock market.
4. Periodically review investments and retirement plan
You’ll want to review your investments at least a few times each year and reassess your retirement priorities. Plans change sometimes and you’ll want to adjust your savings or investments if you’ve changed your ultimate retirement goal.
It may also make sense to rebalance your investment portfolio if allocations have shifted due to market performance. If one investment has outperformed others, it may account for a larger portion of your portfolio than you desire.