10 Steps to a Successful Retirement
TIP: Unless you have a substantial amount of money to invest, stick with mutual funds. Diversifying a small amount of money among individual stocks and bonds is expensive.
Start planning for retirement by using these tips from Certified Financial Planner Terrence Herr, Herr Capital Management of Chicago.
- Calculate your income needs. Although many experts say you should have 80 percent of your current income at retirement, Herr recommends 100 percent. He cites recent statistics from the Consumer Federation of America showing that three out of five people realize a decline in their standard of living after retirement.
- Understand inflation. Inflation erodes purchasing power. That means you’ll need more money tomorrow to buy the same amount of goods you bought today. The cumulative effect of inflation over a period of years is a serious threat to a comfortable retirement. Use this financial calculator to help you factor inflation into your income model.
- Start early. A small amount of money invested over a long period of time really adds up. Assume you saved $2,000 a year from age 19 to age 25 and never invested another dime after that. If you achieved a 10 percent return, at age 65 your net earnings would be $930,641. Your money grew 66-fold. If you started just five years later with identical investment returns, and you invested $2,000 every year until age 65, your net investment earnings would be only $893,704. Your money grew 11-fold.
- Understand compound interest. Albert Einstein called it "the eighth wonder of the world.” If you reinvest the interest you earn, then you earn interest on both the principal and the reinvested interest. With monthly compounding of 15 percent a year, an investment of $100 a month can grow into a nest egg of $8,857 in only five years.
- Understand your investment personality. All investments hinge on a risk-reward concept. How much of a downturn will keep you up at night? Can you accept uncertainty for the possibility of a greater return? If you have a low risk tolerance, federal certificates of deposit might be a good option, even if returns are lower than you may average on stocks or mutual funds. But remember that the higher the risk, the higher the potential return.
- Defer and eliminate tax. Contribute as much as you can to retirement plans such as 401(k)s, Simplified Employee Pensions, SIMPLE IRAs, and IRAs that defer taxes until the money is withdrawn.
- Diversify. Investment research has shown that spreading your money across different types of investments is a good way to reduce risk. Although some of your investments may be in a downturn, you want to have others that are making money. Decide what asset classes to include in your portfolio and the percentage you’ll invest in each.
- Invest systematically. “Buy low, sell high” is easier said than done. Choosing the perfect time to invest is an impossible task. A better approach is dollar cost averaging—investing a specific amount of money on a regular schedule, whether the market is up or down. By investing the same amount at regular intervals, you’re buying more shares when the market is down and fewer shares when it's up. As a result, your average cost per share will tend to be lower than the market's average price per share over the long term.
- Change your investment allocation when appropriate. Review your allocation each year to respond to any imbalances stemming from investment performance. Also reevaluate in light of events such as marriage, divorce, the birth of a child, and retirement.
- Ask a professional. Retirement plan rules and taxation can be complicated. 401(k)s, IRAs, annuities, and life insurance have different distribution rules that affect you and your beneficiaries. Professional advice could save you thousands of dollars.
Courtesy of Terrence Herr, CFP, owner of Herr Capital Management in Chicago.
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