Retirement Investing & Saving

When planning for retirement, the first step that people often take is to look to decide how much money they will need to supplement whatever income they expect to have after they retire. This certainly is a good idea but it’s not a hard and fast thing, because we have to line this up with our capacity to generate retirement savings, and it doesn’t serve any useful purpose to shoot for unrealistic amounts.

So it’s very often not a question of needing this much additional income to maintain your current standard of living as much as it needs to be a matter of what sort of standard of living will be available to you using various strategies. This is why a bottom up approach to retirement makes more sense, starting with saving a certain amount, and then seeing how this may pan out later.

This isn’t all that important though, and it’s more of a psychological thing, where one’s expectations may be set too high initially if we use a top down approach, as in here’s how much a month extra I need, and then may lead to disappointment if the amount that needs to be saved is beyond one’s means.

So starting with that amount, what one could save per month, makes more sense, and then we can adjust that if needed or required, staying within the realm of what we can reasonably achieve.

That’s the first order of business, and then from there we can look at the best way to grow this savings, and then project how much income we may expect from this in retirement. It’s important to not use too high of a number as far as future return goes, for instance we may find something like 6% reasonable for long term growth, but when we retire, we’ll be using it for income, which does not deliver as high of a return on average.

The Long Horizon of Retirement

As we move closer toward our retirement years, we’re also going to need to adjust this expected return, as we’ll need to move more and more toward more conservative investments, and less in more volatile growth investments. This is because the shorter the time frame, the less our tolerance for risk becomes, because there is less time for an investment to be able to recover should we suffer losses.

Earlier in one’s career, with retirement decades away, this presents the best opportunity for growth, as the short to medium time frame ups and downs of the market are rendered meaningless, so long as our portfolio moves forward over time. ThisĀ  has always been the case thus far with stocks. While one still needs to choose one’s investments carefully to get the most return, even random baskets such as index funds have always performed well long term, delivering reliable and impressive returns over time with relatively low risk overall.

So the risk in such a strategy is not staying the course, and this is why investors who set out for the long term are always told to do exactly this. This does not necessarily mean just holding, as there are still times that you may want to move in and out of investments, but it does mean that you are looking to keep your money in growth, and not do an excessive amount of trading.

This is why index funds are so popular, as you can just hold these for any length of time, and as companies move in and out of the index, that will allow the portfolio to be kept current. This does not mean that this is the only good strategy though, but when you deviate from this you have to make sure that you know what you are doing and are not trading based upon a lack of careful consideration.

A lot of investors are more risk averse than they may think, and these are the ones that tend to complain a lot about their positions, and especially when a trade goes wrong. Staying the course mostly means not getting stressed about the normal cycle that equities often take, and having this lead to selling at the wrong time.

How The Retirement Horizon Changes

Eventually, as you move closer to retirement, this window is going to shrink to the point where you simply don’t have the time to ride out the bumps in the road, and you always want to look to avoid selling during these bumps. Eventually though the plan is to sell to supplement your income, so it’s going to happen, and when it does you want to be in more stable investments to reduce the risk of this.

This doesn’t have to be an abrupt thing though, and that’s actually a poor strategy, to one day decide that you want to move your investments into those with lower expected return and lower risk.

It’s better to look at this in terms of portions. Let’s say you plan on retiring at 65 for example. So each year you are looking to draw out a certain amount of money to live on, and the plan is to do this for the rest of your life, let’s say for 20-25 years, or however long you expect to live.

So even at the point of retiring, there’s going to be a good part of your portfolio that isn’t going to be needed for quite a few more years, money that can be left alone for now to grow if one chooses to.

On the other hand, when you hit 65, you want to have already accounted for this, because the portion you need now should not be sold at a loss, we should not have exposed this portion to this risk, which is why we need to transition this portion well in advance.

So in this case, when we turn 55, assuming a 10 year window, we may want to start planning for this by starting to move some of our investments into income investments, such as bonds, which will protect this portion from the risk of stock market downturns.

Of course we always want to let the market guide us as well, as we don’t want to be selling during bear markets, when the investments are more likely to be buys rather than sells. The whole idea here is to avoid events like this, so we both need to be within the window and have favorable circumstances be present.

As we move forward, this will result in a greater and greater percentage of our portfolio moving into less volatile investments, which ideally should be a gradual process. This does require a fair bit of attention, and one needs to make sure that it gets the amount it deserves, as you can’t always rely on investment advisors to manage this optimally for us without our at least making sure that they have us on the right course.

The Retirement Investment Toolkit

Depending on one’s risk appetite and sense for adventure, one may set aside a portion of one’s portfolio for speculation, but unless one is quite skilled, you don’t want to expose too much of your portfolio to too much risk this way.

While you can really help yourself if you win, you can also hurt yourself if you don’t, and with the nature of money being what it is, it hurts more to lose than it helps to win. This is especially the case with retirement savings, where you don’t want to be playing around too much with money you’re going to need to make your life comfortable.

So the main tools are going to be long term stock market plays, with things gradually transitioning into income funds as the window to cashing in on the investment narrows. This is only applicable to money we expect to spend though, and if we have a very large portfolio with a significant amount that we expect to leave to our loved ones upon our passing, this part isn’t subject to the normal volatility concerns, and can just be held in the stock market if one wishes.

Along the way, there may be certain retirement savings programs available to us which allow us to pay less tax, such as an IRA and a 401(k) savings plan in the U.S., and an RRSP or TFSA in Canada. Since these plans present the opportunity for some significant tax savings, they are generally a great idea to take advantage of.

Anytime the government tells you that they have a way for you to pay less tax, and this is pretty easy to do, that should grab everyone’s attention, unless you simply enjoy paying more rather than less tax. While these plans do come with a few restrictions, they are designed to allow for people to have more money in retirement, which is something we want as well.

So there’s quite a bit that goes into coming up with the best strategy to allow you to save and invest for retirement effectively, but it should not be difficult to come up with a good plan. The biggest challenge people face is putting enough weight on doing it, although as you get closer and closer, you tend to realize more and more how important this is, but it’s never too early to start realizing that.