Planning For Retirement

Okay, for the most part, this stuff makes sense. How do I put it all together though?

Here’s how I handle planning for my retirement:

• Put money in my retirement accounts (IRA and 401k in my case) so that I can take advantage of the tax benefits

• Invest that money into index funds like the S&P 500 and the Nasdaq 100 so that I can reap the benefits of diversification

• Make sure that the retirement money comes out of my paycheck before I see it so that I don’t register it in my mind as income (when you take money directly out of your paycheck, you mentally readjust your income to exclude that money from your total income, so after a few paychecks, you become accustomed to your “smaller” paycheck and adjust your lifestyle accordingly)

• Save up some extra money on the side (odd jobs, gifts, etc.) that I can use for additional saving/investing or for a rainy day

• Increase my savings and retirement contributions whenever my income increase

• Let compounding growth work its magic

How do I know how much I should contribute?

First off, you’ll have to do some self-reflection to figure out what kind of lifestyle and budget you’ll need when you’re retired. If you want to drive a new Mercedes and have a vacation house somewhere that’s warm year-round, you’re going to need more money than someone who is comfortable with a Toyota with 200,000 miles on it. Figuring out which category you fall into is important.

Once you figure that out, you’ll want to start making a list of things that you think you’ll spend money on when you’re retired. It doesn’t have to be exact, just a ballpark estimate. You can often get a pretty good estimate of this by looking at your own current spending, talking to people who have a similar lifestyle to the one you’re looking for, and doing a little bit of research on the costs of the things that you want to have in your life.

Once you have a ballpark estimate of how much you want your retirement income to be, you can divide your goal income by 4% (.04) to get a pretty good estimate of how much money you’ll have to have saved up to pull out your desired income every year. From there, you can use a Future Value of Annuity Calculator to figure out how much you should be contributing every year to reach your goal.

For the rate section of the calculator, I assume that my investments will grow by about 10% per year on average because that is right around what the long term average return for the S%P 500 is. I then subtract 2% from that to account for average inflation, and then use the 8% as my rate. *Just because these assumptions were true in the past does not mean that they will be true in the future. This is me assuming that things in the future will continue to be more or less like they have been in the past, not guaranteeing it.*

And there you have it. It’s not sexy to save for retirement, but if you save early, save often, and give your investments time to grow, your little snowball will become an avalanche before you know it.