Part of how you decide how much will be enough for retirement will be affected by how old you are right now. If you’re in your 20s, you’re about 40 years away from dusting off the rocker. While you may have very little information to go on in terms of what things will cost and how much you’ll need, you’re in the best position since you have loads of time on your side.
It’s been estimated that if you wait to start saving for retirement until you’re in your 40s, you’ll have to sock away 18% of your income. But if you start in your 20s, then you only have to put aside 6% of your net income.
Early savers can also behave a lot less desperately when it comes to choosing an investment with a “decent” return. Hunting down an elephant-sized return won’t be half so important if you have time and the magic of compounding return doing most of the work for you.
Sock away $100 a month—or $1,200 a year—in a retirement plan and earn 5% on your money on average over 40 years and you’ll have saved $48,000, on which you will have earned about $133,000 in compounded return, for a total of almost $181,000. Wait until you’re 40 to start, put away the same $1,200 a year at 5% and you’ll have just under $67,000 to work with. If the 40-year-old wanted to have what the 20-year-old has, (s)he’d have to save $3,200 a year instead of just $1,200 a year.
Starting early is best. But no matter where you are now, getting started will get you closer to where you want to be than sitting on your thumbs!
How Much Is Enough?
If you’re spending $60,000 a year now (net!), in all likelihood you’re going to need a little more than $20,000 a year to make ends meet. Some people arbitrarily pick a goal for how much money they think they’ll need. That’s where the Magic Million came from. It was a dart thrown in the dark. And it’s no more true for the guy who is currently living on $250,000 a year than for the guy living on $25,000. Guessing is fine if you’re 20 and just starting out. After all, life is going to throw you a huge number of curveballs before you actually get to shake off the harness. But if you’re in your 50s or 60s, it’s time to stop guesstimating and time to start doing some groundwork. The last thing you want to do is get to retirement only to find out that you have just enough money to last until next Tuesday.
Most people don’t have to come up with all the money they’ll need from their own savings. About half of us have access to a company pension plan. (Sad to say, not everyone takes full advantage of those company pension plans.)
GAIL’S TIPS
I was speaking at a corporate meeting not Long ago, and I asked how many people were taking advantage of the corporate retirement savings-matching program offered by the company. (If an employee contributed 3% of his or her salary to the pension plan, the company would match the contribution up to 3%, doubling the contribution.) Less than half of the people in the room put up their hands. OMG! Your company wants to GIVE you money and you can’t get it together to take the gift! If your employer has a savings-matching program and you’re not taking advantage of it, you’re stupid! It’s Like blowing off free money. Clearly you don’t deserve a raise.
I am constantly amazed at the number of people who don’t know how their company pension plan works. If you don’t know, make an appointment this week with your Human Resources department to find out. Whatever you will get from your company pension plan reduces the amount you’ll have to save on your own, so this is a big consideration.
How much you end up receiving through government retirement benefits will also have an impact on how much you’ll need to save. While it may not be much, it’s better than a kick in the teeth. Find out what you can expect to receive and plan accordingly. Contact Service Canada (servicecanada.gc.ca) for more information.
If you’re going to be funding your retirement all by your lonesome, then a buck ninety-two probably won’t go far enough. The most common rule of thumb thrown around in the media and by the retirement specialists is that you’ll need about 70% of your pre-retirement income to live comfortably when you finally check out with your gold watch.
Keep in mind that you’ll be retired for 20 years or more so that your needs will change because inflation will make things more expensive. Let’s say you decided you could live on $20,000 in today’s dollars during retirement. If inflation averages 1.5% a year, you would have to spend just over $36,000 a year in 20 years to buy the same stuff you’re spending $20,000 on today.
Don’t get so caught up in the rule-of-thumb calculations that you throw up your arms and say, “I’ll never be able to swing that, so I won’t even bother to try.” The Stats Man has found that people who earned $70,000 at retirement use only about 45% of their pre-retirement income to live during retirement. Those who earned between $40,000 and $50,000 end up retiring on just 59% of their pre-retirement income. And less than 20% of people with a pre-retirement income of $40,000+ end up living on 75% or more of their pre-retirement income.
Calculating how much will be enough for you means looking over your budget and deciding which expenses will increase in retirement, which will go down, and which will disappear completely. This is an exercise for people who are five years or so from retirement. For anyone younger, a web-based retirement calculator or an experienced and smart adviser can help you decide how much you should be setting aside each month.
How Greedy Are You?
Once you decide on your retirement savings goal, you have to figure out how you’re going to invest that money so it will grow to meet your expectations. Everything has some risk attached. Being a fraidy-cat and doing nothing with your money means leaving it to wilt under the pressure of inflation. Expecting “big returns” means taking more risk with your money.
“How greedy are you?” is one of those simple questions that has a ton of implications. If you’re content to hold an investment paying you a 2% return and can stand the scorn of all your friends and relatives at your naïveté, your lack of ambition, or your sheer stupidity, then you’d be pretty low on the Greedy Scale. If you’re insisting on an investment that will turn your $1,000 into the Magic Million in 10 seconds flat, then you’d be right up there with Gordon Gekko.
Some people have huge expectations about how investments should perform. It’s probably because the media hype the Bestest Investments and promote the idea that someone knows what’s going on. Hello! I have some breaking news for you—nobody knows. So that’s the first thing you need to wrap your brain around. If all those gurus actually had the key to making buckets full of money from their investments, why wouldn’t they just do that instead of trying to convince us of how smart they all are?
The second thing you need to wrap your head around is this investment creed: the higher the potential return, the greater the potential risk.
So back to my question: how greedy are you? Or put another way, how much risk are you prepared to take?
Want to take the least amount of risk? Hey, I’m not here to judge you, just to inform you. There’s a rule you need to know about if you’re trying to figure out how your money will grow and it’s called the Rule of 72. It’s a simple way to determine how long it will take for an investment to double. It’s often used with people who are investing in interest-bearing options like saving accounts or GICs, usually to make them feel small and stupid because their return is low and it’s taking so long for their money to grow. But it’s a good rule and you should know it. It goes like this: 72 divided by the return on your investment will give you the number of years it’ll take for your money to double in value.
If you’re earning a 5% return on a GIC, then the formula would look like this: 72 ÷ 5 = 14.4 years.
This formula is actually a little off and gets more “off” as the rate of return increases, particularly when you’re looking at returns of 20% plus. But it’s handy, particularly for the math-challenged. And it can be used backwards too: want to double your money in six years? Divide 6 into 72 to find that you’ll need to earn a return of about 12%.
If you invest in a GIC earning 4%, a
ccording to the Rule of 72, it’ll take 18 years for your money to double. If you’re thinking to yourself, “Who would settle for a pathetic GIC when you could jump into the stock market and earn stellar rewards,” you’re falling into a trap. Before you go dissing GICs, might I point out that if you are in any way concerned about protecting your capital—making sure the money you sweated your ass off to earn doesn’t disappear into the ether—then you’re concerned about risk. The least risky investments make sure your capital is completely, totally, and utterly safe. Of course, they also have a tendency to earn the lowest return going.
Which is how I come back to the question: so, how greedy are you?
If you’re not prepared to settle for taking 18 years to grow your $2,000 to $4,000, then you’re willing to accept more risk. In doing so, you’re prepared to accept that some of your sweat-money might disappear if market conditions aren’t working in your favour.
It’s important that you understand how much risk you can stand before you start waking up in the middle of the night with the sweats. That’s no way to live. And it’s no way to invest. You should not only know how much risk you’re prepared to take, you should also know what you’re investing in. If you don’t understand what you’re buying, you shouldn’t be buying it. If you don’t know the risks involved, you shouldn’t be buying it. And if you think it’s too good to be true, you shouldn’t be buying it.
How Committed Are You?
This is a simple question that has a wide range of answers from “not at all committed” to “somewhat committed” to “passionately committed.” Do you know what you are?
Let’s call a spade a spade. There are lots of people who say they want to save but don’t have the tenacity to stick it out. They’re what I call Saving Wussies. Lots of talk, no action. Lots of whining about how hard life is, no commitment to doing whatever it takes to make savings a reality. And then there are the people, the Saving Demons, who won’t spend a penny that’s not in the budget because they are so determined to achieve their goal. Do you know what you are? Once you do, you’ll better understand how to save.
Not at All Committed
You love to shop. You can’t save a penny. You think you should, or you know you should, or you wish you could. But you’re not going to suffer one minute of discomfort. You’re never going to delay your gratification or say no to yourself. Nope. Money is for spending, and that’s what you keep doing.
You know what? It’s your money. Spend it all. Just remember that your conscious decision to spend every penny you make eliminates your right to whine when you finally quit working and can’t come up with food money.
How You Should Invest: You’re going to want to get at your money whenever the whim takes your fancy. You should keep it very handy. Of course, you could help your case of “got it, spend it” by locking your savings up so you can’t get at them. But if you’re hell-bent on spending your money, admit it and don’t do anything to incur penalties when you decide to take the money out. Stick with a high-yield savings accounts, 30-day or 60-day term deposits, a money market mutual fund.
Somewhat Committed
You’ve been told you should be saving and you think that it’s probably a good idea. It’s just that stuff keeps cropping up, forcing you to spend your savings. The car breaks down, your son’s hockey fees come due, your daughter needs a dress for the dance, your husband wants a new TV, your wife is desperate to redo the kitchen. The list goes on and on and on. You squirrel away a few bucks and then, BAM, something knocks the money out of savings and into your pocket. Oops! How You Should Invest: You need to keep some money accessible for emergencies, but you would definitely benefit from locking the rest up where temptation can’t steal it. Think three-to five-year GICs and government bonds. You shouldn’t use anything too liquid (i.e., easy to sell) because the temptation will be to cash out and spend the money.
Very Committed
You get it. You’re determined to save. You may not have a lot to start with, but that’s not going to stop you. You’ve set up an automatic debit from your chequing account to a retirement savings account somewhere that makes it very hard for you to get to the money. And every six months, you increase the amount you’re saving by 10%, 15%, or 20%, so you keep growing your savings. You’re learning all about investing. Ditto educational savings accounts, and whatever else will help you reach your goals.
How You Should Invest: When choosing investments, you’re in the same boat as “passionately committed,” so read on.
Passionately Committed
You’re so committed to reaching your goal that you’ve actually taken an extra job and are directing all the money you’re making from that job to your retirement savings. You’re a fiend when it comes to using coupons, shopping on sale, cutting corners. And every penny you save goes immediately into your savings account. Yup, you don’t “save” (the verb) $10 without applying that $10 to your “savings” (the noun)! Whoo-hoo. You’re a train and everyone better get out of your way because you are determined to achieve your goal.
How You Should Invest: Whether you’re very committed or passionately committed, your investment options are wide open, and should be tempered only by your knowledge and investment time frame—or how long it will be till you need to start using the money.
Knowledge you get, right? If you can explain the investment to your sister, mother, best friend, brother, and still want to buy it, go ahead.
Which brings us to time horizon.
INVESTMENT TIME HORIZON
How long you’re planning to invest has a big impact on the investment alternative you might choose. Pick the wrong timeline and you could find yourself a little sad when cash-out time comes.
The longer you have until you will need to use the money—the longer your time horizon—the more time your investment has to even out its return, taking care of the volatility risk, but the more time inflation has to eat away at the value of your money. The trick is to match your time horizon to the investment you are choosing.
What does the time horizon of your investment have to do with what investment you choose? Well, it’s like this:
Fixed-income investments like certificates of deposit (GICs and term deposits) have no volatility and the return is guaranteed. You can’t lose your principal (the money you initially invested) and you know exactly what you’ll earn in interest on the day your certificate matures. The same holds for a bond or mortgage investment that is held to maturity. (If you’re actively trading bonds or mortgages, they behave more like equities, responding to market conditions.) So it doesn’t matter whether you go long or short, you’re guaranteed your return as long as you hold to the end of the term you choose.
Equities—things like stocks and stock-based mutual funds—are a whole different kettle of fish. They can be very volatile depending on their nature, some offering more price stability and others offering more opportunity for growth. Either way, they don’t work as short-term investments since they may be at a low just when you need the money and must sell them. They work as long-term investments, where you have time to ride out the highs and lows and average out your return.
Less than three years is considered a short-term investment horizon. Three to nine years is considered medium-term, and 10 years or beyond is considered long-term. Short-term investors should avoid putting the majority of their money in investments where the risk of losing that money is greater. Choosing fixed-income investments that generate a steady return while offering a higher level of security is a better idea. Medium-term investors can balance their investment portfolios using both equity and fixed-income alternatives. Long-term investors have the luxury of time and can, therefore, choose an asset mix that is weighted more heavily with equity investments. Since equities have historically outperformed all other types of investments over the long-term, people with an investment horizon of 10 years can benefit from the potentially higher returns equities offer because they have the time to ride out the na
tural volatility associated with the market.
As you get older, or as your personal circumstances or economic conditions change, and as your investment horizon shortens (yes, you’ll get older and closer to retirement, so your time horizon will go from 20 years to 10 to 5 and so on), you’ll need to rebalance your portfolio’s asset mix.
GAIL’S TIPS
The Canada Deposit insurance Corporation [CDIC] provides deposit insurance on eligible deposits at member institutions up to $100,000 per registration, which means your principal is safe regardless of what happens to the bank. So your RRSP deposits are covered separately from your unregistered GICs, and your personal bank account is covered separately from your joint account. Deposits must be in Canadian currency and payable in Canada. Term deposits must be repayable no Later than five years from the date of deposit. For more info, visit the CDIC website—www.cdic.ca.
MINIMIZING STUDENT DEBT WITH SAVINGS
While saving for retirement is something most of us think about—at least from time to time—there are other reasons to save, including making sure we can help our children avoid a huge amount of student debt when they head off to the halls of higher learning.
Back when my children were born—so about 16 years ago—the RESP wasn’t the RESP we have today and I wasn’t convinced it was the best deal going. But over time, the product has improved, the legislation has been made more user-friendly, and the reasons to use it have become crystal clear.
There are still plenty of people in Canada who aren’t using an RESP to save for their children’s future education. Only about 35% of eligible kids receive the Canada Education Savings Grant (CESG). That’s the money the federal government gives you to put money away for your kids. Really? The feds want to give you money and you don’t want to take it? What’s up with that?
Debt-Free Forever Page 14