We all want to be financially independent when we retire. However, too few will do enough, and millions of Americans will have financial struggles in retirement. These financial struggles can lead to emotional and health problems, turning retirement dreams into a nightmare.
At the same time, millions more will have happy, healthy retirements with the financial freedom to enjoy life. And you don't have to be rich to reach your retirement goals. As much as the financial industry can make it seem complicated and expensive, it's all pretty simple if you follow these three rules.
Image source: Getty Images.
1. Live beneath your means
This is where your ability to reach your financial goals lives or dies, and it's something far too many Americans simply fail to do well. But it's simple math: If you spend more than you earn, you'll never, ever get ahead.
It's not just about spending less than you make; it's also about setting money aside for emergencies and rainy days. At some point, everyone experiences an unexpected auto repair or a kid that needs braces. Even worse, many of us lose a job at some point and need to have a safety net ready to cover living expenses while we look for new work.
To sum it up, living beneath your means will help you do the following:
- Develop healthy money habits that will pay off your entire life.
- Allow you to build up emergency savings for the unexpected.
- Allow you to have money to invest for retirement.
2. Invest in stocks to grow your retirement wealth
If you think stocks are too risky, don't click away just yet.
Yes, stocks are one of the more volatile things you can invest in, and this volatility can create risk if you aren't prepared to ride out the ups and downs and hold for the long term. The thing is, all that volatility pays off over the long term.
Here's a table that shows the returns over the past 10 years of stocks, as measured by the Vanguard 500 Index Fund Investor Class, compared with bonds, as measured by the Vanguard Total Bond Market ETF:
BND Total Return Price data by YCharts
What's interesting about that chart is that the starting point is right before the financial crisis in 2007, when the stock market was very close to its peak. Within a year, the value had fallen sharply, and it would take years to recover. But as the chart shows, the market did recover, and then some. To date, a decade-long investment in stocks has not only generated twice the return of many bond investments but has also nearly doubled in value.
And that's from an investment at what was considered the worst possible time: Right before the worst market crash in 80 years.
That's not to say bonds are bad investments. In fact, the chart shows how bonds are great for shorter-term investing, such as in or near retirement, when you need to protect cash you'll count on in the next few years. But if you're still a decade or more from retirement, the majority of your retirement savings should probably be in stocks, simply because long-term returns are your goal.
3. Your most important asset may surprise you. Use it.
Money is important, but the most valuable asset you have is time, and for one simple reason: compounding growth.
That chart is an excellent example of how important time is to your equation. Using it as an example, if you were 30 years old a decade ago and had $15,000 in your retirement account, you'd have $30,000 today. In other words, you'd have to come up with 30 grand to "catch up" on your retirement savings today at age 40. And it gets better (or worse, depending on your situation), since that compounding potential continues. Based on the market's historical averages rate of return, that $15,000 at age 30 could be worth more than $160,000 at age 65.
But even if you don't have $15,000 saved for retirement yet, or you're well past 30, the compounding power of time is still your ally. Here's a chart to help show how powerful it can be to invest even a small amount of money over time:
Chart by author. Assumes historical average annualized rate of return of 10%
As this table shows, even contributing a small amount like $150 per month can really make a big difference in the size of your retirement savings -- especially if you do it long enough.
It's up to you
There's no denying this simple fact: The quality of your retirement will be based in a large part on how well you prepare. Social Security isn't going away, but you shouldn't count on any program as your sole source of retirement income -- especially if you want to have a full, active retirement without the limits a fixed income brings.
Whether you're closer to 30 or 60, the three rules we've discussed here still apply. If you're not following them already, start today, and your retirement will almost certainly be better and happier for it.
