Figuring out exactly how much to save for retirement is quite a challenge. After all, you're saving for something that won't happen for years or decades. How can you possibly know how much money you'll need that far in the future? Without a crystal ball, you can't get an exact number -- but you'd better be sure you're in the ballpark.
Think through your dreams
Everyone has a different idea of the ideal retirement. While you can't know exactly how you'll spend your golden years, you can narrow the field a bit. Think about the kind of activities you'd most enjoy during retirement. Do you want to stay in your family home, or do you want to move to a villa in Tuscany? Will you travel everywhere from Antwerp to Zimbabwe, or mostly stay near home? Would you rather live the high life with lots of restaurants, plays, and fancy parties, or live simply and spend quiet time with loved ones? If you have a general idea of what you be doing during your retirement years, you'll also be able to get a sense of how much money you'll need to fund those activities.
Image source: Getty images.
Do the math
If your planned retirement will involve free-to-cheap activities and a low-cost housing situation, you can probably live comfortably on 70% to 80% of your current income. Most of your expenses will decrease in retirement, with the likely exception of medical expenses. If you plan to indulge in all the activities you don't have the time or money for now, budget for at least 100% of your current income (if not more). Adding up your probable retirement expenses can help you come up with a more accurate income requirement: Just compare your projected retirement expenses with your current expenses to see what percentage of current income you'll need. However you identify your retirement income requirements, the next step is to figure out how much you need to save in order to reach that level of income; luckily, a retirement calculator makes figuring this out a snap.
Save regularly
You've figured out how much money you'll need and consequently how much you should be saving each month to hit that goal. Compare that number to the amount you're actually setting aside for retirement. If you're saving at least that much, congratulations: You're on track for the retirement of your dreams. If not, you need to amp up your savings effort immediately. This is best done gradually to avoid shocking your budget. For example, let's say you've been saving 10% of your paycheck in your 401(k) account, and the retirement calculator tells you you need to be saving at least 15%. Instead of jumping straight from 10% to 15%, change your contribution level to 11% and hold it there for a few months so you can get used to the slight decrease in your disposable income. Then bump the contribution up to 12%, and so on until you hit the required level. If you start feeling some financial pain, you may need to take a hard look at your expenses and see if you can cut anything out.
Invest wisely
Once you're making retirement contributions regularly, you need to figure out what to do with that money. Leaving it in a savings account or money market account is a nonstarter: Your returns will be far too low to build a viable retirement nest egg. Early on in your career, most or all of that money should be invested in stocks inside a tax-advantaged retirement account such as a 401(k) or IRA. These retirement accounts allow your investments to grow tax-free, which can save you huge sums of money. As you approach retirement, you can allocate more of your money out of stocks and into less volatile investments like bonds. Your portfolio allocation should depend on your personal goals, but one relatively reliable method is to subtract your age from 110 and invest that percentage of your money in stocks. For example, a 40-year-old would invest 70% of their retirement savings in stocks, while the rest would go into bonds. If you're not up to the task of hand-picking investments, you can simplify things by investing in a good target-date fund that will allocate your investments for you.
Do your investment checkups
Annual checkups aren't just for doctors anymore. Review your retirement investments at least once a year to make sure you're getting at least the returns you plugged into the retirement calculator. If you're not getting an average return that's as high as the one you initially planned for, you'll need to either find a way to get better returns or increase your contributions to make up the difference.
