Many people don't realize that they're a few simple steps away from being financially prepared for retirement. The longer you wait to develop the right strategies, the harder it will be to get on track later. Consider making these moves today to ensure that your golden years are stress free.
Save systematically
It shouldn't be news to anyone that it's important to save for retirement, but Americans still aren't doing a good enough job at retaining their hard-earned money. Most people need to save 15% to 20% of their income, but the average savings rate is roughly one-third of that. Surveys indicate that many families don't think they're putting enough in the bank each month, and studies suggest that people generally underestimate how much they'll need for retirement.
Image source: Getty Images.
There are a few reasons for this worrisome deficit. Not everyone has the means to save a big chunk of their income. After taxes, bills, and the unexpected expenses that inevitably pop up from time to time, there's just not any money left over for many households. Your options might be limited in those situations, but many other families squander their potential thanks to disorganization and a lack of clarity.
That's why it's so important to have a plan with quantifiable goals and measurable progress. Calculate your household's monthly income before any taxes or retirement account contributions, and set a goal to save at least 15% of that. That's not a realistic goal for everyone, especially right away. There are a handful of effective steps boost your savings rate, including:
- Figure out your monthly expenses for basic needs and how much you typically spend on lifestyle. A budgeting tool can help you analyze your spending to identify any costs that might be higher than you anticipated. Many people are spending more than they realize on all sorts of things, such as unused subscriptions, takeout meals, and frivolous purchases. Living by a budget and tracking your spending are huge steps that many families only take in a vague, informal manner.
- Take full advantage of your employer's 401(k) contribution match, if there's one available. This is an efficient and easy way to automatically save money and potentially double the amount of cash flowing into your retirement fund with every paycheck.
- Prioritize paying down high-interest debt, such as credit cards. Credit card balances typically carry interest costs that crush your ability to save, and many people routinely carry a balance that incurs those high levels of interest.
- If your paychecks are deposited directly, see if you can automatically split the deposits into multiple accounts. Taking 5% to 10% of every paycheck and sending it to a separate, dedicated savings account can be a great way to impose discipline. Checking accounts are designed to be spent, so it's helpful to keep those funds separate from your savings.
- Consider making monthly contributions to a health savings account (HSA) if you're eligible, or to an IRA or brokerage account.
For the best results, come up with a plan for savings, and track your progress toward those goals at least once a quarter. Review your overall plan every year or any time there's an important change to your financial situation.
Invest the right way
Once you're saving the right amount, you can put those assets to work. It's important to have liquid, accessible money available to cover unexpected expenses. Any savings beyond that cash buffer should deliver some sort of return.
Investors should prioritize growth if they're multiple decades away from retirement. This doesn't mean that you should take unreasonable risk to achieve big returns, but it does mean that most of your retirement savings should be invested in equities. Stocks are volatile in the short term, so there's a risk that even diversified portfolios can suffer temporary losses due to market conditions -- even if the companies are performing well. However, stocks tend to rise over time with corporate earnings, and earnings tend to expand with the global economy over the long term. If there's a long enough time until you sell your stocks for cash, history suggests that a diversified equity bundle will reliably appreciate. During your 30s and 40s, your retirement account should be heavily allocated toward equities, with relatively high exposure to growth stocks.
Volatility becomes a greater concern when your investment time horizon gets shorter. A bear market can wipe out years' worth of gains, and you might not have time to recover if you need to access retirement accounts in the relatively near future. That's why your asset allocation should shift toward bonds and dividend stocks as you get closer to retirement.
Make sure that your retirement account reflects your investment time horizon, and that it's set up to deliver gains without taking on too much risk.
Diversify tax exposure
It's also important to consider the types of accounts that you're building. Contributions to a traditional IRA or 401(k) are deductible from taxable income, and you'll only pay taxes on those earnings when you withdraw from those accounts down the road. Most people fall in lower tax brackets during retirement, so it makes sense to defer payments to the IRS while your gains compound over years.
However, that's not always the case, and it's impossible to know what tax rates will be several decades from now. For that reason, it's important to develop multiple sources of retirement income with different tax treatment. A Roth IRA or 401(k) doesn't offer any benefits on contributions, but distributions from those accounts are made tax-free in retirement. They can be powerful tools when used in conjunction with tax-deferred accounts. If you have multiple sources of cash flow as a senior, you can source funds from whichever is the most advantageous at the time.
Unlock the benefits of various retirement accounts by using them in conjunction.
