Retirement 101.
“The goal of retirement is to live off your assets-not on them”
-Frank Eberhart
Rule No.1 of living off your assets: You must have assets.
You may plan to retire. You may not.
Either way, it’s a good idea to have a plan for wealth building. You may need it.
So, when do you start planning for it? And how do you do it?
Retirement 101: When Do You Start?
You probably saw this coming: you start now.
You may think retirement is for old people, but those “old people” started contributing to their retirement when they were young.
Oh, the miracle of compound interest.
It’s a miracle that you won’t know anything about if you wait to start planning you retirement.
Retirement should be something that you contribute to diligently over your entire life.
And actually, you don’t really have to be that diligent and disciplined anymore. With technology, you can set your retirement on autopilot.
The Story of Bob and Pedro
Let’s look at some numbers. You like numbers, right?
Well…you probably do when they involve your money.
For example, we will use the fictitious charters: Pedro and Bob.
The Story of Pedro
Pedro understands that he needs to start contributing to his retirement at a young age, so he begins to put $100 into an IRA every month. Let’s just say he puts it all into index funds and he averages a measly 8% annual return on his money. Pedro is 20 years old and he contributes to this IRA until he is 50. Hence, Pedro will end up with $146,815.04. Probably not enough for Pedro to completely stop working, but he is only 50 now and this is assuming that he was never able to contribute more than $100 per month. Not bad, Pedro!
The Story of Bob
Bob knows everything. He realizes he has plenty of time to think about retirement. Despite what Pedro tries to tell him, he waits until he is 35 to start thinking about it. At the age of 38, Bob decides that he can’t work as the head-repairman of Chuck E Cheese’s for the rest of his life. He’ll need to start contributing to his retirement. At 38, Bob is starts to realize that he may be a bit behind the game, so he contributes $400 every month into an IRA. He had heard Pedro mention something about index funds, so he puts it all into those…whatever they are. Since he is using the same index funds as Pedro, we will give Bob the same assumption of an 8% interest rate. Bob contributes until he is 50 (like Pedro) and he will end up with less than $100,000 (98,377.42 to be exact).
Well…what did we learn, class?
Firstly, we learned that Bob should really be taking advice from Pedro.
We also learned the compound interest that accumulates is much more powerful than contributing more money.
Bob contributed 4 times the monthly amount that Pedro contributed! But since it was only invested for 12 years, he still ended up with much less money.
Bob actually contributed more in 12 years than Pedro did in 30 years.
Comparatively, Bob: $57,600 Pedro: $36,000
Oh, the benefits of starting early.
Retirement 101: How Do You Start?
There are 2 words that can take most of the stress and confusion out of retirement…
Index funds.
Pedro was right.
Don’t know what an index fund is? Read this article.
If you like the idea of using index funds for your retirement, you can tax-shelter them in an IRA.
Don’t know what an IRA is? Read this article.
That’s as simple as it gets.
Set the deductions to come out automatically every month and you will have an automatic retirement account.
Really, That’s It?
There are thousands of options when you are investing for retirement, but if you are looking for the most direct way to set it and forget it, then you will be best off using index funds in a tax-sheltered IRA.
Your company may offer a retirement plan and that’s great! If they offer a match, then you should contribute enough to get the match…it’s free money, after all.
What if your company doesn’t offer a match? You will need to do some research to see if it’s worth investing in. If you don’t get a match, IRAs are often better than a company retirement plan since you have more options (in this case, more index funds to choose from).
For more on company retirement accounts, like a 401(k), read this article.
Lastly, don’t get discouraged or think it’s too late for you. It’s never too late!
Start now. Start today. And learn a lot more about investing here.
Related: How to Choose Specific Index Funds for Retirement Based on Your Age
Photo Credit: Rene Bastiaanssen, 401(K) 2012