3 tips to maximise your retirement savings
When it comes to building wealth for retirement, the sooner you start, the sooner the magic of compounding kicks in. Whether you prefer stocks, bonds, property, alternative assets or a combination of those things, time in the market can help your portfolio reach great heights.
So if you’ve already started your wealth-building journey – congratulations. If you haven’t – today is the perfect time to begin.
When planning for your post-work life, the first question to ask is: "How much money will I need to fund a comfortable retirement?" You can then work backwards to calculate how much you need to save and invest each year.
‘Comfortable’ means different things to different people, so everyone will have different numbers. But one principle that everyone can apply is a rule of thumb known as the ‘4% rule’.
This is the result of a famous study by professors at Trinity University in Texas, who found that, based on historical stock market results and inflation data, you should never run out of money in retirement if you withdraw a maximum of 4% of your savings each year. In other words, your long-term market returns should always exceed a 4% withdrawal rate plus inflation.
Of course, past performance is no guarantee of future performance. But if you do want to use the 4% rule, it's easy to apply. All you have to do is calculate your annual expenses, multiply by 25 and you have your investing target. So if you spend $50,000 per year, you’d need $1.25 million to fund a comfortable retirement (because 4% of $1.25 million is $50,000). If you spend $100,000 per year, you’d need $2.5 million.
Once you've calculated your investing target, you can use these three tips to maximise your investment returns for retirement.
Compound accumulation is a powerful force. For example, if you start with an investment of $50,000 in stocks that returns 7% per annum, and you automatically reinvest your dividends, your investment will be worth $380,613 after 30 years.
But your investment portfolio doesn’t stand still. If you start with that $50,000 initial investment, and invest an additional $10,000 annually, your portfolio will be worth $1,325,221 after 30 years. Comparing the start and end of that 30-year cycle is revealing. At the end of year one, you've invested $50,000 and earned $3,500. By the end of year 30, you've invested $350,000 and earned $975,221. That's the power of compounding.
The fastest way to grow your portfolio is to reinvest your dividends. Commonly known as a dividend reinvestment plan, DRP or DRIP, investors can opt-in to have their dividends reinvested automatically - which offers two key advantages:
● You get to buy new stocks without paying brokerage fees
● You can take advantage of dollar-cost averaging
Brokerage fees, over the long term, can be surprisingly costly. For example, let’s say dividend reinvestment saves you $100 per year in brokerage. If we again assume a 7% return, that compounds to $10,200 over 30 years.
Besides saving on brokerage fees, you also get to use dollar-cost averaging, which is a strategy endorsed by Warren Buffett. Dollar-cost averaging involves investing a set amount of money (in this case, your dividends) at a set time (whenever you receive dividends), whether the market is going up, down or sideways. When we automate our investing in this way, we eliminate the cognitive biases that often harm our results.
Don’t be intimidated by the thought of having to track all those reinvested dividends and calculate their returns – Sharesight’s tracks DRPs all that for you.
● Australia – you invest pre-tax income into superannuation, which is then taxed at 15%, compared to a top tax rate of 45%. If you choose to use an SMSF for your super, you control how those funds are invested.
● New Zealand – if you opt in to KiwiSaver, your employer will make a contribution equivalent to 3% of your salary. The government will also give you 50c for every $1 you invest (up to an annual limit of $521.43).
● Canada – if you establish an RRSP, any deductible contributions you make will reduce your taxable income, while the funds will generally be tax-exempt while they remain in the plan. If you transfer assets from an RRSP to an RRIF, your earnings will be tax-free, although distributions will be taxable.
Investors would be wise to research these schemes. Again, it’s all about the power of compounding: even a modest tax saving or government payment each year can grow into a sizeable amount when compounded over decades.
Your retirement may be decades away, but there’s no time to waste in building your retirement income. The investment decisions you make today could deliver tens of thousands or even hundreds of thousands of dollars’ worth of compounded returns by the time you retire.
As they say, what gets measured gets managed. That’s why investors building their retirement wealth track their investments with Sharesight. Custom built for the needs of anyone investors directly managing their retirement investments in an SMSF (Australia), KiwiSaver (New Zealand), RRSP or RRIF (Canada), Sharesight is the perfect portfolio tracker.
Just make sure you take action (and sign up for a free Sharesight account today). Because if you want to be sitting comfortably in the shade years from now, you need to plant the seed for the tree today.