Retirement is a significant chapter in our lives, a time when we finally get to reap the rewards of decades of hard work. However, ensuring a comfortable and worry-free retirement requires careful consideration and strategic planning. In this blog post, we’ll explore the important factors to keep in mind as you embark on the journey of planning for your retirement.
Firstly, What are the Risks?
There are three main risks that need to be considered and managed effectively when planning for retirement. These risks are inflation, longevity and sequence risks.
- Inflation: Inflation is why we need to invest for retirement really. If you only keep cash saved in your bank account, you will not have enough money for retirement (maybe you will if you have managed to save A LOT of cash, but you will lose purchasing power still).
- Longevity Risk: As the name implies, this risk is all about the uncertainty in longevity during retirement. Since we will never know how long we will actually survive after retirement, our savings will need to fund us for an unknown duration.
- Sequence Risk: This is a special risk associated with funding retirement from volatile assets. The stock market is known for delivering 8%+ per year over long periods of time. But this is a long term average. In reality, the stock market goes up 15% one year and drops 10% in another year. Sequence risk materialises when retirees need to withdraw money when the markets are dropping. These withdrawals lead to a reduction in the expected long term average rate of return.
Financial planners and advisors focus on managing these two specific risks. But after reading this article, you will at least make their life easier when you speak to them before retiring.
How to Manage These Risks?
There are a few things that you need to do to manage these risks effectively. These are described below.
Start Investing Early
One of the golden rules of retirement planning is to start early. The power of compounding means that the earlier you begin saving and investing, the more your money can grow over time. Even small contributions can accumulate into a substantial nest egg if given enough time to compound. You also need to generate inflation beating returns, which is achievable through real estate and stocks.
Understand Pensions
Understand the various retirement savings options available to you, such as 401(k) plans and IRAs in the US and pension schemes and ISAs in the UK. Take advantage of employer-sponsored plans and consider consulting with a financial advisor to determine the best strategy based on your individual circumstances. We discuss pensions in more detail in our next article in this series.
Determine Your Retirement Goals and Lifestyle
I am sure we all want a comfortable retirement. But comfortable is subjective, it could mean a couple of holidays abroad to some and just a worry-free retirement to others. You should spend some time working out the income level needed to cover your basic needs in retirement. Then you can take it a step forward to estimate how much more you’d want for a comfortable retirement. The Retirement Living Standards have good guidance and indicative figures for retirement income.
Assess Your Current Financial Situation
Conduct a thorough assessment of your current financial situation. Calculate your net worth and have an up to date budget. Understanding your current financial standing will help you set realistic goals and identify areas where you can cut unnecessary expenses to redirect funds towards your retirement savings.
Know Your Benefits
Consider your state benefits, in the form of social security in the US and state pension in the UK. Also, investigate what the state offers in the way of healthcare so you know how to consider healthcare.
Healthcare Considerations
If public healthcare is not an option, healthcare costs need to be considered. These costs tend to increase with age, so it’s crucial to plan for medical expenses during retirement. Investigate health insurance options, and consider setting aside funds for potential healthcare needs not covered by insurance.
Account for Inflation
Inflation erodes the purchasing power of money over time. When planning for retirement, consider the real value of your savings and expenses, rather than the nominal value. In the UK, inflation averaged 3% for most 30-year periods since the 1940s. This means that prices double roughly every 24 years. During retirement, state pension increases in-line with inflation, but you will also need to increase your withdrawals every year to be in-line with inflation.
Plan for Debt-Free Retirement
You should really plan for a retirement that is free from debt, especially one that carries high interest rates. Ideally, you should also aim to be mortgage-free during retirement. This does not necessarily mean paying off the mortgage on the family home, it could just mean downsizing to something smaller to be mortgage-free.
Regularly Review and Adjust Your Plan
Life is dynamic, and circumstances change. Regularly review your retirement plan to ensure it aligns with your evolving goals, financial situation, and any shifts in the economic landscape. Adjust your strategy as needed to stay on the path to a secure and fulfilling retirement. I personally update my net worth, budget and retirement estimations every year in December.
Speak to a Planner
The truth is, it is always better to have another pair of eyes look over whatever plan you come up with. A financial planner or advisor will either assure you that you are on track for a decent retirement or will identify pitfalls and recommend corrective action. Our advice is to find a highly reviewed, reputable advisor and pay them a one-time fee for their time. They will love to bring you in and charge you 1-2% for managing your investments, but this is counter-productive. Investing is simpler than you think and our investing 101 is a good place to start.
Conclusion
Planning for retirement is a multifaceted journey that requires careful consideration and proactive decision-making. By starting early, setting realistic goals, and staying informed about your financial options, you can pave the way for a retirement that is not only financially stable but also personally fulfilling. Remember, the key to a successful retirement lies in thoughtful planning and adaptability as you navigate the ever-changing landscape of life and finance.
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