The Retirement Crisis
One of the least reported social problems in the U.S. is the growing retirement crisis. There are several statistics that point to just how severe the crisis has become. According to Morningstar’sCenter for Retirement and Policy Studies, 45% of Americans who leave the workforce at age 65 are likely to run out of money during retirement.Furthermore, a study by the National Council on Aging shows that over 27 million adults aged 60 and up cannot afford basic living needs. This does not even include additional expenses that may arise for things such as nursing homes. (Source: Retirement in America isa disaster for many. Is there hope? Kerry Hannon, Yahoo Finance - October 6,2024)
Several reasons have been put forth to explain the root of the retirement crisis. However, the focus of this article is on one of the solutions to the problem. Namely, the importance of planning for retirement. What shouldn’t come as a surprise is that this planning shouldn’t begin the week before you retire. In fact, retirement planning should begin as early as possible. This argument isn’t always an easy one to make. After all, most 25 year-olds aren’t too concerned with how much assisted living will cost when they’re 75. But the truth is, those that get an early start on retirement planning, ultimately end up in much better shape.
Investing - The Basics
In order to convince people on the benefits of retirement planning, they first need to understand the basics of savings and investing. At its most simple level, investing small amounts of money in the present, can lead to substantial wealth in the future. Building this type of wealth usually requires investing in some combination of stocks and bonds, orin index funds that invest in these securities. There are a number of different types of investment accounts available in the United States. Of course, most can open a non-registered (taxable) account with a licensed financial institution. But investors should become familiar with the different types of registered accounts that are available to them and the different tax advantages connected to each account.
Many individuals invest for their future through employee savings plans such as a 401(k). However, those that don’t have access to such plans (and even those that do) can still start investing with other types of registered accounts such as Individual Retirement Accounts(IRAs) and Roth IRAs. Both of these accounts provide investors with a number of advantages. Most notably, the gains made in an IRA are not taxed until funds are withdrawn. This allows these accounts to enjoy compounded growth for many years, which, as their names imply, are especially intended for peoples’ retirement.Before opening any type of registered account, investors need to be aware of the contribution limits for each because over-contributing can lead additional taxes and penalties.
Neither Rome Nor Your Retirement Fund Was Built in a Day
One of the biggest myths when it comes to investing is that you can only begin to invest once you are earning a lot of money. This point of view is categorically false. But what is often easily lost on investors with less experience, is that it takes time to build wealth. As such, younger investors actually have an advantage over older investors.Namely, that they have that much more time to let the market work in their favor. The chart below illustrates the difference in how much wealth is accumulated by three individuals that each start investing at different ages - 25, 35, and 45. The results are based on a 7.0% annual return after inflation.
The chart above (Source: U.S. News & World Report, August 2024) makes it clear that the younger you are when you start investing, the better off you will be when you reach your retirement years. Unfortunately, some that are new to the stock market have a misconception that investing is a way to ‘get rich quick’. So if they don’t see spectacular results right away, they abandon their approach and come up with what they perceive to be a better one. And when that strategy doesn’t yield quick returns, the cycle continues. However, in the famous words of Warren Buffett’s longtime associate, Charlie Munger, “The big money is not in the buying and the selling, but in the waiting.”
Investing Later in Life
Of course, the discussion above is not meant to suggest that anyone above a certain age should close the door on investing. For example, even a 55-year old may continue to work for another 15 years - and may live another 20 years in retirement! Surely, these people should also be concerned about planning for their retirement. What is likely to change as an individual gets older, from an investment point of view, is their ability to take on risk. This simply means that their investment portfolio should look different from someone who is 35years old. Where the 35-year-old would likely have a higher portion of their portfolio in riskier assets, such as stocks, the 55-year-old would have a higher allocation in investments with inherently less risk.
Every individual’s asset allocation varies based on their risk profile and personal circumstances. So even investors that are retired can justify having a sizable portion of their portfolio in stocks.Fortunately, it is fairly easy to build a portfolio for individuals that are more risk averse through the use of index funds. In fact, index funds allow investors to gain access to a wide range of assets that are more suited to retirees. This includes government bonds, high interest savings accounts and even investment grade corporate bonds. These are known as income generating assets and typically provide investors a source of income on a periodic basis. This additional source of income can be particularly helpful to retirees in meeting their regular living expenses.
