To gain insights on how our financial priorities change from early adulthood through retirement, we spoke with Jeffrey Hunter, Wealth Strategist, with TD Wealth®.
Start out strong
Typically, when you’re just starting out, you don’t have a lot of income, but you do have a lot of time. It would be wise to use some of that extra time to start developing strong financial habits that will benefit you the rest of your life.
- Track your income and expenses to understand your spending habits.
- Create a budget that you can stick with and follow it.
- Establish credit and monitor your score.
- Establish a cash reserve for emergencies.
- Avoid building up high interest credit card debt.
- Start making investments for your future.
Although retirement may seem like a lifetime away, it's important to start saving early to take advantage of the power of compounding. When you're in your 20's, a little bit of savings can go a really long way:
For example, let's assume you stash away $5,000 at age 25 and that you earn a compound annual return of 7.5% for the next 40 years until you retire at the age of 65. Your initial $5,000 investment would grow to approximately $90,000 (18x your initial investment). Now instead, let's assume that you delay investing the $5,000 until age 40. If we assume that same 7.5% annual growth rate, you would have approximately $30,500 when you turn 65 (only 6x your initial investment and approximately $60,000 less as a result of this 15 year delay).
When you're young, time is absolutely your greatest asset when it comes to investing. If your company offers a retirement plan, get set up right away and contribute as much as you can afford, but at least up to the amount needed to take full advantage of any free company matching funds. A good initial target for saving in your 20's would be 10% to 15% of your income.
Build for the future and keep the momentum going
As people advance in their careers and start families, their financial priorities shift and a new set of opportunities and challenges are presented. Generally, you go from having little money and lots of time in your 20s to having more money and much less time in your 30s.
Assuming you now have a bigger paycheck, it's important to consider beefing up your savings as well. Just as the other areas of your financial life continue to mature, you want to make sure that your savings follows suit. If possible, you should now be working towards a goal of saving 15% to 20% of your income. If this feels like too big a jump, you can begin by making small incremental adjustments to your savings (i.e., an additional 1-2% each year). These smaller adjustments will likely go unnoticed, but they can have a dramatic impact on your retirement savings in the decades to come.
This is also a time when you want to be very mindful of lifestyle creep. By the time you reach your 30s, you've likely been grinding away at work for the past several years so it's completely understandable that you may want to elevate your lifestyle a bit. And, while there's nothing inherently wrong with improving your quality of life as your income increases, you just want to make sure that you're also increasing your investment contributions and that you're not living beyond your means or taking on any unnecessary debt.
If you're married or started a family, you should also consider purchasing some life and disability insurance in order to protect your family's financial future. This is also a suitable time to start thinking about and putting in place a basic estate plan, especially if you have children. This will ensure that your loved ones are taken care of if something unexpected were to happen to you.
Assuming you spent your most of your 20s and 30s getting your finances in order and building a strong financial foundation, planning in your 40s should be somewhat easier because you just need to keep doing what you've already been doing…keep investing and keep building your wealth. The main goal here should be to just stay on track.
The home stretch
By the time people reach their 50's, they are often in their prime earning years. In addition, their children may be wrapping up college and becoming more financially independent. This combination of peak earnings and lower family expenses, makes it an ideal time to consider maxing out your retirement savings by taking advantage of catch-up contributions. These are extra retirement account contributions that people over age 50 can make ($7,500 for many employer retirement plans and $1,000 for IRAs). Another good use for some of these extra dollars is to allocate them toward reducing any of your remaining debt. This reduction in debt will further boost your chances of achieving your desired lifestyle in retirement.
This is also a good time to assess whether you're on track towards meeting your retirement goals, especially if your aspiration is to walk away from the workforce and a paycheck sometime in your 60s. This will entail running some detailed long-term projections to determine if your current nest egg is sufficient to support your vision of an ideal retirement. This analysis will also alert you to any adjustments that may be needed to your plan. After all, the last thing you want to do is jump into retirement only to find out that there's a financial gap, which forces you to go back to work.
One of the most significant expenses that people encounter during retirement relates to their healthcare. Your pre-retirement years are the right time to start educating yourself about some of these healthcare costs and your various options under Medicare. It's also a good time to familiarize yourself with the projected costs and the probability of needing some type of long-term care services in the future. That way, you can make an informed decision on whether you want to insure yourself against some of these expenses by purchasing a long-term care policy. Your mid-50s is typically an opportune time to consider long-term care insurance because the premiums for these policies tend to increase significantly beginning around age 60 and they continue to rise sharply with each passing year.
Transition to sustainable spending while preserving capital
Once you reach retirement, it's really important to reassess your financial goals and adjust your investment strategy accordingly. While you were previously focused on growing your nest egg, your focus now shifts to living off of that nest egg and it's going to need to support you throughout your retirement.
Many retirees decide to shift their portfolio allocation towards more conservative income-oriented investments, like bonds, to provide additional stability and a predictable stream of income. However, you don't want to lose sight of the fact that your retirement may last another 30 plus years, so you also want to retain some growth-oriented investments as well to safeguard against the escalating costs caused by inflation. One of the keys to a successful retirement investment strategy revolves around striking that appropriate balance between conservative lower-growth and riskier higher-growth investments.
One popular strategy among retirees involves the concept of "bucketing" your portfolio. For example, you could allocate a portion of your portfolio to be more conservative and that would be the bucket you draw down first to meet any cash flow needs over your first 3-5 years of retirement. You can then allocate another portion of your portfolio with long-term growth in mind for your later retirement years or for leaving a legacy to future generations.
Some other important financial priorities at this stage include:
- Dusting off your budget and refining it to reflect your retirement lifestyle.
- Running projections to test the long-term sustainability of your withdrawal strategy.
- Developing an optimal claiming strategy for Social Security
- Signing up for Medicare and deciding which parts to choose (A, B, C, D) and your supplemental coverage options.
- Revisiting your estate planning and legacy goals
For more on personal finance topics
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