Understand the Basics of Investing for Retirement to Save More

Know the basics of investing for retirement to maintain the right mindset for making investment decisions

If you’re heading into retirement and are short of money, you should move your investing in the direction of safer, more conservative investments. That’s a far better option than taking one last gamble.

The basics of investing for retirement involves understanding what you want from retirement  while you’re still working. Our best retirement planning advice is to invest early and often—and don’t forget to use our three-part Successful Investor philosophy: (1) Invest mainly in well-established companies; (2) Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; and Utilities); (3) Downplay or avoid stocks in the broker/media limelight.


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Understand what you can live without as one of the basics of investing for retirement

One thing we encourage all investors to do is perform a detailed study of how you spend your money now. Then, you analyze your findings to see what personal expenses you can cut or eliminate. This too can have fringe benefits, especially if it helps you break unhealthy habits. You may be surprised at how much you’re spending and how much more you could be saving for retirement.

For instance, cutting out fast food can save the average Canadian anywhere from hundreds to thousands of dollars a year. In retirement, you’ll have time for a cooking class or two, and soon you’ll be able to cook better-tasting and healthier food than you can buy at any fast-food chain. The cost difference between home cooking and fast food can be substantial, and it’s like tax-free income.

Use conservative estimates as one of the basics of investing for retirement and you will be better positioned to live comfortably

As for the return you expect from investing for retirement, it’s best to aim low. If you invest in bonds, assume you will earn the current yield; don’t assume you can make money trading in bonds.

Over long periods, the total return on a well-diversified portfolio of high-quality stocks runs to as much as 10%, or around 7.5% after inflation. Aim lower in your retirement planning—5% a year, say—to allow for unforeseeable problems and setbacks.

Above all, it’s important to remember that while finances are important, the happiest retirees are those who stay busy. You can do that with travel, golf or sailing. But volunteering, or working part-time at something you enjoy, can work just as well.

Figuring out the basics of investing for retirement involves a mix of calculations and predictions to make the right choices

It’s hard to figure out how much money you will have accumulated when you retire, and how much you’ll need.

Even the most-seasoned expert can only estimate your investment income. It depends on how much and how long you save, your investment returns, RRSP/RRIF rules and so on. And since you may only have a general idea of what you’ll do when you retire, you don’t really know how much you’ll spend. A conservative estimate is more realistic than one that counts on too many optimistic projections.

Let’s say you’re 50 and you want to retire at 65. You have $200,000 in your RRSP, and expect to add $15,000 to it in each of the next 15 years. To determine if this is enough to retire on, you need to make assumptions about investment returns and income needs.

Long-term studies show that the stock market as a whole generally produces total pre-tax annual returns of 8% to 10%, or around 6% after inflation. To illustrate, let’s assume a 6% yearly return, and disregard inflation. Your $200,000 grows to $479,312*, and your yearly $15,000 RRSP contributions add up to $370,088, for total retirement savings of $849,400. (*Be sure to check your figures. There are many compound-return calculators available online.)

If you continue to earn 6% a year, and you withdraw $50,964 a year (6% of the $849,400 in your RRSP at age 65), you can avoid dipping into capital until your mid-70s, when RRIF rules require larger withdrawals.

However, if you start taking money out faster, or earn lower returns, you may live long enough to run out of money. If you withdraw $90,000 a year while earning 6%, the money you’ve accumulated will last just over 13 years. If you earn 5% but withdraw $90,000 a year, your money will run out in just over 12 years.

Focus on long-term savings so you can enjoy a safer, happier retirement

The best retirement plan you can have is to start saving as early in your working career as possible. You then invest a steady or rising amount of that money in the stock market every year. When you follow this plan, you automatically profit from dollar-cost averaging. You will automatically buy more shares when prices are low, and fewer shares when prices are high.

How much of a role are you expecting Canada’s CPP benefits to play in your retirement income?

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