8 Principles of Preparing for Retirement – Part 1 - Rodgers & Associates

8 Principles of Preparing for Retirement – Part 1

8 Principles of preparing for retirement – Part 1

I am often asked how young people should prepare for their retirement. Consid­ering the financial challenges to Social Security and the demise of pensions, what should a person be doing early in their career to make sure they can retire one day? My response to this question is that retirement should not be the goal. The goal should be to become finan­cially independent so that you can do whatever you want without financial restraints. Many of us would choose to work even if we didn’t have to because we like our jobs. I think a key to healthy living is having a purpose in life and many people find their purpose through work. Therefore the financial challenge to young people should be to reach the point where they no longer have to work – financial indepen­dence.

This week’s newsletter is the first of three parts dedicated to laying out the eight principles for reaching financial indepen­dence. Memorize them and share them with your family and friends. Too many people go through life stumbling around finan­cially hoping that one day they’ll win the lottery. Financial indepen­dence does not come by happen­stance. It is within everyone’s reach if they learn these principles and apply them to their daily life.

Principle 1: Always live below your means.

Many financial advisers say that you should always “Pay yourself first” which places a priority of savings. I think the impor­tance of this principle is deeper than just accumu­lating savings. It is about controlling your spending. It doesn’t matter how much money you have, if you can’t control your spending you will never be finan­cially independent. The US Government took in $2.3 trillion of income in the last fiscal year but spent $3.6 trillion. The government doesn’t have an income problem they have a spending problem.

Your savings will include the money you put into your 401(k) plan or other company sponsored plan. However, you should pay close attention to your after-tax savings. Build up a cash reserve for emergencies and keep saving to fund tradi­tional IRAs or Roth IRAs. Invest regularly into mutual funds through deduc­tions from your bank account, or if your employer offers it, deduc­tions directly from your paychecks. Automatic investment plans are an easy way to stick with a retirement investing program because the money is invested before it can get spent on anything else.

Principle 2: Time is your most important ally.

Start early and save regularly. George Clason’s classic “The Richest Man in Babylon” says that you want to accumulate an army of golden slaves who will tirelessly work for you. You start off life working for money. When you save early and regularly, your earnings will grow to the point that your money will be working to support you. When you give your money more time to accumulate, the potential earnings on your invest­ments — and the annual compounding of those earnings — can make a big difference in your final return and the timing of your financial indepen­dence.

A person that starts saving $200 per month at age 20 will have $1 million at age 65 assuming their savings grow at an average rate of 8% annually. If you wait until age 30 to start savings, you would need to save $460 per month to have $1 million at age 65 assuming the same rate of return. Procras­ti­nating until age 40 will require a monthly savings of $1,100 per month. This illus­trates how important time is to the success of your financial future.

Principle 3: Social Security is a safety net. Not a retirement plan.

I believe that Social Security will be around for future gener­a­tions. However, it will have to change from the system we know today to remain solvent. When Social Security became law in 1935, the average life expectancy was only 61.8 years. Half of working Americans were never expected to live long enough to collect their benefits. Today, life expectancy is approaching 80. A healthy 65 year old couple has a 25% chance that one of them will live to age 95. Social Security doesn’t have the resources to cover this longevity. Retirement age will need to be raised, benefits will have to be reduced, and the ability to collect benefits may need to be means tested.

Politi­cians will need to work out the solution and that may take some time. Those seeking financial indepen­dence should seek to do so without the aid of Social Security.

Rick’s Insights

  • Never spend every­thing you make. Your budget should be based on a maximum of 90% of your tax-home pay.
  • Time is the most important word in your investment vocab­ulary. Starting today beats waiting until tomorrow if financial indepen­dence is your goal.
  • Don’t count on Social Security for financial indepen­dence.

Continue reading: Part 2, Part 3