How Much Money should I Save for Retirement?
This million-dollar question rings in the minds of everyone who works for a living, whether they’re just starting off in their career, are reaching mid-life or thinking seriously in the twilight of their professional life about the golden years right around the corner.
How much money do I need to save in order to retire comfortably?
There is actually no standard answer to this question, as lifestyle requirements vary greatly from one individual to another. What is critical, however, is that you have a savings plan mapped out already in the early days of your working life, to ensure that you will have the money you personally need to retire when the day comes.
Figuring out what level of savings you need in order to retire is not an easy task. While financial planners provide guidelines, each of us is responsible for creating our own strategy based on how much we can afford to contribute to a retirement – without pinching ourselves too hard in the process.
You should continually be asking yourself questions like: When do I want to retire? How much do I expect from Social Security? How much will I get in return when saving at the current rate? Asking and answering these questions should give you an idea of where to start and provide you with a blueprint of where you’ll be going.
There is no way of telling the direction that interest rates or inflation will go, but the magic of compound interest will always increase your savings.
When you save on a retirement benefits scheme, the interest rate is calculated using the compound interest formula. Compound interest is the most important reason why you should start saving early for retirement.
Through compounding, accrued interest grows exponentially and adds to your principal every year. Let’s start with an example to give you an idea of how it works:
Suppose you deposit $ 1,000 in a fund that earns 3% interest on an annual basis.
At the end of Year 1, your investment has grown to $ 1030. In effect, it has increased by $ 30 (3% x 1,000).
During Year 2, your investment growth will be calculated with the opening figure as the principal: 3% x 1,030=$ 30.90 which is a bit more than it was at the end of Year 1.
If you fast forward to Year 39, your money will have grown to $ 3,167. By Year 40, the investment will have grown to $ 3,264. Notice the interest growth of $ 95 in just one year’s time.
That’s the magic of compound interest and the reason behind the importance of starting to save early. The sooner you start saving, the better. When you start saving early, you can even afford to put aside smaller contributions over more time since compound interest will be on your side.
What Percentage of Your Salary should You Save?
Most advisors recommend that regularly saving between 10-20% of your salary is sufficient to build the nest egg you need. However, before setting up your contribution rate you should ask yourself the following questions:
- Do you have pending education expenses?
- Do you intend to take a mortgage or stay in the same house?
- Will you be contributing to charity or caring for elderly in the future?
- Do you have any medical condition that might necessitate more medical expenditures in the future?
- How much money do you want to leave behind to family when you die?
Your answers to these questions will affect your future cash flow. If not addressed correctly early on, you could find yourself making an unwanted early withdrawal of retirement money or otherwise squeezing the percentage of your contribution.
One easy way to determine your range of contribution is by using an online retirement calculator. This will show you worst-case, average and best-case scenarios using different contribution rates. You can also apply these online calculators to determine how saving less or more will affect your results.
If you are uncomfortable with the worst-case scenario, you can increase the contribution rate to see what that result looks like.
Adjusting the contribution by even a small amount can have a tremendous effect due to the compound interest result. For instance, if you’ve saved $ 1,000 and you opt to increase the amount of contribution from $ 500 to $ 1000 for each of the next 25 years, you will have saved almost $ 350,000 by the end of Year 25, assuming 6% interest compounded monthly.
The bottom line is to adopt a strategy that you are comfortable with and then invest in a tax-free retirement scheme.
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