Become a better investor
Lesson in Course: Finance at work (beginner, 5min )
We want to retire one day, but where do we begin today?
Our first step to saving for retirement is to define what we want our retirement to be. It will give context to our decisions about accounts, strategies, and investments later. We can get started by asking ourselves a few questions.
The best way to prepare for retirement is to start saving early and often.
Even with small amounts, starting early and being consistent with adding to our account can build up sizable portfolios over time because of compounding. The lesson about compounding returns shows how significant waiting 5 years can be for young investors.
Every account starts with $0 until we put money in it. We don't need to have any prior retirement savings to start contributing.
As a ballpark example, investing about $250 each month in the US stock market for 30 years could grow our retirement account to over $500,000 -- assuming we start with nothing and our investments grow at 10% each year, the long-term average of the S&P 500.
Many employers offer retirement plan matches where they contribute to our retirement plans when we do. If we can, we should put away enough to get at least all of our employer match each month. Otherwise, we'd be leaving free money on the table.
The amount we need to save depends on our lifestyle during retirement and roughly how long we will need our savings to last.
Having an expensive lifestyle or a longer retirement will require more savings and taking on riskier investments to seek greater returns. Otherwise, if we plan to work for a longer time and prefer to live more modestly, our contributions and investment decisions can reflect that.
The amount of time we have until we retire is known as our time horizon, and it plays a significant role in determining the appropriate strategies and investments.
For example, we can take on more risk if retirement is further away because we have more time to recover if our investments don't perform well, especially during economic downturns. As we get closer to retirement, we want to switch to lower-risk investments because we don't want the value in our account to drop right before we need the money.
On any given day, our investments could be up or down. Riskier investments are like bigger rollercoasters, capable of rising or falling faster and further.
Our risk tolerance tells us how much risk we are comfortable with - too much will make us feel nervous, while too little can cause us to miss our retirement goals.
We can create an investor profile based on our time horizon and risk tolerance. Then, we can use it to make informed decisions about which investments and strategies will help us reach our retirement goals. We can find questionnaires online to guide us through this process.
Let's carefully think about how we would answer these questions when saving for retirement. However, our answers can and should change over time, so your investment choices will change accordingly. Re-evaluating each year, at least when a significant life event occurs, helps keep our investments aligned with our goals.
If we need more help, we can learn a practical framework from the lesson about creating investment goals.