Retirement planning is a numbers game.
An evolving one that requires active participation to manage the many variables that exist.
Finding the right balance between them means making tradeoffs so it’s important that you make the best decisions you can with the information you have.
But, the good news is that success can be as simple as just knowing the things that matter so that your retirement is an event you can look forward to.
So, here are 6 critical elements to get right.
1. Making the most of your time
Time is the same for everyone in that we all age at the same rate; one day at a time.
As such, it can be your best friend or your worst enemy depending on how effectively you use it.
Time is a critical component for investing because it’s the element that facilitates compound interest and, the one thing compound interest needs to work, is time.
…and lots of it.
Once you know how many years you have left then you can easily work out the number of potential monthly contributions you have from today to accumulate your fund.
Since this is a definitive number it means that each month counts because;
- Tax relief is available each month.
- Tax free growth is available each month.
- Compounded returns are available each month.
Outside of the time factor, there are other elements to a plan and these elements need to reflect your individual circumstances because everyone has;
- Unique personal circumstances,
- Unique personal and financial goals,
- Varying degrees of debt and financial worries,
- Individual health concerns,
- Different financial means and assets,
The key takeaway here is that the cost of retirement funding doubles every 6 years so the more months you lose the more expensive it gets.
2. Your contribution frequency
Given the amount of cash needed to sustain a 25 year retirement you should seek to employ every possible advantage you can.
One of the ways you can do this is by increasing the frequency of your contributions – something the majority of self employed investors can improve on.
Most sole traders make one annual pension contribution each year. The problem with this is that they make one big purchase decision on an undetermined, random day.
The result of this is that the price they pay for their investment relies more on luck rather than deliberate, consistent investment behaviour.
And infrequent, inconsistent investing means that people tend to miss out on the fluctuating market prices to accumulate the volume of assets they need.
A simple way to take advantage of this is to change from making one large annual contribution to making 12 smaller, monthly contributions with the option of a discretionary contribution at the end of the tax year.
This increases the annual frequency from 1 random event to 13 sequential events and, once set in motion, can continue on automatically. It’s also a more cash-flow friendly approach.
This simple change can make a big difference over time.
For example, a self employed 40 year old could boost their total investment count from 28 all the way up to 364 by simply changing the mechanics of how they invest.
Buying 364 times rather than 28 times helps to mitigate the risks of consistently buying into the markets at the wrong time.
Luck and timing are not reliable components for long term investing.
3. Beating inflation
Inflation is the silent assassin of wealth.
It’s the single biggest threat to your future net worth because stagnant money gets massively devalued over time.
When harnessed for good, compounded returns can generate exponential growth for your assets. Compounded erosion, on the other hand, does the exact opposite and it’s every bit as powerful.
To illustrate a simple example, here is the effect of 2.5% inflation on €100,000 after;
- 1 year = €97,560
- 2 years = €95,181
- 5 years = €88,385
- 10 years = €78,119
- 20 years = €61,028
- 30 years = €47,674
- 40 years = €37,243
Simply put, if your investments aren’t growing, they’re losing.
This simple truth is the main reason why being too cautious with long term investments is a losing strategy. Inflation is unrelenting in its quest so your strategy should be built to fight it.
The inflation rate we assume is 2.5% so this should be your minimum expectation.
4. Risk versus reward
Risk is a central theme in Financial Services because risk and reward are intrinsically linked.
As such, your first point of contact into this world is in being assigned your own personal profile number. This is derived from a standardised set of 15 questions used to ‘grade’ your investment experience and tolerance for risk.
The industry standard is called ESMA (European Securities and Markets Authority) and you can be scaled from 1 (low tolerance) all the way up to 7 (high tolerance).
It’s not an exact science but it does give an indication as to the appropriate ballpark of investments you should be considering.
Once recorded, we can recommend a portfolio of investments designed to fit in with the range of long term returns most suited to your personality type.
And since the risk/reward ratio plays a significant role on long term returns, your profile number will have a significant influence on the fund size you end up with.
In the world of investing, there exists a vast range of options that cater to both ends of the consumer spectrum and everything else in the middle.
Some limit your exposure to risk whereas others are inherently built for growth. The difference lies in their potential so it’s important that you’re comfortable with the option you choose.
Ultimately, the tradeoff you have to make is between performance and security since you can’t have both at the same time. This means that your ideal choice strikes a balance between the level of returns you need and the level of risk you’re comfortable with.
But don’t be overly defensive, especially when you have a significant timeframe, because getting a long term average return of 5% means investing the majority of your money in equities.
5. The decisions you make
It is said that the two most influential factors on the final value of your pension will be;
- The charges you pay
- The decisions you make
Charges can impact the value of a pension fund but bad decisions can be very damaging, to such an extent that they can be hard to recover from.
Emotional decision making is very costly because the price of mistakes can be extremely high. This is where the value of a good advisor comes into play because they will be able to help you navigate tough decision by helping you focus on the fundamentals that matter.
6. The charges you pay
Nobody likes charges but you tend to get what you pay for in life.
…well, most of the time anyway.
The trouble is that many Irish investors pay relatively high charges on their plans without getting much value in return.
I have always found that the majority of investors are happy to pay additional management fees when they feel like they’re getting something extra in return.
Added value can come in the form of additional functionality, specialist management capabilities or the added value of a trusted advisor.
Paying extra should mean getting extra.
But, most people don’t really know where to start and tend to just assume that they’re ok. However, it’s always worth checking these things because the worst kind of problem is the one you don’t know you have. And the only way you can start fixing a problem like that is realising that you have it.
That’s why it’s always worth reviewing your existing pension plans.
Good decision making is an incredibly valuable skill because they directly influence the results you achieve. Good ones will add value to your investing where bad ones will do a lot of damage.
A good advisor can help guide you through the ones that you face and enlighten you to the issues you might not be aware of and the influential details that can make the difference.
And therein lies the value of advice.
Pensions Are Complicated. We’ve Made Them Simple.