Once you’ve built an emergency fund, and perhaps even while you are building it (I will get into more detail on that in a future post), it’s time to do something else with your extra money every month. Investing it.
Investing your money puts it to work for you to earn more money, which then also goes to work for you to earn even more money, and so on.
But investing can be incredibly daunting. There are many types of investments (stocks, bonds, property and other tangible assets), and within each category there are a multitude of options to choose from. There is a reason people get paid to invest your money for you. It can quickly become overwhelming for someone who’s just starting out. And making a mistake and investing in the wrong option can be costly.
I’m always an advocate for learning (I am, after all, an enormous nerd) and knowing what you’re getting yourself into, but for a long time, I had a hard time wrapping my brain around any type of investing, as analytical and math oriented as I may be. Investing money was never a focus in my family (at least not one that was ever talked about), and they don’t teach it in high school, so I grew up with almost zero knowledge about it. As I got older, when I would hear people talk about things like bonds, dividends, or mutual funds, it was like they were speaking a foreign language.
Fortunately for me (and you), the internet has a vast amount of information, presented in a multitude of ways, so it’s become easier for me to learn (which I’m still doing). I suggest at least attempting to learn about your options to better choose what fits for you.
The first thing you need to do is ask yourself some questions to determine what kind of investor you want to be or are comfortable being.
- What is your primary goal right now? Eventual retirement? Early retirement? Are you merely looking for financial security or do you want financial independence?
- When do you plan to retire?
- How much money do you need to retire? Will your housing expenses go down because you’ve paid off your house? Are you planning on doing a lot of traveling? Don’t forget to account for medical costs (the average medical expenses of retired Americans are conservatively estimated to be between $140,000 and $155,000). Do you want to leave an inheritance behind?
- How much do you need to invest each month and what kind of return do you need to get on your investment in order to reach your goal?
- Do you want to make all the decisions about how your money is invested, or do you want to tell someone your goal and have them make the decisions for you?
- How much of a risk taker are you? Can you handle volatile swings in your accounts, or would you prefer slower, steadier growth?
- What is the best type of retirement fund for you, and what do you qualify for? 401K? Traditions IRA? Roth IRA?
- What is the best kind of non-retirement investment for you?
Since there is so much to investing, I’m going to do series of posts about it to try to help you answer the questions above. For the rest of this post, let’s focus on how much you need to retire, and how much you need to invest.
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There are some general rule-of-thumb suggestions for how much you should have when you retire, and to gauge whether you are on track to hit that goal. They basically boil down to, at age X you need to have Y times the number of your current yearly salary saved/invested. These are the suggestions (depending on which expert you listen to, and how far into that decade you are):
|Age||Yearly Salary Saved/Invested|
|30s||1/2 – 3|
|40s||2 – 5|
|50s||5 – 7|
|60s||7 – 9|
If you fall short of these suggestions, you’re in the majority. There are millions of Americans with no retirement savings at all, and most Americans who do have retirement savings are generally well below the figures above. The good news, is it’s never too late to start. But starting later means you need to invest more per month to reach the same goal.
There is another method for figuring out how much you need to have saved for retirement based on your annual spending, not your annual income. With this method, living frugally now and in retirement has added benefits later in your life. The less you spend each month, the more you save towards retirement, and the more you will have in retirement, but you will also need less.
To use this method to figure out how much you should have saved for retirement, divide what you expect your yearly spending to be by 0.04.* Let’s say your currently household expenses (not including saving) are $4,000 a month, but you plan on having your house paid off before retirement, bringing your monthly spend down to $3,000. That means you’ll need $36,000 a year (plus taxes, depending on where your money is coming from). $36,000 divided by 4% is $900,000, and to be safe, let’s add in another $150,000 for medical expenses, which brings us to $1,050,000 (it may sound like a huge amount of money, but I promise it is attainable).
Whichever method you choose to use to determine your retirement savings goal, you will then need to figure out how much to save each month. Some experts suggest putting between 10-15% of your income each month towards your retirement. But those numbers can vary significantly depending on your age and how much you already have invested. The younger you start, the less you have to invest each month, thanks to compound interest.
Everyone’s numbers are different, and it’s a lot of math, and as much as I love spreadsheets, I love a good calculator almost as much. So, please allow me to introduce you to our very own Basic Investment Calculator. We also have an Investment Goal Calculator which will allow you to enter your goal and figure out exactly how to reach it. Using how much you already have saved toward that goal, your expected rate of return and how long you will be saving it will let you know how much needs to be set aside each month. While the rate of return can be anything you choose 6% is typically a good conservative estimate, based on the past performance of the market.
Don’t get discouraged if you’re starting late and/or the numbers are intimidatingly large. Start anyway. Even if you can’t hit the amount you’ve calculated you need, start now. Putting away $10 a week is better than nothing, and you can increase it over time as you increase you income or decrease your spending (we’ll have some posts coming up with suggestions on ways to cut your spending). And starting as early as possible will allow that compound interest to earn you as much money as possible.
*Why 0.04, or 4%? It’s based on a bunch of math people did to determine that over a 65 year period, 4% is the maximum amount you can withdraw safely (meaning, you won’t run out of money over a 30 year retirement period) to survive even the worst-case scenario over that period of time.