Retiring is a scary word and if you are worried about whether you will have enough money for your retirement you are not alone, The majority of Americans out there think the only way they will have enough money to retire is by winning the lottery. There is good news though, if you want to save enough to meet your retirement needs you can realize it but you need to think beyond the simple IRA or 401(k) that you have been paying into religiously. Even if you don’t have any money saved at this particular moment in time you can start to take advantage of compounding interest. Before I can explain the benefits of compounding your investments I need to explain the impact that both inflation and taxes provide. The primary benefits of an IRA and 401(k) is being able to let your investments grow tax deferred until you take the money out at retirement time but what is the greatest cause for concern is inflation.
What In Inflation And What Does It Have To Do With Me?
Do you remember when you were a child and you could buy something with a $1 and actually have change left over ? What can you buy today for a $1 and more importantly will you have any change left over? This is a result of inflation which is a hidden tax that everyone pays without their knowledge or consent. The government did not pass some law behind your back but the reason our money has less value is do to poor fiscal policy. Open your wallet and look inside right now, that paper we call money is only worth something because we can trade it for products, services and to pay taxes, there is no actual value in the money itself.
Don’t worry I am not going to bore you with some lesson on economics but let me use an example we can all relate to. At the end of the month the federal government gets all of its bills and has to pay them but the way the government pays these bills is with the tax revenue generated by the sales and labor performed by Americans. When the government realizes it owe more money than it is taking in what will it do ? It cannot miss a payment since defaulting will have a profound impact on the global economy, If the Americans can’t pay then who can we trust will be running through the mind of investors. Imagine if Uncle Sam can’t pay the bills we would have economic anarchy!
So what does the government do when it has more debts than cash ? It does what we do they take out their credit card to pay for things. The government doesn’t have a physical credit card but they can borrow money from creditors at interest with treasury bills (T Bills) sold via the Federal Reserve. Countries like China and Japan buy them because they know the US Dollar is accepted all over the world. When the country borrows money at interest it has to pay it back, at least the interest and this is how the national debt starts. As the government borrows more and more money the money we have in our pockets loses value because there are more dollars in circulation and these dollars must be used to pay interest on the staggering national debt. Right now inflation is around 2-3% according to some analysts but others say it is higher, I will let you draw your own conclusions but here is the challenge in front of us.
In order to save enough for retirement you need to figure out how much money you will need to live every day but if our dollars are losing buying power it can be difficult to know how much is enough. What we need to do in a situation like this is look for ways to grow our money at a rate faster than inflation. If inflation is at 2% and your investment is giving you a 2% return then you have neither gained or lost anything but you are investing your money to gain in value not decrease so here is where things get interesting.
The Taxman Cometh Eventually
Death and taxes are certainties, when will you die I do not know but Uncle Sam will stick his hand into the casket before they get the last bits of dirt on you. When retirement time rolls around and you start taking money out of either your IRA or 401(k) then you will need to pay taxes on it but presuming you are in a lower tax bracket those costs will be manageable but you still need to account for potential future taxes. Some people are soo scared to pay taxes they will sabotage their own investments just to pay less but it is rather to pay 10% of something than keep 100% of nothing ! If you have sizable investments then you should speak with an estate planner but for the average person you should look for an investment that produces the rate of inflation plus five percent (Inflation+5%) to make a decent dent in your retirement savings goal so based on the current rate of inflation you are looking at 7% which is very conservative when we look at banks making over 20% on credit cards!
Selecting The Right Investment For Your Risk Appetite
First thing to get clear is there are no sure things in life and if you want a “risk free” investment it doesn’t exist. Even if you purchased T-bills you would be losing money, sure you will get the original amount investment back plus interest but the money will not have the same buying power so even if you try to “play it safe” you are losing.
What you need to do is look for investments that have manageable risk. I cannot tell you where to invest your money because that would be rude on my part to presume I know what is best for you. One of the more popular investments is real estate where you take out a mortgage (the interest is tax deductible) on a rental property. The money that is paid for rent can be stashed away in your retirement account tax deferred. Since you can write off expenses, depreciation and other costs of having a rental property it is one way to grow your investment. Since the rental property brings in cash on a monthly basis you have positive cash flow but there is another benefit, as time passes the property will appreciate in value so you could sell it for a profit or keep it during your retirement to bring additional income to help offset the costs of living.
Real estate is not for everyone and depending on where you live it can be a bad investment but as mentioned earlier it is one way to generate income for your family so it is something you need to seriously consider. Do not invest in things that have no documented income, some people get caught up in what I call investment hype, these individuals try to be “day traders” where they trade stocks inside their investment account on a daily basis hoping to make a profit. This is similar to playing roulette at a casino with similar odds of turning a profit, If you want your money to grow you need to follow advice from investors like Warren Buffett who invest for the long term.
Power Of Compounding
When you leave your money in an investment that is tax deferred you are earning money on your profits. No where else in life can you make money without doing extra work, to put it in context it is like a farmer plating 1 seed and getting 2 individual plants for it. As time progresses your investment is growing at 7%,10%,15% year on year you will have more money to enjoy your retirement but you have to start saving now.
There are some people who think that it is too late but even if you save 5% of your income you are saving something which is better than nothing. One great way to have a comfortable retirement is to get out of debt as soon as possible. Credit card debt is wreaking havoc on people and the sooner you can pay it off the better, since most of these credit cards are charging more than 20% interest you should focus the bulk of your money on these debts since there are no investments that will give you a 20% return on investment at least not the ones we would suggest you invest in.
Where Should I Start?
The fact you have read this far shows you are genuinely interested in your retirement savings so what you need to do is seek out a qualified investment advisor who can assess your particular needs and provide you with the right approach. A note of caution about who you turn to for retirement planning or investing advice. Find out whether the individual you are speaking with has actually helped other people reach their retirement goals. You may come across individuals who just finished their academic studies when it comes to investing but sadly the real world and academics are not the same.
Find out whether the retirement planner is registered with any peer review panels where they have received industry awards for results. Another important item to address is how these individuals earn their money. Some charge an upfront fee to provide advice while others take a commission whenever you buy a stock or investment. How these individuals are compensated will give you some really good insight into whether they are suitable or not. The last thing you should do is simply trust your “gut”. If something inside is telling you to not deal with that person then follow that instinct.
When it comes to retirement planning a little can go a long way, you don’t have to sacrifice the quality of your life now to have money for retirement it just takes planning and the rest will fall into place but you must take action now otherwise you lose out on the power of compounding.