R - Why Plan for Retirement? Lesson

Why Plan for Retirement?

While it is still many years in the future, it is never too early to start thinking about and educating yourself on the costs of retirement and various ways to fund your retirement. By considering options early and planning your savings strategy, you will be able to enjoy a retirement lifestyle that allows you to do the things you want to do. Learning about ways to save and how you can use the power of compounding interest to build wealth can lead to a retirement free from financial stress.

Retirement Basics

We spend years going to school and learning so we can obtain jobs to help us earn a good living. Many people take all of these steps in anticipation of retirement, when they no longer have to work and can spend each day doing the things they truly enjoy. Whether it is travel, being with family, or pursuing a hobby, retirement has traditionally been viewed as the time in life when people enjoy themselves without having to worry about working and earning income.

There is one catch to this scenario. Retirement can be very difficult if people do not begin planning for it very early in life. Once people retire they are expected to live off the money they have saved over the years. Most financial planners tell people to plan to save up to ten times the amount of their annual final salary in order to retire without having to make major changes to their lifestyle.

Retirement Basics

If the thought of trying to save thousands of dollars per year seems difficult, you need to remember that when we save money we earn interest on it. Many of the investments people select for retirement savings rely on compounding interest. The beauty of compounding interest comes from the fact that, over time, these investments grow significantly because investors are paid interest not just on the principal amount invested, but also on the interest they have already been paid. With compounding interest, it is important to pay attention to how frequently the interest is compounded. If it happens daily, you will earn the greatest amount of money. If the interest is compounded monthly, you will earn a little less. If the interest is compounded annually, you will earn even less.

Challenges of Saving For Retirement

Clearly, having a plan in place for how you will pay for retirement is important. There are a couple of challenges you must consider beyond that of how you can actually set aside enough money each year. One of the most important factors to consider is the amount of risk you are willing to take with your retirement investments. Generally speaking, investments that offer higher returns also reflect a greater level of risk of loss. For young investors just starting in the workforce, investment options with higher risks and potential earnings (such as stocks) can be considered because retirement is still years away, and if short-term losses occur, there is time to make them up. However, as one gets closer to retirement, the amount of risk on investments should be decreased. If great losses are suffered through events such as declines in the stock market, making up those losses gets increasingly more difficult as retirement age edges closer.

Besides risk, inflation also plays a role in the amount of money that needs to be saved for retirement. Ask retirees what a gallon of gas or a candy bar cost them when they were your age. In all likelihood, the amount of money you spend on these items today is much more than it was for the retirees. This is due to inflation. Costs typically increase over time. You have to take this into consideration when calculating your retirement needs. To understand the cost of inflation view the table below. It lists several items commonly used today. The column on the right shows its cost in 1960. Do you know how much it costs today? The increase in price is due to inflation.

Items	1960
One Gallon of Milk	$0.49
One Gallon of Gas	$0.31
One Stamp	$0.04
One Dozen Eggs	$0.57
One Movie Ticket	$0.75
House	$12,700

IMAGE SOURCE: TRADINGACADEMY.COM