I had a great question from a young client the other day. While the question itself seems simple enough, the answer is far from easy.
The client in question is a young professional in her late twenties who is embarking on an exciting career. We talked about her existing portfolio, and where she could best invest her money for long-term growth. She was very clear about her interest in ethical investing, and her desire to make sure her money goes in the same direction as her principles.
But what was much less clear to her was how much she should be putting away each month at this stage of her life, to make sure she’ll be ready to meet all her career, life and retirement goals?
The answer, of course, is that it depends. First, her life is probably going to change a lot over the next few years. There could be a house purchase one day. Major moves to consider. Maybe a few kids to raise. And at the end of what’s promising to be a successful career, there’s her retirement to plan for, which these days could last for nearly as long as her entire working life.
For better or worse, long gone are the days when you could just check into a job in your early twenties, and 35 years later, a grateful employer hands you a gold watch and your first pension check. Today, most professionals will change jobs or even careers several times in their lives. Along the way, many of the companies that employ them will also likely fold, merge, downsize or change direction.
All of which means that, when it comes to planning and saving for retirement, most of the heavy lifting is now pretty much up to each of us. Of course, few 20- and 30-year-olds are all that worried about their retirement. With so many more urgent fish to fry, retirement can seem like a distant dot on the horizon, and most young people feel that planning for it can wait for another day.
In fact, waiting to start thinking about retirement is just about the worst financial decision anyone can make. The distance between you at 30 and your retirement at 65 (or later) is the single biggest financial advantage any young person has. Why? Because of the miracle of compound interest.
As Albert Einstein reputedly said: “compound interest is the eighth wonder of the world.” Young people who are able to start saving money in their twenties or thirties are uniquely poised to take full advantage of this wonder and reap the benefits as the passage of time grows their wealth exponentially.
So it’s clear that getting started early is key to a successful savings plan. But back to the question of how much? The standard answer is to always save 10 per cent of your income. But the problem with relying on these kinds of rules of thumb is that other priorities will inevitably come along that can relieve you of a big chunk of all those accumulated savings right when you least expect it.
Buying a house, taking a year off to travel around the world, or even just paying for your kids’ hockey practice or private school can all bring even the most committed savings plan screeching to a halt. And while putting all your savings into a house is surely building a nice asset, you’ll still need to have enough money put aside to enjoy living in that house when you retire.
Becoming a lifetime saver is the best way I know to get you there. Fortunately, developing the habit of being a lifetime saver doesn’t have to be complicated. While they may not be handing out quite as many gold watches these days, many employers offer retirement savings plans that have some sort of a matching component. So why not start by grabbing the lowest-hanging fruit?
If your employer has a group RRSP where they’ll match your contributions for up to three per cent of your salary, for example, then all you have to do is set aside seven per cent of every paycheck and you’ll already be at your 10 per cent savings goal. If your company doesn’t offer a group RRSP, you can set up a payroll or automatic bank withdrawal equal to 10 per cent of your monthly income. That way, if your pay goes up, your 10 per cent savings rate stays the same, but your total monthly dollar contributions will automatically increase as well.
To put some extra accelerant in your plan, invest those savings in an RRSP first, to make sure you qualify for that big tax break every April. And if you need to borrow some money from that RRSP one day to buy your first house, try to keep saving that same 10 per cent a month while you pay back the RRSP loan.
Thanks to the power of compounding, over time, the 10 per cent rule will almost certainly yield some pretty impressive results. But to really work, it needs to be a true habit, that you treat as something almost sacred. And whenever unexpected bumps in the road take you off the 10 per cent savings track (as they inevitably will), don’t beat yourself up about it. Just take care of whatever it is that life is throwing at you, and then get back on track as quickly as possible.
This article is supplied by Alan MacDonald, an investment advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund.
