When Should I Start Planning for Retirement? (Answer: Today)
You need to start planning for retirement today.
Every financial planner has one thing they want to tell young people. It applies to anyone who is earning any income, even young people. And, the advice is even more important for young women than men.
Start planning and saving now.
It doesn’t have to be a lot, but every dollar you save now, your future self will thank you for it. And this is because of compounding interest.
What is Compounding Interest?
This is when you make interest on interest on your original principal (your original savings amount). Money, makes money, makes money. It’s how you’ll get rich without really trying.
If you get a job at 18 years old, maybe you can afford to save $10 a week. Things are tight, but you prioritise your savings. Over a year, you save $520, which isn’t a lot, but it’s a good start. Over the next few years, you save more and more, and by the time you are 25, you have $10,000 which you put into a high interest savings account. And then, you forget about it.
After a year, you have $11,000, that original $10,000, plus the interest of $1,000. The next year, you’ll have $12,100, which is your principal, the interest from last year, and the interest on that amount. Leave that for 40 years- no need to contribute towards it at all- and you’ll have $452,000 by the time you’re 65.
How Much Do You Need to Retire in NZ?
This is not an easy question to answer, and it needs time, depth, and planning that’s specific to you. But, plucking a figure from the middle of nowhere, say you need $1,000,000 to retire, live to age 90, and have a comfortable lifestyle that allows travel, hobbies, and a few meals out every now and again.
KiwiSaver is fantastic, but it’s not enough. If you start saving at age 20, earn $70,000 annually, contribute 4% and your employer contributes 3%, with an aggressive investor profile, you’ll only have $602,000 by the time you retire.
You need voluntary savings too, for a house deposit, unexpected expenses, and retirement. And that’s why starting young, being consistent, and using compounding interest is vital.
Ella and Alice; the Grasshopper and the Ant (The Story of Compounding Interest)
There’s sensible Ella, who started her savings plan when she was 20, and Alice, who didn’t really understand money and only started saving when she was 30. While both are serious about retirement savings and have made great choices, Ella did a course at secondary school and learned about compounding interest- Alice didn’t.
Ella started investing when she was 21, after she got her first job following Uni. Over and above her 4% KiwiSaver, she decided she’d invest 6% of her income each month. This came to $4,200 a year. She did this for nine years, so that was $37,800, and by the end of the 9 years she already had $47,641. She threw that into a savings account, and forgot about it, and focused on mortgages and travelling and all that life stuff. With an interest rate of 5%, Ella has $274,121 by the time she retires.
Alice always did KiwiSaver because her mum said she had to. But at 30, she realised she didn’t have any savings, and KiwiSaver was simply not going to be enough. So, she started investing $4,200 a year from age 30, and contributed until she was 65. That’s $147,000 over 35 years of saving – $100,00 more than Ella. At age 65 Alice, with the same 5% interest rate has $402,512.
However, if they happened to find a higher rate of return, say 10%, Alice will have $1,256,322, and Ella – with no more contributions to her original $47,641, will have $1,338,828! The magic of compound interest will see Ella outperforming Alice.
The key is starting to save early, finding a great rate of interest, and then forgetting about it.
What About Debt?
Don’t get into bad debt, and if you are, get out of it as quickly as possible. Get rid of that 21% credit card debt as soon as possible.
What’s an Interest Rate and How Is It Calculated?
In a very simplistic sense, banks and lenders use your money to loan to others, they make interest on that loan, and then pay you a fraction of that. So they might charge 7% interest on a mortgage, and then pay you 2%.
Interest is calculated on a daily, weekly, or monthly basis, depending on the scheme you agree to. The rate can be fixed or variable, and this often depends on if you’ve signed up for a fixed deposit (higher and set rates, because banks like certainty of having access to your funds) or simply money sitting in a bank account.
The best way for you is daily interest, and at a higher rate of interest.
Typically, bank interest rates aren’t that high. If you want higher rates of returns, consider investing in a Managed Fund, where a professional will invest money on your behalf. Over the long term, you should be expecting five to ten percent growth, depend on market volatility.
Overwhelmed? Don’t Be.
Contact us at Smart Adviser. We can help you make a plan to get out of debt, prepare KiwiSaver, start saving for a mortgage or retirement, or anything else financial. We can provide you with all the information you need to make great choices about your money.
