Four steps to a secure retirement
08 May 2018 | Topical insights
Commentary by Colleen Jaconetti, senior investment analyst with Vanguard Investment Strategy Group.
An investor who works and saves from age 18 to age 63 will spend about 45 years preparing for a retirement that spans about half as long – around 22 years.1 Personal circumstances will determine whether he or she remains in the workforce (and continues saving) longer.
Either way, investors have to make the most of the time they have. Here are four steps, broken down into simple tasks investors may want to consider:
1. Save … early and often.
Start early. Time is money. Thanks to compounding, the value of an investment can increase over time when earnings generate interest and capital appreciation.
Increase your savings each year. Increasing the percentage of income an investor saves by one percentage point each year and earmarking a certain portion of every pay rise or bonus for retirement can add up to big savings over time. Work towards saving a total of 10%–15% of your annual income (including any contributions from your employer or other sources) for retirement during the working years.
Pay yourself first. Automate savings through paycheque deduction or automatic contribution. Once enroled, an investor won't have to think about saving again until it's time to increase the saving amount.
Take advantage of any matching money. For example, if an employer offers to match a percentage of employees' contributions to a retirement account, deposit at least enough to get the full amount offered. After all, the match is a 100% immediate return on the investment.
2. Use a portfolio of diversified investments to create a balanced foundation.
Start with your asset allocation. Choose the asset allocation before selecting any specific investments. Vanguard research shows that most of a portfolio's long-term return can be attributed to its asset allocation.2
Be diverse. All investing is subject to risk. The value of investments (and the income from them) may fall or rise, and investors may get back less less than they invested. But by investing in a diversified fund or exchange-traded fund (ETF) – rather than individual stock shares, for example – investors can avoid the risk of losing everything if a specific company or sector goes under. Owning just one share of a fund or ETF provides exposure to all of that fund's underlying investments, which makes it easy to build a broadly diversified portfolio.
Invest globally. International markets don't always rise and fall in concert, so investing in international mutual funds and ETFs is another way to diversify a portfolio and lower risk.
3. Rebalance to stay on track.
Stick to your target asset allocation. When the current asset mix strays from its original target, the investor may be subject to a level of risk – either too much or too little – that doesn't align with his or her long-term goals. To stay on track, review the account once or twice a year and rebalance when the asset allocation differs from the target by 5% or more.
Follow a glide path. It's important to stick to the target asset allocation. But it's also important to revisit that allocation and make necessary adjustments over time – especially as the investor's goals, time frame or risk tolerance change. In the years leading to retirement, consider gradually making the portfolio more conservative by increasing the allocation to fixed interest.
Tune out the noise. No one can accurately anticipate what the markets will do next. There's no guarantee that the shares and bonds chosen will perform better than the market. In fact, they might perform worse, so you could receive a return lower than that of the market. My approach? Stick to the plan.
4. Control costs and pay attention to taxes.
Choose low-cost investments. Investment costs can add up over time and eat into returns. Say you make a one-time investment of £10,000 in two funds. Both funds have a 6% average annual return (hypothetical), but 'Fund A' has a 1.0% ongoing charges figure (OCF) and 'Fund B' has a 0.30% OCF. In ten years, the balance in Fund A would be £16,196 and the balance in Fund B would be £17,378. That's a difference of more than £1,000, attributable entirely to investment charges.3
Be tax-efficient. The government created Individual Savings Accounts (ISAs) to encourage tax-efficient saving (up to £20,000 per year). In a stocks-and-shares ISA the investor will not pay any income tax or capital gains tax (CGT) on returns from the investment. What's more, you don't have to declare ISA investments on a tax return.
CGT is charged on profits when certain assets, including funds and ETFs, are sold or transferred.4 Everyone, including children, has an annual CGT exemption, which is £11,700 (£23,400 for married couples and civil partners) in the 2018–19 tax year.
Food for thought
Retirement, like eating, is part of life. Some days I don't have a clear plan for what I want to cook for my family, don't have time to prepare, or I'm distracted by other responsibilities.
Thanks to takeaway, there will still be food on the table even if meal planning falls by the wayside for a night or two. Unfortunately, there's no substitute for retirement savings if we don't make saving a priority throughout our working years.
We all have a finite amount of time to prep for retirement. We should make the most of it.
Thanks to my colleague Steve Weber for his contributions to this blog.
1 For example, according to data from the US Social Security Administration, a man who reaches age 65 today can expect to live, on average, until almost age 85. Under the same circumstances, a woman can expect to live until just over age 86½.
2 Source: Brian J. Scott, James Balsamo, Kelly N. McShane, and Christos Tasopoulos, 2017. The global case for strategic asset allocation and an examination of home bias. Valley Forge, Pennsylvania: The Vanguard Group.
3 These hypothetical examples do not represent the returns from any particular investments.
4 You can transfer to a spouse or civil partner without incurring CGT.
Investment risk information:
Past performance is not a reliable indicator of future results.
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Other important information:
This document is designed for use by, and is directed only at persons resident in the UK.
The opinions expressed in this article are those of the individual author and may not be representative of Vanguard Asset Management, Limited.
Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.
This article was produced by The Vanguard Group, Inc. It is not a recommendation or solicitation to buy or sell investments.