These methods have stood the test of time.
Being able to retire after decades of working is a good thing. Being able to retire financially comfortable and not worrying about outliving your savings is even better. For long-term investors, the goal throughout your career should be to make sure you’re investing so you can be part of those who can do the latter.
There’s no one-size-fits-all investing strategy, but there are strategies that have stood the test of time and are proven to help investors prepare for retirement. Here are three of them.
1. Starting as early as possible
Time is an investor’s best friend. Compound earnings — which is when the interest on your investments begins to earn interest on itself — is by far the greatest wealth creation tool in the stock market. And the more time you have, the more it can work its magic.
Many people will need at least $1 million to retire comfortably and not outlive their savings. Getting to $1 million is all but impossible by strictly saving for most people, but thanks to compound earnings, it’s achievable for those with time on their side. Assuming you retire at age 65, here’s how much you could have accumulated at different starting ages by investing $500 monthly and receiving 10% average annual returns:
| STARTING AGE | YEARS UNTIL 65 | PERSONALLY INVESTED | AMOUNT ACCUMULATED |
|---|---|---|---|
| 35 | 30 | $180,000 | $986,964 |
| 45 | 20 | $120,000 | $343,650 |
| 55 | 10 | $60,000 | $95,624 |
DATA SOURCE: AUTHOR CALCULATIONS.
As you can see, the more time you give yourself, the greater the difference becomes between your personal contributions and account total. Even the smallest of investments can make a big impact if you give yourself enough time. There are no guarantees in the stock market, but consistent investments over time is a tried-and-true method of building wealth and getting financially prepared for retirement.
2. Taking advantage of IRAs
If you’re going to be saving and investing for retirement (which you absolutely should be), you might as well take advantage of retirement accounts and get tax breaks along the way. A 401(k) is the most popular retirement account because it’s offered through employers, but it’s not the only retirement account available. Both Roth and traditional IRAs can be great sources of retirement income.
Unlike a 401(k), IRAs aren’t offered through employers and must be opened on your own, similar to a bank or brokerage account. The main difference between the two types is when you get your tax break. You contribute after-tax money into a Roth IRA and can take tax-free withdrawals in retirement. Although you technically contribute after-tax money into a traditional IRA, there’s a chance you can deduct your contributions.
The contribution limit for IRAs in 2022, both Roth and traditional combined, is $6,000 ($7,000 if you’re 50 or older). Due to their relatively low contribution limit, IRAs likely won’t be your primary source of retirement income, but they can play a significant role. Since IRAs operate like brokerage accounts in that you can invest in any stock you want, investors should maximize their contributions first — taking advantage of the potential tax breaks — before making the same investments in a regular brokerage account.
3. Reinvesting dividends until you reach retirement
For many investors, dividends make up a good portion of their total returns — especially when they’re reinvested. In fact, from 1960 to 2021, reinvested dividends accounted for 84% of the S&P 500‘s total return. Receiving any dividend is good, but you can maximize them if you wait until retirement to receive your dividends as cash payouts.
Let’s imagine you invested $500 monthly into a stock that averaged 8% annual returns and a 2.5% dividend yield over 25 years. Here’s the difference in account values between reinvesting dividends and not:
| REINVESTED DIVIDENDS? | AVERAGE ANNUAL RETURN | PERSONALLY INVESTED | ACCOUNT VALUE AFTER 25 YEARS |
|---|---|---|---|
| No | 10.5% | $150,000 | $438,635 |
| Yes | 10.5% | $150,000 | $636,313 |
DATA SOURCE: AUTHOR CALCULATIONS.
If you received your dividends as cash, you would’ve made money over the 25 years, but it wouldn’t compare to the more than $197,000 difference in account values. If you began receiving your dividends as cash at those account totals (assuming the 2.5% dividend yield still), you could expect over $10,900 and $15,900 in annual payouts, respectively. An additional $5,000 in supplemental retirement income could benefit anyone.