Retirement Plan For Today's Twenty & Thirty Somethings

If you're currently in your twenties you might not have 'plan for my retirement' at the top of your to do list. The event itself is so far in the future that it may seem of minimal importance. But as we're all living longer healthier lives these days, there's more than a good chance you'll get there. No more work and a life of leisure. How will you pay for it? 

With the trend in life expectancy continuing to accelerate, the state pension age will probably be 70 by the time your generation is nearing retirement. A private pension will give you the opportunity to retire earlier (currently 55, but this is also predicted to rise), so in a sense this increasing timescale gives you more time in the workplace, and hence more time to contribute to a company pension. You may have to wait for the state pension, but in the meantime you can take solace in the thought of how much strain you're taking off the government's coffers.

But here's the rub: - your employer's pension scheme is probably a defined contribution scheme. The money you pay in (along with your employer's contribution) goes into investment funds. When it comes to retirement date your pension depends on the performance of those funds. You have some choice about which funds to invest in, but you're still subject to the whims of the market. Not exactly predictable then.  

It was easier for your parents' generation, most of them had a final salary scheme, which guaranteed them a percentage of their final salary on retirement. This could be as high as 70%, and remained unaffected by market performance. A final salary scheme produces substantially more income, but they are seen to have become increasingly expensive to employers, many of whom have switched to the defined contribution model. By the time you're 70 final salary schemes will be history.

So there are two elements here: -  the certainty of knowing that if you're working and contributing to a pension it will almost certainly not provide you the same standard of living your parents will enjoy in retirement. And the uncertainty of knowing that you won't be sure just how much you have to look forward to until the time is almost upon you. It may sound a little daunting and depressing, but if you are interested in having a financially stress free retirement, it's a wake up call and an opportunity.

The responsibility to plan for a secure retirement is much more pronounced for this generation than the one preceding it. The onus is firmly on you. But help is at hand. William Bernstein, who is an American investment advisor, has recently written a short e-book specifically for young people in their 20's. According to him there is a strategy even a seven year old could understand, that if followed will beat the professionals and ensure your comfortable retirement.

The book is called 'If You Can: How Millennials Can Get Rich Slowly'. It's available for free on his website at www.efficientfrontier.com. Before you rush off and read it, let me summarize its approach for you.

In a nutshell, all you need to do is save 15% of your salary every year. You then divide this money between two stock index funds and one bond index fund. You spend 15 minutes a year reviewing and re-balancing these funds so they're equal, and voila - at retirement you'll have a comfortable amount of money to live on. All you need to do is stick to the plan. And this is where it gets tricky.

There are certain things you need to do and know to be successful, or as Bernstein describes it, five hurdles to overcome. 

 1: - you must curb the urge to overspend, or to put it another way you must ensure you keep putting away that 15% every month. Don't be tempted by impulse buys that cut into that money, even by a little bit. Make getting rid of current debt your most pressing priority. It's costing you more to be in debt than it is to save regularly (debt interest outweighs savings interest rates, but when you're saving it's you that's accruing interest, not your lender).

2: - Learn to understand finance. How do stocks and bonds work, and what's the associated risk? What kind of return can you expect? The more you understand the better - information is power.

3: - Understand the history of the market. Whatever's happening now, you can be sure it's happened before. There will be times when your portfolio is flourishing as stocks hit the heights, and times when it goes the other way. This is nothing new, and it can inform your rebalancing strategy. Selling stock when the market is high and getting in cheap when it's low will be easier for you. Understanding history will inform your decision making. It's like a movie you've already seen.

4: - Defeat the enemy, namely yourself. This strategy is a long term effort and you don't want to derail it by making stupid decisions. Don't be swayed by the guy at work who tells you 'Acme Tech' is the next best thing. Maintain your discipline in the long term and you'll be rewarded.

5: - Avoid financial professionals like the plague. They are there to serve their own interests, and have no professional obligation to put your interests above theirs. And it can be difficult to avoid them too, according to Bernstein. One of them may be your brother in law or an ex college mate. You'll need to learn to say 'No' when they turn the talk towards investment. Yes, you'll be invested in funds, and these funds have managers, but ensure as much as you can that you get a fair deal. Remember that if the management fee goes up from 1% to 1.5% the fund manager has just increased his income by 50%. And that's coming out of your wallet. Bernstein doesn't seem to have a lot that's good to say about advisors. It's a bit ironic, as he's one himself.

  

So, that's all you need to do to build your retirement pile. Bernstein also gives you a couple of relevant books to read at the end of each hurdle. If you do your homework not only will you probably know more than most investment professionals, but you'll end up outperforming them too.