“Save, save and invest.” These three words are considered the best advice anyone who wants to prepare for their retirement can receive from their peers. Investing is easily understandable, especially when considering how much money you should put into your investment.
However, savings are a different story. With investment, you know how much you need to put into that vehicle you’re looking to bet your money in. With savings, you don’t really know. The sky is virtually the limit here, because you can decide for yourself how much you really want to save. The question is – is the amount that you’re looking to save actually enough for your needs in retirement?
Thanks to academic studies, particularly by the Center for Retirement Research at the United States, retirees have a goal that they can set for themselves in terms of savings and residual streams of income that will benefit them greatly once they retire.
First, in order to understand how much they should save, future retirees should learn about replacement rate. To summarize what replacement rate means, it means the ratio of your current income and what you should be receiving regularly once you retire.
Let us say you’re earning $100,000 a year on your current employer. Of course, this could grow if you’re still on the run for promotions and stuff. Now, when you retire, you’re going to receive less than that. If you expect to receive, say, only $50,000 per year, then you’ve replaced only 50% of your current income. Hence, the replacement rate is 50%.
It’s very easy to compute. Since you don’t really know for sure how much you’ll be receiving regularly on your pension, you could, at this point, set for yourself a goal in terms of replacement rates. According to the Boston-based Center for Retirement Research, the safest percentage is 70%. In other words, you should recover 70% of what you’re earning now with whatever investments you’re doing in preparation for the magic number of 65.
The future is uncertain, but it doesn’t have to be 100% volatile. You can still hedge yourself and control your risk exposure, especially since retirement can be far away for most professionals. With replacement rate in mind, you can now narrow down your options when it comes to choosing the right investments and savings packages from what are available to you.
You no longer have to blindly invest in this financial instrument and that, because you have a target that you can use as a benchmark especially when calculating expected returns in the long term. So, simply set for yourself a replacement rate, and you’ll find your options in investment and other retirement-related opportunities narrow themselves down considerably.
Replacement rate is a very useful tool when preparing for your retirement, so make sure that you use it wisely!
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