They say that the best investment ally is time. And there is no doubt that compound interest plays a fundamental role in boosting the returns on our savings when preparing for retirement.
In recent years, what is known as the pension piggy bank has been squeezed to the maximum. Continuous withdrawals of capital and lower contributions leave a very pessimistic outlook for future retirees. Before, we needed to supplement our pension with extra income if we wanted to enjoy the same standard of living we had before retiring. Now it is practically vital.
There are no magic formulas or products. Experts agree: the best time to prepare for retirement is “as soon as possible.” Time and good planning are the only way to guarantee our retirement. But where should we start? What is the most suitable product, and how much should I contribute? Everything will depend, and a lot, on your expectations and investor profile. If you are concerned about your retirement and want to start preparing for it, it is best to draw up a plan and find a product that suits your circumstances.
When to start saving for retirement
The exact time to plan for retirement savings is as soon as possible; it would be best to start when we get our first job. There are two reasons for this: The younger we are, the more risk we can and should take since we have many years to recover from any short-term downturns.
The long-term will give us higher returns and, in addition, will prevent our annual savings effort from being too great. This is because, by being invested for a more extended period, we multiply the effect of compound interest. This means that our particular piggy bank will grow year by year, and the interest will be applied to a larger and larger amount. So the returns on our savings will also increase.
For example, if we decide to start investing for the future at the age of 25 and make monthly contributions of 50 euros. We would end up with assets of around 150,000 euros when it is our turn to retire. This means we would contribute 600 euros to our retirement annually, an affordable amount. Suppose we want to achieve similar assets but decide to start saving at 40. We would need to make monthly contributions of 150 euros by then, which would entail an annual outlay of 1,800 euros.
All this, assuming we had a savings product with an annual yield of 6.06% (the average of the 20 best pension plans with a moderate level of risk over the last 10 years). And assuming that in both situations, we assumed inflation of 2% and that the savings capacity increased annually in the same proportion.
In total, the actual savings that the person in the first example would have to accumulate would be a total of about 40,000 euros. However, for the second person to reach the same standard of living as the first, he or she would have to contribute a total of 63,000 euros. All this is because compound interest has been applied year after year on the accumulated amount, favoring the younger investor.
How much to save for retirement
Financial advisors recommend starting by saving a minimum of 10% for retirement, which can be progressively increased up to a third or even half of our total savings. However, these percentages will have to be adjusted according to our age. It is expected that as time goes by, our standard of living will improve; therefore, we will have to contribute more to maintain it. How our financial situation evolves over the years and, above all, our expectations for the future.
Which investment instruments are suitable in preparation for retirement?
Many think the only retirement option the market offers us is a pension plan. However, in recent years there has been a proliferation of different alternatives that can be much more interesting for other investor profiles.
The fact is that the ever-decreasing profitability offered by the plans and the high number of taxes to be paid on redemption. Making these products an exciting option for those who have a very high net worth and who, therefore, can benefit from the tax deduction on the amounts they contribute. For the rest, there are other alternatives. Some of the most popular in the current market are:
- Pension Insurance Plan: This product is very similar to pension plans. Although the main difference is that it is a savings insurance that guarantees that when we retire, we will have at least the same amount of money that we had invested.
- Investment funds: They invest in a diversified portfolio of assets. They generally have higher returns and can be withdrawn without waiting for retirement, but with the corresponding taxes. Index funds are an excellent way to invest for the long term. You can see a selection here.
- Systematic Individual Savings Plan: This life insurance policy invests in funds with a guaranteed interest rate. Like the funds, it can also be withdrawn at any time and is only taxed on capital gains. However, taxation is significantly reduced if it is withdrawn as an annuity after five years.
- Linked unit: This product is very similar to the SIPP, but in this case, the premiums paid are allocated to funds and the purchase of a life insurance policy, which guarantees coverage in the event of death but does not guarantee a return, however small.