Becoming a dollar millionaire in your golden years is possible if you are a savvy saver.
Do you feel well prepared for your retirement? We tend to underestimate the power of planning for our financial future but it’s never too early to start.
As an example, if you start saving US$2,000 a year for seven years from the age of 18, then stop saving and park the money in diversified investments, compounding at a rate of 10 per cent a year, you would become a dollar millionaire by time you are 66.
Now let’s imagine you start saving much later, when you are 26. To become a millionaire at 66, you will need to save US$2000 every year from the age of 26 till you are 66 or a total sum of more than US$80,000 over 40 years and let the money compound at the 10 per cent rate.
Saving US$14,000 for seven years versus USD$80,000 for 40 years – that’s the advantage of saving and investing early.
The key to boosting your savings
Now, how do you make the most of your savings to reach your goals sooner?
Most people put their savings in bank deposits. This is understandable given they are low-risk but lower risk means lower return. It is important to consider the ‘real’ returns on these savings as the value of a US dollar today will be worth less in future once you factor in inflation.
To help protect your money, it is critical to diversify your investment across several solutions. Apart from bank deposits, one of the most common ways to protect and increase wealth is through insurance solutions such as annuities and endowments which are typically long-term products offering defined returns after a certain date.
The flip-side of this certainty is that you cannot access your investment easily in emergencies.
What if you need to fund other life-time goals such as children’s education, a wedding or health emergencies?
An allocation to a diversified basket consisting of stocks, bonds and precious metals then becomes useful as these investments can be converted into cash easily.
Getting the investment basket right
Historically, stocks have delivered higher returns than bonds. An investment basket of 50 per cent stocks and 50 per cent bonds would provide a higher return over an extended time-period than one exclusively parked in bank deposits.
The traditional approach to allocating investment between stocks and bonds is to put a larger share into stocks during the early part of your working life. This ratio inverts the closer you get to retirement and the need for wealth preservation becomes increasingly important.
Of course, as life expectancy increases, you may need to increase the allocation to stocks, especially if you are looking at handing down your wealth to younger generations.
The stage of the market and business cycle is important when fine-tuning the allocation between stocks and bonds too.
Take today’s market cycle. The current global equity market recovery is the second-longest on record and recession risks remain muted due to loose financial conditions and earnings upgrades. This is supporting stocks and other risk assets globally. With global growth expected to accelerate modestly and inflation to remain subdued, there is room for further upside for risk assets, despite higher valuations and the late economic cycle environment.
You might think this would justify a pro-risk tilt in your asset allocation but given today’s late-cycle conditions and low volatility, it’s even more important to diversify across asset classes.
The steps to financial freedom
What our scenario shows is that securing your financial future starts with a well-thought-out plan and some thinking about your life goals. The next important step is to save and invest early. And if you have not started yet, remember that it is never too late.
Finally, by diversifying savings across various investment solutions, you can generate better risk-adjusted returns. This would go a long way in helping you become a dollar millionaire in your golden years. GB
The writer is an expert on the world economy and global markets and the chief investment strategist of Standard Chartered PLC.