There are three keys to saving successfully for retirement: Contribution + Time + Investment return.
Let’s look at each key.
Saving the right amount
Even small amounts add up over time, so it’s important to balance today’s needs with tomorrow’s goals.
It is usually recommended to replace about 70% of your salary keeping in mind your retirement income will likely come from a combination of three sources:
- Government programs (Old Age Security, Canada or Quebec Pension Plan)
- Your group savings and retirement program
- Your personal savings (real estate, other savings plans or other income)
Saving a little bit over a longer period of time is an effective way of maximizing your savings while keeping your efforts to a minimum.
The third key involves choosing your investments carefully. And the most important thing to remember is to choose a balanced investment mix.
Why? Because every investment bears a certain degree of risk. But a balanced mix will help you manage risk and return over the long-term.
It can also help you take advantage of a strategy called Dollar Cost Averaging.
Here’s how Dollar Cost Averaging works
You invest a certain amount of money regularly (such as $100 monthly) in a particular investment or portfolio consisting of market-related funds.
With market-related funds, unit values fluctuate, so you buy more units when unit values are low and fewer units when unit values are high. This lowers the total average cost per unit of your investment, giving you a lower overall cost for the units purchased over time.
You see that after 3 years all the funds end up at $20 per unit, but each took a different path to get there.
- Fund A made a profit of $1,429, with 251 units purchased at an average cost of $14.32.
- Fund B made a profit of $222, with 191 units purchased at an average cost of $18.84.
- But fund C is way ahead with $6,981 in profits, and 525 units purchased at an average cost of $6.86.
Your $100 can buy more units when the unit prices are low, so any small positive movement of the fund translates into greater returns than if fewer units were purchased at a higher price.
So as you can see, it’s not just about whether the fund grows, but how it got there, because occasional negative returns can help lower costs and increase profits.
On the other hand, if you withdraw from a fund when its unit value is down you cannot fully benefit from Dollar Cost Averaging.
Dollar Cost Averaging also takes the guesswork out of “when” to invest. If you were to invest your money all at once, you’d risk investing it at the wrong time.
What this means…
- Choose a diversified mix of investments to help you manage risk and return over the long-term.
- Contribute a small amount regularly, rather than one large sum all at once.
- Stay the course! If you had dropped Fund C when it was at its lowest point, you would have missed out on a hefty profit.
Now that you know the three keys to successful saving, let’s look at how you can save more.