Many people make the mistake of building their retirement funds by simply saving money in the bank.
Putting your money in a savings account that earns less than one percent per year will not help you to retire early. You would still probably be working at the time when you should have already retired.
In order to grow your savings, you need to invest regularly. When you invest, your savings will grow faster because the returns that you will get from your investments will accumulate over time.
But building an investment portfolio for the long term can be challenging because it requires you to carefully tailor fit your strategy to your risk appetite and life goals.
Your strategy to achieve your goals must align with your retirement timetable. You cannot afford to delay your plan to start investing because time is gold as they say. Every day that goes by can be another wasted opportunity to put your money to work.
Planning your investment strategy early in the game is one sure way to achieve early retirement in the future. Here are the five ways you can build your investment portfolio to achieve your retirement goal:
1. Determine the amount of money you need to retire
When you decide to retire someday in the future, it means that you stop working to earn a living. You must have saved enough money to sustain your living expenses until you die, without the need to work. How much money do you need to achieve in order for you to retire comfortably?
Try to look at your current personal expenses. Most probably there are expenses you will no longer need to spend when you retire someday but certainly there are essential expenses you need to keep you healthy and happy.
You need to estimate these expenses on a monthly basis because this is the amount of income that your retirement fund will need to generate passively in the future.
2. Determine the amount of money you need to invest regularly
Let’s say you have figured out that you will need around Php20 million to support your financial needs when you retire beginning at 65 years old. Given this amount as your retirement fund, you need to know how much you need to invest now, on a monthly basis, in order to achieve your goal.
Your monthly investment will depend on your time horizon and target returns. The younger you are, the lower the amount you need to invest and the higher the chances that you can achieve your goal.
For example, if you are 25 years old now, you will have 40 years to build your retirement fund. At target returns of eight percent per year, the annual investment you need to contribute in order to achieve Php20 million goal by 65 years old is Php77,203, which translates to monthly savings of just Php6,433.
If you are older at 35 years old, you will need more money to invest to achieve the Php20 million goal. You will roughly double your budget because your time horizon is shorter.
Your challenge will be to look for returns higher than eight percent to keep your investment low. Perhaps you may have to look for more aggressive, riskier investments to get higher returns.
3. Determine your investment allocation to achieve best returns
Once you have settled with your investment plan, the next item you need to decide is the asset allocation. How much should you invest in stocks? Stocks are riskier investments but earn far more than fixed income or cash historically.
One way to determine your exposure to stocks objectively is to use the formula 120 minus your age. If you are 25 years old, your stocks exposure can be as much as 95 percent, but if you are 55 years old, your exposure should not be more than 65 percent.
As you get older, it is advisable that you invest less in stocks and focus more on less risky investments such as fixed income.
4. Determine your risk preference by diversifying your assets
When you invest in stocks, you can manage your risks by diversifying your investments in different types of stock such as blue chips, second-liners and small cap stocks.
If you are looking for stability, choose blue chip stocks with predictable earnings and less volatility. Stocks such as PLDT, Meralco, BPI and SM Prime have compounded annual returns of not less than 10 percent in the past five years.
These stocks can be your core holdings because they provide secured growth that will last, not to the mention the annual cash dividends that they give which help lower your investment costs over the years.
On top of your core holdings, you can consider other stocks that have historically high returns. Stocks such as Megaworld, Ayala Land and Metrobank have annual compounded returns of 25 percent for the last five years while Universal Robina, Aboitiz Equity Ventures, ICTSI and Jollibee have historical annual returns of at least 40 percent per year.
The stock market has compounded annual returns of 15 percent per year for the past years. It is possible that when you do your investment planning, you can also make several scenarios assuming your target returns can be as low as four percent and as high as 12 percent so you can estimate how much more or less savings you need to contribute to your fund.
5. Determine your capacity to invest to improve your returns
Throughout your investment journey, there will always be opportunities for you to save more from higher income. You don’t have to stick to your monthly or annual investment contribution.
If you can invest more, the better for you because this will help you cut down the number of years to achieve your investment goal, or increase the amount of the fund you originally projected for your retirement.
Creating an investment fund for retirement may not be easy if you don’t have the skills to do it. It will be helpful if you can also consult an expert or a Registered Financial Planner (RFP®) to assist you in developing your investment plan.
In this way, you will be guided and learn from it at the same time. Avoid the temptation to outsource the job to other people like a financial consultant or fund manager. Always make an effort to learn and understand the process in order to build your confidence in decision-making.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice firstname.lastname@example.org or follow him on Twitter @henryong888