Your 20s may seem too young to be thinking about retirement, but, in reality, it is never too early to start planning. In fact, the power of compound returns means the earlier you start saving, the better.
But how do you go about planning for a retirement that is likely to be four decades away? And how do you balance the need to save for retirement with other financial demands, such as repaying student debt and getting on to the property ladder?
Sheila Dickinson, Senior Wealth Manager at the Fry Group, says, regardless of your age, a retirement plan needs to be part of a holistic financial plan. She says, “Sit down and look at where you are now, what your income is, and what your objectives are in the short, medium and long term. Do a thorough budgeting exercise and put in place a sound financial plan that maps out what you want to achieve, how you will get there and what you need to do to stay on track.”
Jessica Cutrera, Managing Director of EXS Capital, agrees. She says, “If you have credit card debt, you probably need to pay that off before you save anything because it is likely you are being charged double-digit interest.” By contrast, it may make sense to pay off student loans more slowly if the interest rate is low.
Management, advises young people not to see saving for retirement and buying a home as competing financial goals. He says, “Owning your own property is the ultimate hedge against inflation. If you own your property, you also have the option to take out a reverse mortgage on it when you retire, so it is like an annuity.” Owning your own home will also reduce the level of retirement income you need, as you will not have to pay rent.
How much should you save?
Working out where you may be living and how much money you will need when you retire is not an easy task when you are only in your 20s. The calculation depends on a number of factors, including how old you want to be when you stop working, where you will live and what kind of lifestyle you want. But Cutrera points out, “Wherever you end up, it is universal that you are going to need money.”
Dickinson suggests people sit down with an online retirement calculator or financial planner, and look at what income they are likely to need in today’s money, and then work backwards to see how much they are likely to have to save to achieve that, factoring in inflation and investment returns.
Liem suggests people on a typical graduate salary of HK$10,000 to HK$15,000 should try to save between 15% and 20% of their pay each month, although initially this money is likely to go towards a deposit for a flat.
Cutrera agrees. She suggests young people try to set aside between 10% and 20% of their pay, while those on very high incomes should try to save 50%. But she adds, “Even if you can only save a few thousands dollars a month, the power of compounding means that in theory you should be doubling your money every ten years or so if you are investing in an equity portfolio.”
For example, someone who wanted to amass a lump sum of HK$6 million by the time they were 65, would have to save just HK$2,400 a month if they started saving at the age of 25, assuming investment growth of 7%. If they delayed starting a retirement account until they were 40, the monthly contribution they would have to make would more than triple to HK$7,500.
Where to save
Cutrera suggests that the first thing people do when deciding where to invest money for their retirement is to look for any savings vehicles that have tax benefits or into which their employer will also contribute. She says, “If your employer will match some of your contributions, such as if you pay into an MPF account, take advantage of that, as you are effectively doubling your money instantly.”
In terms of asset classes, Dickinson advises people in their 20s saving for retirement to consider investing in equities. She says, “Obviously, it depends on the level of risk a client would take with their portfolio, but if you are investing for a 20 or 30 year period, you have got to look at growth areas and that usually means investing in equities.”
Cutrera agrees that in the current low interest rate environment, a diversified equity portfolio is a good bet for long-term investors. She recommends people consider putting their money into index funds, which replicate the performance of an index, such as the Hang Seng, or exchange traded funds (ETFs). These instruments have low charges, generally just 50 basis points or less, and more flexibility than structured products, such as investment-linked assurance schemes, which lock investors in for a set period and have high front-loaded charges.
Liem takes a slightly different approach and suggests that clients should have two portfolios. One of these would be a diversified growth portfolio containing a mixture of Hong Kong-listed stocks and mutual funds. For the second portfolio, he suggests people save into assets that will provide them with an income during retirement, such as blue-chip stocks that pay good dividends or an investment plan linked to an annuity.
Inflation and charges
It is crucial that savers do not ignore the impact inflation and charges will have on their nest egg. If inflation is running at 3%, it means the value of the money they have set aside will half in real terms every 24 years. As a result, someone who wanted to amass a retirement pot that was worth HK$6 million in today’s money in 40 years’ time, would actually have to save HK$19.5 million, assuming inflation of 3% a year.
Charges can also have a big impact on the rate at which a fund is growing. If you are earning investment returns of 7%, but paying charges of 3%, the value of your investment will actually be growing by just 4% a year. Once you have factored in inflation of 3%, it is increasing by just 1%. As a result, if you want to make net returns of 3%, you will actually need to make a gross return of 9%, which in this economy is not an expectation of any investor who is not expecting to take a great deal of risk. Cutrera says, “You need to consistently make returns that are greater than charges and inflation. It is also important to increase the amount you are setting aside over time.”
It is important to keep reviewing your retirement plan to ensure it remains on track. Liem advises younger savers to review their retirement plan every three years. He says, “Looking at it too often puts you under unnecessary pressure. But every three years you will have a better understanding of where you are in life, such as when you want to get married and have children.”
But while he advises young people to have a plan to save, he also urges them to be flexible. “Don’t be too focused on the plan. Life is about opportunity and if you are too focused on saving for retirement, you might give up good opportunities, such as the chance to start your own business,” he says.
While it’s for you to decide whether or not starting a business is for you, one unwavering fact is that people are living longer. Use this longevity to your advantage and benefit from compounding! BM