Dubai: Saving for your retirement can feel challenging at first, particularly when the idea of reaching a substantial financial milestone just before you retire appears too formidable or daunting. However, there are ways to temper these worries.
Over the years, investment experts have come up with several useful hacks that can help you grow your savings pot in a lesser time. To be sure, there is no one-size-fits-all approach to retirement savings, but these strategies are a great place to start.
Retirement rule #1: ‘7-5-3-1’
“When saving for retirement, the widely recommended 7-5-3-1 rule is a simple yet super effective rule that will not only enjoy superior returns over the long term, it will help you become a good SIP mutual fund investor,” said Brody Dunn, an investment advisor based in the UAE.
“The 7-5-3-1 rule is a strategy for investing in stocks through a systematic investment plan (SIP). The rule suggests that an investor should allocate 7 years, 5 years, 3 years, and 1 year of their investment horizon [how long you plan to stay invested] to stocks through SIPs, respectively.”
How does the 7-5-3-1 rule work?
The rule is based on the fact that stock markets do exceptionally well over 7 years. Statistics historically indicate that in the past decades, in 8 out of 10 times, your savings would grow over 10 per cent over a 7-year time frame.
“The idea behind the 7-5-3-1 rule is to invest a smaller portion of the investment in stocks for a short time period and a larger portion for a longer period,” said Zubair Shakeel, an investment advisor at a Dubai-based wealth management firm.
“This is based on the principle of investing in stocks for the long-term, to benefit from the potential for higher returns and to weather short-term market volatility. This approach aims to balance the investor's expectations, while accounting for their investment goals and risk tolerance.”
So, if you’re looking to stay invested for 10 years, divide your savings into four parts, with the biggest portion for 7 years in a stock SIP investment. However, Shakeel also noted that the 7-5-3-1 rule is just a general guideline as returns on the stock market fluctuate each year.
Retirement rule #2: ‘8-4-3’
“With the 8-4-3 rule, you can turn 8 years for your first savings target into just 4 and 3 years for the same amounts in the subsequent periods,” added Dunn. “The sooner you reach the first-year milestone, the faster you'll achieve your second and third.”
Here’s an example: If you invest Dh1,000 per month at a 10 per cent annual return rate on the stock market, you can attain your first Dh100,000 in 8 years. Adding another 4 years will halve the time required for the second Dh100,000, and the third Dh100,000 can be achieved in only 3 years.
However, the above is conditional that you keep investing Dh1,000 per month till you retire. This is the ‘power of compounding’, and by the 20th year, you'll be adding nearly Dh100,000 every year to your retirement savings.
Retirement rule #3: ‘90-10’
In 2013, world renowned investor Warren Buffett revealed that he ordered the trustee of his estate to allocate 90 per cent of his cash to a very low-cost ‘stock index fund’, and the remaining 10 per cent to short-term bonds.
Warren Buffett’s advice didn't go unnoticed by investors. Between Buffet’s move in 2013 and 2016, investors moved $1.7 trillion (Dh6.24 trillion) of their investments into index funds and witnessed a return on investment of 263.73 per cent, or 13.09 per cent per year.
“Putting 90 per cent of your retirement savings in a low-cost stock index fund greatly minimises your investment costs, since the expense ratios (the annual fees charged to shareholders) are much less than for actively managed funds,” added Shakeel.
“This means more money is left in your account to grow, and therefore you increase your chance of hitting your savings target. However, as you get closer to retirement age, consult with a financial professional on how to adjust your portfolio allocation according to your changing needs.”
Stock index funds generally have annual expense ratio as low as 0.05 per cent, which amounts to a low percentage of your investment or retirement savings, and those investors tracking a benchmark of stocks or an index saw their savings grow over 10 per cent, as indicated above.
Apart from the above savings rules for retirement, there's a much more popular and simpler rule of thumb for how much of your income should go specifically toward retirement. According to many advisers, you should contribute at least 10 per cent of your salary to your retirement fund.
Why is 10 per cent a rule of thumb? One possible explanation is the ease of calculation: Just take out a zero. With a gross monthly salary of Dh5,000, you know that you have to contribute Dh500 to your retirement account.
“A caveat with the popular 10 per cent retirement rule is that you should be doing this for as long as you are working, starting as soon as possible. Younger savers will benefit the most from interest-on-interest,” added Dunn. “The more you contribute early, the more time your funds have to grow.
“Regardless of which rule you use, as any of them can give you a leg up on your retirement strategy, think of these more as guidelines and not so much as commandments, as every financial situation is different. So, make the most of what’s available to you and what suits your needs.”