What if I woke up one Tuesday morning and decided to take my kids to Disneyland that day? Now, I live in Phoenix. Disneyland is about a 5 hour drive through the burning hot and lonely desert. What if I got a wild idea that I needed to ride the Matterhorn that day… right then! Could I just throw the kids into the car in their PJs and head out without a thought? Well… I could. But that would be dumb.
I would never get there! I don’t know the way, first of all. I would end up just driving in circles around Phoenix. I’d never leave the city because I would never venture out into the desert without being sure I was going the right way, and that I had enough gas and emergency supplies to make it across. Plus, what if I did actually make it? Do I have enough money to get into the park? Where are we going to sleep? What are we going to wear? And so on…
No, instead when I plan a road trip I first make sure I have directions. I know how long it’s going to take me to get there and when I need to leave in order to arrive on time. I get the car checked out and get a full tank of gas. I pack up too many suitcases and half the pantry. I improve my chances of arriving at my destination by knowing what to expect on the drive and being prepared for emergencies.
Getting ready to save for retirement is much the same. You don’t just start piling all your money into the first investment you see. No. First you prepare for emergencies by putting some money in savings. Only when you know you can handle life’s emergencies do you start down the road to retirement. Then you need to figure out how much you need to save for retirement, both as a lump sum and as monthly savings goal. This is your road map. You need to know how to get there and you need to know what it will look like. Right, if I’m going to Disneyland I need to know what Disneyland looks like so I can identify it when I see it. So you need to know the grand total amount that you are aiming for.
On The Road
Ok, so you are ready for your road trip. Your car is prepared and your stuff is packed. Now how fast do you want to drive? Out in the desert the speed limit is 75 mph. That’s a good speed to go out there. Where the road is straight as an arrow for as far as you can see and the closest human is even farther. However, when I get into LA it wouldn’t be appropriate to go 75 would it? No, on the freeways there I would need to slow down, right? I could maybe go 55. Then as I get even closer to Disneyland I would get onto surface streets. I would have to slow down even further. Maybe down to 35 mph. Then when I get into the parking lot of Disneyland I’m so very close to my destination I would have to go even slower. I might drive 10 mph in the parking lot until I finally find my spot and I pull in ever so slowly as I carefully come to a stop. Right? I don’t whip into a parking spot at 75 mph like I was driving out the open desert!! I could kill someone! That would be very dangerous!
What does that have to do with saving for retirement? I’ll tell you!
When you are young and have a long way before you will retire it’s like you are out in the desert. You won’t need the money for a long time so you can take extra risk and let your money grow at 75 mph. You might want to consider aggressive growth mutual funds. But just like on the road not everyone wants to drive the same speed. Some people drive the speed limit but some people drive faster. Some might want to go 100 mph. Then again, others drive 60 mph. It depends on your personality and risk tolerance. On the open road you need to weigh out your risk tolerance. As you go faster you have the benefit of getting to your destination quicker but you run the risk of getting into an accident. However, if you drive slower you have less risk but it takes longer to get there. So you have to make a decision on how fast you want to go. Just like in a car, you have to decide your risk level when it comes to investing. If you want to grow faster you have to take on more risk.
As you get closer to retirement you have to take less risk. Just like when we transition from driving out in the open desert to driving in the city. We had to slow our car down and we have to slow our investments down. We can’t drive 75 mph anymore, it’s too risky. So we move from aggressive growth funds into something more stable that provides a little more income and less growth potential. We might add some more bonds to the mix and larger more stable companies.
Then as we get a bit closer to retirement we need to slow it down again. Now we are on surface streets, we are really close now! So maybe we move more of our money to bonds and the only stocks we have are very stable low growth, high dividend companies. Then as we pull into the parking lot of retirement we really start slowing it down. Probably want to have some cash (to buy tickets to the park!) and have everything else in very safe, investments. We don’t want our money zooming around anymore. We need stability of principal. We have arrived at our final destination!
Congrats! You’ve made it to retirement! I hope you enjoyed the ride!