3 golden rules that make saving for retirement easier

If you’ve thought about how much money you need to save so you can retire comfortably, it might feel a little daunting. Maybe so much so, you’d rather not think about it at all.

But, according to AMP Technical Strategy Manager John Perri, there are three simple rules anyone can follow that make saving for retirement a lot easier.

1. Follow the sleep test

All investments come with a level of financial risk. Understanding your risk appetite, says John, is essential when setting goals for your superannuation and retirement savings. “I look at it from the perspective of whether you can invest and sleep at night. If you’re not sleeping, then the level of risk you have is not for you.”

Generally, the higher the expected return, the greater the risk. And lower risk means lower expected returns. Risk appetite is often linked to age and how far away a person is from retirement because this influences their ability to recover from financial losses.

For example, someone close to retirement may be more risk-averse than a younger person, who can perhaps pursue a higher risk strategy, knowing that the market is most likely to deliver in the long term. For younger investors, they typically have the luxury of time to recover from any short-term blips.

Super funds usually offer a range of investment options with varying risk, so you can choose the one that’s right for you. These include:

• Growth options – aim for higher returns over the long term but come with higher risk 
• Balanced options – aim for moderate returns and come with moderate risk 
• Conservative options – aim to reduce the risk of market volatility, so may generate lower returns but are lower risk 
• Cash options – aim to generate stable returns to safeguard the money you’ve accumulated and are usually the lowest-risk option offered by super funds.

If you’re thinking about switching investment options, it’s important to do your research so you can be confident it’s the right decision. If you have a financial adviser, it’s worthwhile seeking their opinion so you might avoid locking in losses that are difficult to recover from.

2. Make the most of tax benefits in super

The second rule that makes saving for retirement easier is understanding that Australia’s superannuation system has been designed to create incentives, and that means there are tax advantages in saving through super rather than investing outside of it.

“Super is a structure that is purpose-built to acquire investments for retirement, and it’s not necessarily an investment in itself,” says John.

Earnings you make on the money invested inside super are taxed at 15% on income and 10% on capital gains. This is lower than the marginal tax rate paid by many Australians, which can go as high as 45%.

“Once you’re retired, you can use those savings as an income stream in the form of regular pension payments. And the tax rate on investment earnings inside the income stream is nil,” says Perri. Plus, “there’s no tax on the income stream payments if you are over 60 years of age.”

How super is taxed depends on your age, contributions and other factors, so it’s important to understand the different tax implications that could apply to your nest egg. You can learn more about tax on super here.

3. Use compound interest to your advantage

The famous physicist Albert Einstein once described the ability to understand compound interest as the eighth wonder of the world. Building up a healthy super balance is aided by the principle of compound interest, which delivers its best rewards to people who invest early and stay in the market.

“The rate of return on a super balance is calculated on a potentially higher balance over time because your employer makes contributions, or you’re making contributions yourself,” says Perri.

“But your balance may also rise due to investment returns, so the following month you will receive returns on those returns.”

“Given the long-term view with super, and starting early, the longer you have your super invested, the longer it has to grow and compound over time,” he says. And if you make extra contributions, then the benefits of compound interest are exponential.

In times of uncertainty, it can pay to take control of your finances, so you feel peace of mind that you’re prepared for the future. And you don’t have to do it alone. Speak to your financial adviser, or find a financial adviser near you.