The Motley Fool

2 costly retirement mistakes I’d avoid now!

Many people spend countless hours worrying about how they’ll be able to afford their retirement. Therefore today I’d like to discuss how to possibly avoid two potential retirement errors that affect many adults.

1. Not knowing how you will pay for retirement

The first mistake most people make is not knowing how they will pay for retirement. And part of the of the reason is that they may actually have unrealistic views of how much retirement may cost. 

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One suggestion is that you’ll need between half and two-thirds of the salary you earned before retirement. A safe range would be between £24,000 and £28,000 a year. This amount assumes that you do not have any mortgage or rental payments to make in retirement.

Let us assume that starting at age 65, you’ll need £28,000 per year and you expect to live for another 25 years after retirement. Let us also leave your potential State Pension or any other private pension income aside for now.

One way to calculate how much in savings you’d need is to multiply £28,000 by 25. The result is £700,000. This calculation further assumes that the £700,000 will earn no interest income.

In other words, if you’d like to finance your retirement fully with your savings, simply multiply the amount you’d need per year by 25.

You may also be entitled to the State Pension or have other streams of income, such as from rental property or a private pension. The important takeaway is to be realistic about how much money you will need in retirement.

2. Not knowing how to save £0.7m by age 65

The other error most people make is not appreciating how important it is to start saving and investing early on when you can take maximum advantage of compound interest.

My Motley Fool colleagues point out that the stock market returns about 7% to 9% annually on average, much more than the best regular savings account. An important part of that return comes from dividends.

Research also shows that investors who purchase dividend-growth stocks and reinvest the dividends to buy more shares are likely to see considerable growth in their savings.

Let us assume that you’re now aged 40 with only £100 in savings and that you plan to retire at 65.

You decide to invest that £100 in a FTSE 100 tracker fund now and make an additional £9,000 of contributions annually at the start of each year. You have 25 years to invest. The average annual return is 8%, compounded once a year. At the end of 25 years, the total amount saved becomes £711,274.

Saving £9,000 a year would need you to put aside almost £750 a month or about £25 a day. Although the amount may look daunting at first, you’d be surprised at how much you could save if you paid attention to your monthly outgoings.

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tezcang has no position in any of the shares mentioned. The Motley Fool UK has recommended AstraZeneca, HSBC Holdings, Imperial Brands, and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.