Why Is it Important to Invest Money for Retirement?
Consider what you are going to live on in retirement. There are three major sources of retirement income for most people: Social Security, employer-sponsored pensions or retirement plans and personal savings. And if those are not enough, the other options are not very appealing: work in retirement or die poor.
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Social Security
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If you are paying Social Security taxes, you are entitled to get Social Security--provided it's still there when you need it. Congress might take action that cuts or postpones your benefits.
Employer-Sponsored Plans
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Few employers provide pensions these days. You are more likely to have a 401(k) at work--a plan that lets you put aside a certain amount of pre-tax earnings for retirement. Some employers match employee contributions up to a certain level, but you need to contribute to get the match. Your contributions can be invested in anything from guaranteed contracts to a portfolio of stocks and bonds, to the company's stock. How much you will have at the end depends on how much you put in, how much in matching funds you get from your employer, how your investments perform, and, in rare instances, whether your employer fails.
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Other Sources
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You may also have military pensions, employee stock options and grants or deferred compensation plans.
Personal Savings
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Personal savings supplement other sources of retirement income. You can go to a financial planner or use an online calculator to determine how much you should be setting aside for retirement, but any calculations will be approximate. Social Security benefits may be cut or eliminated, your 401(k) may perform poorly or your stock options may become worthless, so the more you put aside the better.
Purchasing Power
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When you set money aside for future use, you are storing its purchasing power. Inflation erodes it over time. What that money can buy today will not be the same tomorrow. You must at least preserve your purchasing power by keeping pace with inflation. Ideally you can increase it by earning a rate of return in excess of inflation. The only way to achieve that is by investing your money in instruments, mainly stocks, that appreciate more than the rate of inflation.
Compounding
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Simply put, compounding is earning interest on interest. Let's say you invest $1,000 at 10 percent. At the end of the year you will have $1,100. Next year, you will earn $110---10 percent on $1,100, and so on. Obviously, the earlier you start, the more time you will have for compounding, and the less you will have to set aside to accumulate the same amount.
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