Several years ago, in one of his annual letters, Warren Buffett (Trades, Portfolio) published what has since turned into the go-to piece of advice from many pension savers.
Writing about how he would instruct trustees to invest his fortune after his death (Buffett is giving away the bulk of his estate and will only be leaving a small amount to his wife), Buffett wrote:
"My advice to the trustee could not be more simple: put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund ... I suggest Vanguard's."
For the average investor, I believe it is impossible to offer better advice than this. A simple investment in the S&P 500 is by far the easiest way to build a diversified portfolio of the world's most prominent companies, and it is also one of the most efficient, with index tracker funds now charging on average less than 0.1% per annum in management fees.
The one thing that might be unsuitable for some investors is the advice to put 10% of cash in short-term government bonds. This should be evaluated on a case-by-case basis, based on the retirement age. Investors with several decades until retirement may be damaging their retirement prospects by investing in bonds considering the historically poor level of returns bonds have produced when compared to equities.
That being said, it is all very well and good recommending that investors buy a simple S&P 500 tracker fund, but it is another thing altogether making sure that you hold the fund until retirement.
Easy if you know how
In reality, investing for retirement is relatively simple. A tracker fund is all you need. Buy and forget a tracker, and you can rest safe in the knowledge that, based on past performance (which is no guarantee of future returns but can still be an informative resource) you could achieve high single-digit annual returns.
However, where the effort is really required is building the funds to invest in the first place. Saving for retirement is something most people put off purely because of the constraints of retirement products. If you're struggling to pay your rent or mortgage today, there is no incentive to put money aside for the future, especially when you might not have access to this money for decades.
Rather than focusing on where to invest the funds saved, the better topic of discussion might be how to save the funds required.
In theory, it's not difficult. According to my calculations, you only need to put away approximately $20 to $30 per week to build a sensible pension pot. Of course, these figures will vary greatly depending on who is doing the saving. If you are 50 and plan to retire at 60, you are going to have to save a lot more than just $30 a week to be able to retire comfortably.
Even compound interest, which Einstein called the seventh wonder of the world, cannot save you if you have left it until 50 years of age to start saving for retirement.
Crunching the numbers
Let's look at the numbers. If you are putting away $30 a week, this works out at $1,560 a year or $130 per month. Compounded at an average annual rate of 8%, which is slightly below the S&P 500's long-term average annual return of approximately 9%, from a standing start over 20 years you would build yourself a pension pot of $76,500.
Over three decades, the total would be closer to $200,000. If your target is retirement age is 60, this $200,000 goal is not that unrealistic. Even for low wage workers $30 a week is not that unrealistic as a savings target. If you double the monthly contribution to $230, my figures show an estimated retirement pot of $341,000, once again a sizable sum for minimal contributions.
Conclusion
So overall, investing for retirement, is simple if you follow Warren Buffett (Trades, Portfolio)'s advice. The hard part is setting a savings plan and sticking to it. Once you have this plan in place, however, compound interest will do all of the heavy lifting for you.
Disclosure: The author has no share mentioned.
