If you start saving for retirement early in your working career, your investments are less vulnerable to the ups and downs of the market cycle. Long-term, regular investing also allows you to benefit from the cost average effect, where by regularly investing the same amount over a long period of time (e.g. several decades), you can reduce or avoid the need to worry about paying expensive prices for assets purchased at the peak of a market boom, because you will also be buying other shares cheaply when prices are depressed. In other words, you buy fewer shares when prices are high and more when prices are low.
Investment funds are a useful tool for retirement planning because of their diversity, flexibility and liquidity. Fund units or shares can be bought and sold easily, without high costs and at fairly short notice. The vast choice of funds available in the European market (a large proportion of them based in Luxembourg) allows you to build a portfolio of investments with varying degrees of risk and return. Over the retirement saving period, the degree of risk and return in the investor’s portfolio can be adjusted to match their changing profile and stage of life.
In general, financial advisors recommend investing in a larger proportion of assets that carry a higher risk but promise higher returns when you are young and then positioning your portfolio more conservatively later on as you approach retirement. This should minimise the risk that a market disturbance could significantly reduce the pool of money you have available to use during your retirement. As they reach retirement age investors may want to switch part of their portfolio into investment funds that pay out dividends or interest on bonds. This would provide a regular income stream at a time after you are no longer earning a full salary or not earning a salary at all.
A popular form of investing in investment funds for retirement is through unit-linked life insurance or pension schemes, for which Luxembourg is also a European leader. For example, the value of a unit-linked life insurance policy depends on the performance of the investment fund in which it invests. Unlike with direct investments in investment funds, investing in unit-linked plans generally entails restrictions on investors’ ability to cash out the assets in their life policy or pension scheme before reaching retirement age, or even financial penalties for doing so. Therefore, you should always take professional advice, including advice on tax-related matters, before investing in a unit-linked pension scheme or life policy.
Rules and tax regulations for investments made as part of a retirement plan vary greatly according to the investor’s country of residence. In some cases there are tax incentives for retirement investments at the time the investment is made but the eventual retirement income is taxed, whereas in other countries it is the other way round. Most investments made as part of an approved retirement planning scheme benefit from some form of tax benefit, whether at the time of the initial investment, as the regular contributions are paid in, or when the benefit is drawn on.