Saving and Investing
Time is possibly the greatest gift you have. It is finite, so you must use your time wisely, as you can never get it back. Time is an incredible advantage or disadvantage when saving for retirement. If you start early it will make the journey much easier and less stressful. If you start later it will make it much more difficult and a lot more stressful.
Regardless of whether you are early or late, start today! There are lots of ways to save for your future. You can save on taxes if you use the retirement tools offered by the IRS. When doing so it is important that you understand the rules to avoid surprises later (when or if it is taxable, avoiding penalties and when you may be required to begin withdrawing funds). You can always decide to save and invest for your future outside of these tools, but you may be at a tax disadvantage when doing so.
If you work for a company (unless it is very small) it is likely that they offer a defined contribution plan called a 401(K) [or similar product if you work for a non-profit organization or government such as a 403(B) or TSP, for example]. Regardless, the concept is similar in that you have money withheld from your paycheck and put in investment options that you choose. This is the best way to invest because you are paying yourself first before paying other bills and expenses. This ensures that you always make your investment because it is done first before anything else. If you invested last (after you pay your bills) you may find that you don’t have enough money (and then it doesn’t happen). If your company offers you a match on your contributions (for example,
they will match dollar for dollar for the first 5% of your contributions) you should always make sure you at least contribute an amount to get you the full company match. That match is part of your compensation and if you don’t take advantage of it you are leaving money on the table.
If your company does not offer such a plan, or you are self-employed, there are still ways you can invest for retirement and get tax advantages. Those include retirement vehicles such as Individual retirement accounts (IRAs or Roth IRAs) or SEP IRAs (for the self-employed).
There are a number of dynamics to consider when evaluating your retirement savings plan. First, what is the amount you should be contributing (what is the pace) with each paycheck in order to hit your goal. Second, you have to assume an investment rate of return (growth %) that you can reasonable expect. Third, you also need to have a goal number (amount you need to have saved) and the date you want to hit that goal.
So in summary you need (1) contribution pace, (2) assumed rate of return and (3) a goal amount at a future date. Ideally you would want to work this backwards. First determine your goal amount and date, which is probably the most difficult of them all. What makes it so difficult is that you need to know if it is enough (if we are talking retirement). One preliminary rule of thumb is the 4% guideline, which means you would need to have a goal amount saved equal to 25 times of what you need to live on each year. Again, this is just a rough rule of thumb to get you in the ballpark thinking of the amounts you need. This guideline assumes that if you only pull out 4% of your initial investment total each year (have the money properly invested) the probability is high that you won’t run out of money over a 30 year period. So, for example, it is saying that if you had $1,000,000 invested properly you could pull out 4%, or $40,000 each year for your living expenses (adjusted for inflation each year) and there is a high probability you won’t run out of money for 30 years (if invested properly). One cool website to run scenarios for free is dinkytown.net. This site has a number of calculators. If you go into the retirement calculator section you can run the numbers to see what it will take to hit your goal. Another site to consider is caniretireyet.com.
- Don’t put all your eggs in one basket. In other words, be careful investing all your money in one investment, especially if it is your own company stock. You need to very careful as it is risky to have your money in one place. Numerous people have seen their retirement savings destroyed by having too much money in one failed investment (ie: Enron stock). I recommend that if you do invest in your company stock you limit it to no more than 10% of your investments. No matter how great it seems, I feel you are taking too much risk if you put more than that in one stock (your company or really any one company for that matter).
- Fees can eat you up. You should review the fees for each fund. One rule of thumb is to look for investments that have less than a 1% fee each year. Fees that are too high can have a significant impact on the time it takes to hit your goal so don’t ignore this important area. Use Morningstar.com to look up the expense ratio and fees of any investment fund. Some of the investment companies that offer good investment options at low fees are Vanguard, Fidelity, and Schwab.