Retirement Planning: 10 Things You Need to Know
Hello Everyone! I am still in way over my head with this move (moving is really one of the worst experiences ever, even when the move is the best possible thing for your family). Luckily, though, John found time to write a guest post when he was stuck in a hurry-up-and-wait situation. I am very excited to bring you this interesting and useful post from my brilliant best friend and love-of-my-life.
Without further ado, a guest post from John Applebaugh!
Although money doesn't equal happiness, worries over money can certainly make person unhappy.
Unless you plan to work until you die, you should think about your retirement when you are young. Many people don't really pay attention to their 401k or IRA, but you should. Not only can being informed about investments make your retirement happen sooner, it can also lessen your anxiety about money overall.
Frequently, I encounter young professionals who believe that retirement is so far into the future that it really isn't worth worrying about. Other times, I have encountered experienced workers who assume that getting 3-5% from their savings, pension, and retirement accounts is quite good. This post is written to dispel such notions.
Saving earlier is much better for your overall financial health. Though it seems like a burden and a waste of hard-earned money, putting away money for retirement is the best thing you can do in your youth. Why? When you are young you have many years of being in the workforce ahead of you. Every year is another year that your money can be compounded (meaning that it earns interest = more money). If you wait to put money away, you'll still earn interest but it won't be as much as if you had started when you were younger. Also, when you are younger you can take more risks with your investments because over time any losses you might incur from a risky investment will be smoothed out. This is different from when you are older and closer to retirement -- you can't take risks thus you are stuck with weaker (but safer investments).
Three to five percent is nowhere near good enough if you actually want to retire on time. When you are young (less than 40), you should be earning somewhere above 10% (above 15% is great) in returns on your investments. Earning only small amounts like 3% basically means you are losing money because of inflation.
So, now that I've convinced you to start your retirement in earnest, let me give you some general guidelines. There are several strategies for what you should do with your retirement investments and a many more how-tos for investing day-to-day; however, what I'm giving you is a general road map for you financial future. Think of of it like a GPS that you have in your car -- it is mostly the best path and will get you there.
Assuming you are still working and under the age of 45, here's what you should be considering:
1) If your place of employment has a 401k, does it offer a contribution match? If it does you should contribute to that plan up to that matching amount (typically 1 to 5% of your salary). This is free money, are you really going to pass that up? If there is period before you start to get matching contributions, wait to invest until your employer is actually going to contribute.
2) Find out how long before you are "vested" in your 401k. Being vested means you will get to keep whatever your employer contributes (note: you always keep what you contribute). This will give you the knowledge for how long, at a minimum, you should try to stay at your place of employment.
3) Determine the costs associated with your 401k. Costs, what costs? Plans like 401k are setup and run by investment companies that your employer will contract to provide such plans. Most 401K plans have investments that are mutual funds. The mutual funds may be setup by the company administering the 401k, or they may be from another investment company. The mutual funds themselves will have costs associated with setting up and running the fund (which includes managing which stocks are held in the mutual fund, how often investments are re-balanced (changed) and other administrative costs). Additionally, the company that administers the 401k will also charge administrative costs to the holders of 401K (aka you and your co-workers). The costs are typically taken out of returns before they are distributed to plan holders, so you never actually see what has been taken out. However, they are required by law to disclose this information. A 401K plan with an expense ratio (cost) of 1% or less is pretty good. If your plan is over 1.3% in costs, then you are paying too much. If you change jobs, compare the costs of your old 401K to your new one -- keep your money in the old plan if it costs less than your new one (otherwise transfer your funds to your new plan)
4) Open a Roth IRA. A Roth IRA (Individual Retirement Account) is an individual retirement plan that isn't contingent on where you work. Unlike the 401k, you make contributions to this type of account with post-tax dollars (like you how you pay for basically everything else). The benefit of the Roth is that you do not pay tax on your earnings. If you make a million dollars in your Roth, you pay no tax! Additionally, you can invest in just about anything -- stocks, bonds, ETFs, mutual funds, etc. The downside is you can only contribute $5,500 a year, per person (roughly $105 per week). When you retire, you can take money out of your Roth and avoid paying tax. Do not open a traditional IRA.
5) Try to keep your IRA and 401K portfolios diverse. As a young professional, you don't need to put any money in bonds, government treasuries, or anything that is fixed income -- they just don't earn enough for what you are trying to accomplish. If you are under 35, you should have at least 20% of your portfolio in foreign investments (international stock). The remainder of your holdings should be a mix of domestic (US) stocks. For your 401k, this will mean mutual funds. For your Roth, the easiest way to get diversity is through ETFs (exchange traded funds). These are funds that act like stocks. You don't actually own any of the companies in the ETF (unlike mutual funds) but you benefit from making money off of the index (which exposes you to less risk). You should also look for ETFs that have low costs (expense ratios).
6) Do Not Mess with your investments more than once a quarter. Too often, people will react to the market and sell when there is drop and buy when there is a spike. These are the worst and most inefficient things you can possibly do. If you are young, you want to let your investments sit and not think about it often (once you've set it up like I'm suggesting). At a minimum, you should look at your portfolio once a year and re-balance (moving money to different investments) as necessary. As you get older, you will need to shift your portfolio away from high risk assets (international and small companies) and into more reliable assets (value stocks and some fixed income securities).
7) Once you have maxed out your Roth IRA (and that of your spouse) for the year, then work on increasing your 401K contributions up the maximum amount for the year (currently $17,500 per person). This may seem unattainable, but if you make small increases over time your lifestyle and household budget will adjust. One strategy is to increase your contribution every time you get a raise, that way there will be no real difference in lifestyle.
8) Do Not take money out of your 401K or Roth before retirement. The only time you should consider doing this is if there a dire situation -- someone died or is about to die, your house has burned down, etc. If you have to take money out, consider taking money out as a loan rather than withdrawal. You will pay interest but if you pay it back in time there will be no tax penalty . The whole point of putting money in these accounts is that you plan to use it solely for retirement (which is why you get the tax benefits). Additionally, there are better ways for getting access to money that won't put your retirement in jeopardy. Consider peer-to-peer lending (Prosper or Lending Club) as an option since the interest rates are often better than credit cards.
9) If you max out your 401k and Roth (and your spouses' accounts), then pay off your student loans and/or mortgage. Up to this point, I've assumed you aren't delinquent on your debt. If you are, however, get up to date before shifting money into retirement accounts. There are very few good reasons to be behind on making payments to creditors. If you are current on your debts and have your credit cards paid off, this is point where you start to make larger payments, starting with the loans with the highest interest rates.
10) Once you have all the above completed, consider putting money into other investments -- like a brokerage investment account. You will pay tax on investments like these but you are able to take deductions if you lose money (isn't America great!).
There are many other bits of advice I could impart on you, but I think for now this should be sufficient to get you started and well on your way to successful retirement -- one which you will be able to live free from fear of want.