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Given what’s at stake, saving for retirement can feel like a financial and emotional burden. And knowing what to do –and not do – can be downright confusing. Time for a deep breath. You can ace saving for retirement by following these 10 lessons. Do Not Procrastinate. The earlier you get started saving, the more…
Given what’s at stake, saving for retirement can feel like a financial and emotional burden. And knowing what to do –and not do – can be downright confusing. Time for a deep breath. You can ace saving for retirement by following these 10 lessons.
Do Not Procrastinate. The earlier you get started saving, the more time you give your money to compound. Underestimating the power of compounding is one of the biggest retirement mistakes.
Let’s says you save $500 a year between the ages of 25 and 35. You will have nearly $82,000 assuming a 6 percent annualized return at the end of the 10 years. Even if you never save another penny, letting that pot keep growing for another 30 years will give you around $470,000 by age 65, built on the $60,000 you invested for the 10 years between the age of 25 and 35.
If you wait until age 45 to get started on saving, you’ve squandered 20 years of having compounding do the heavy lifting for you. To land at age 65 with the same $470,000 will require saving about $1,000 a month for the 20 years between age 45 and 65. That means saving $240,000 of your own money to end up with the same money that $60,000 could generate for you if you gave it the extra twenty years to compound.
Your Savings Rate. Most employers now automatically enroll new employees in their retirement plan. That’s all good, but it also has a big problem. When employers provide automatic enrollment, they typically set your contribution rate at 3 percent of salary. That is way too low. Financial pros typically recommend saving at least 10 percent, and preferably 15 percent to have a solid shot at a comfy retirement. Push yourself to save more; it’s easy to contact H.R. to up your rate.
Don’t Turn Down the Bonus. If you have a workplace plan, make sure you are contributing at least enough to grab the maximum company matching contribution. Nearly 1 in 5 retirement savers do not save enough of their salary to earn the max match.
Hands off the Cookie Jar. Any time you leave a job, you are allowed to cash out your 401(k). That can be very tempting. But it’s a surefire way to undermine your retirement security. Cash-out a $10,000 401(k) at age 40 and you’re going to net less than $7,500 after paying income tax and the 10 percent penalty for withdrawals made before ag 59 ½. Keep the $10k growing for another 25 years and you will have around $43,000, assuming a 6 percent annualized return.
Plan on a Loooooong Life. A woman who makes it to age 65 today has a 50 percent probability of still being alive at age 88. A man who makes it to 65 has a 50-50 chance of still being alive at 85. Living into one’s 90s is no longer an outlier event. Use that as motivation to save more in retirement accounts.
Lean into Bear Markets. If you are investing for a goal that is still decades away, you should actually look forward to bear markets (when stocks lose at least 20 percent.) If you keep calm and continue to contribute money to your 401(k) or individual retirement account (IRA) you will be buying shares of stock that are on sale. Might it take a few years for stocks to rebound? Yep! Try to focus on what matters: you aren’t retiring for a long time so you don’t need to worry about the down markets.
Don’t Be a Market-Timing Fool. It is perfectly natural to think about getting out of stocks when they start to fall. But it’s a costly mistake. The data research firm Morningstar took a look at the period 1997-2017. That included a couple of ugly bear markets. If you stayed calm and didn’t bail out of stocks throughout that entire 20-year stretch you earned a 7.2 percent annualized return. But if you had missed just the 10 best days for stocks in that 20 year period your return was cut to 3.5 percent. If you missed the 30 best days among the 5,217 trading days you would have a negative return on your stock portfolio.
Avoid Taxes Completely with an HSA. Opting for a high deductible health insurance plan (HDHP) makes you eligible to save money in a health savings account (HSA). An HSA outdoes even a Roth 401(k) or Roth IRA as it delivers three tax breaks: you get the upfront tax break on deducting the value of your contribution, your money grows without any tax while it is invested, and as long as you use withdrawals to pay for qualified health care expenses you will not owe a penny of tax.
Consider Paying Taxes Upfront. Traditional 401(k)s and Traditional IRAs dangle what can be a tempting tax break: you can, in most cases, get a tax break on the money you contribute. But keep in mind that you will owe income tax on every penny you pull out in retirement. If you use a Roth 401(k) or Roth IRA you effectively pay the tax when you make your contribution; you will not get any upfront tax break. The payoff comes in retirement: withdrawals from Roth 401(k)s and Roth IRAs are 100 percent tax-free.
Focus on Fees. Mutual funds and exchange-traded funds charge an annual fee, called the expense ratio. Expense ratios on index mutual funds and ETFs can be less than 0.10 percent, while some funds charge more than 1 percent. That’s a huge difference. Over a 40-year investment horizon, $10,000 invested in low-cost funds (average expense ratio of 0.10 percent) or ETFs will grow to around $100,000, assuming a 6 percent gross annualized return. If you’re invested in a fund that charges a 1 percent expense ratio you will have about $70,000.
About the author
Carla translates business and personal finance concepts into engaging content that helps individuals make more confident choices in how they manage their money. Her work appears in The New York Times, Money Magazine, Barron's and Consumer Reports.