Investing in retirement is something everyone should do. Even small contributions can pay off in the future, particularly if you start investing early. If you invest $5,000 a year for 20 years with average annual growth of 8%, you’ll have $247,115. If you’re ready to start thinking about how you can prepare for your retirement, there are several avenues to explore. Evaluate these retirement investment options to determine which one is best for you.
- Many employers provide investment opportunities such as a 401(k), but there are ways to get employee matching for your retirement funds even when this isn’t available.
- Understanding the different types of investments will help you diversify for a lower-risk portfolio.
- Several types of funds are available that will manage diversification for you if you prefer a hands-off approach.
How Much Do You Need for Retirement Investment?
Understanding how much money you need for retirement is the first step to developing an investment plan. Your local cost of living, preferred leisure activities, health, and other factors will determine the total sum you’re working toward. A general rule of thumb is to have at least 80% of your current income available annually, but this number may fall short of your actual expenses if you hope to spend your retirement traveling or you incur significant health expenses. It’s best to create a detailed budget so you can get a more exact number.
You should also estimate how many years of retirement you need to pay for. The age that you’d like to retire at and your expected lifespan will help you come up with this number.
Finally, you need to factor inflation into your budget. Inflation averages about 3% a year, so you’ll need a progressively larger income each year to sustain the same quality of life throughout your retirement.
Get Your Finances in Order
Before you start channeling funds into your retirement investments, it’s important to make sure your other finances are in order. You’ll get the best return on your investments when you can comfortably leave them in place for five to 10 years. If you have a lot of debt and little savings, you may find that your investment plan is unsustainable. Before you begin investing, you should:
- Pay off your credit cards and any other debt with high interest rates of 10% or more.
- Create an emergency fund with at least three months of living expenses.
- Develop a spending and savings plan that will help you avoid future debt.
Establish Retirement Accounts
When you’re ready to begin working on your retirement investments, one of the first things you should do is establish a retirement account. There are two primary options that you should consider.
401(k) accounts are typically available through employers. Some will match your contributions, which translates to free money for your retirement. There are two primary options:
- Traditional 401(k): Contribute pre-tax money to this account and reduce your taxable income for the year. The money grows in the account and is taxed at the regular income rate upon withdrawal.
- Roth 401(k): Contribute post-tax money that grows and is then available for withdrawal free of taxes.
Read the fine print regarding your 401(k) so you understand exactly how it works. Some of the things you need to know include:
- When the funds vest, or become yours. Some companies have a long vesting schedule, so you need to stay with your job until you reap these rewards.
- Fees. Some 401(k) plans have high fees. Ideally, your fees will be 0.25% or less.
- A selection of investment options. Low-fee index funds are one of the best options.
Individual Retirement Account (IRA)
You can open an IRA through a brokerage, which makes this an ideal option for those who are self-employed or who don’t have a good 401(k) plan through their employers. There are several options.
- Traditional IRA: Contributions are not taxed when you make them but are taxed upon withdrawal
- Roth IRA: Contributions are taxed before you make them but are not taxed when you withdraw your funds
- SEP IRA: Offers higher contribution limits aimed to serve self-employed earners. Contributions are tax-deductible and taxed on withdrawal.
- SIMPLE IRA: Allows employer matching, which is ideal for small companies that don’t have 401(k) plans set up. Contributions are not subject to federal income tax witholding.
Explore Your Investment Options
There are several types of investments you can work with to enhance your retirement savings. Understanding the options will give you an idea of where to start with these.
- Stocks: Stocks give you partial ownership of the associated company. Some offer dividends so you can earn money from them quarterly, while others only pay out upon liquidation. The stock market can be complex and volatile, but smart trading strategies will help you build your retirement savings.
- Bonds: A bond is essentially a loan that you issue to the government or a corporation. The borrower will pay you interest until the bond matures, at which time the loan is repaid in full. Issuers can default on their bonds, but this is typically unlikely, particularly with bonds issued by the U.S. government.
- Exchange-Traded Funds (ETFs): An ETF is a portfolio of investments that helps you diversify. The assets in an ETF are selected to parallel the movement of a particular stock or bond index. Administration costs are lower with an ETF than with a managed portfolio, so this is a wise approach if you don’t want to manage numerous investments on your own.
- Mutual Funds: A mutual fund is a portfolio of stocks and bonds that’s professionally managed. The investments in a mutual fund are selected to align with a specific objective, such as low risk or high growth, so you can select a fund that aligns with your retirement investment goals.
- Annuities: An annuity is a contract between an insurance company and a policyholder. The insurance company guarantees a certain return on the capital and makes regular payments to the policyholder. Taxes are deferred on the principal until distribution, but you will face penalties and taxes for early withdrawal.
Build an Investment Portfolio
Now that you have a well-rounded understanding of the types of securities that you can invest in, it’s time to build your portfolio. You can do so on your own by purchasing a selection of securities as outlined above, or you can use one of the following tools for a streamlined approach to your portfolio management.
A total-return portfolio is a selection of stocks and bonds that are focused on providing long-term growth. This is an alternative to a portfolio designed to allow you to live off dividends and interest. The approach is designed to minimize exposure to market volatility and risk. There are many ways to structure a total return portfolio so it aligns with your timeline and risk tolerance.
Retirement Income Fund
A retirement income fund is a type of mutual fund that allocates your money through a diversified portfolio that includes both stocks and bonds. The goal of this fund is to provide you with monthly income that you can live off without depreciating your principle significantly. Depending on the investment strategy utilized by the fund, however, you may find that some of your payouts do diminish the principle.
Index Mutual Fund
An index mutual fund enables you to diversify your portfolio and invest in a number of outstanding stocks without purchasing full shares on your own. Investors pool their money for shares of a fund that in turn contains shares of several different types of stock. Some retirement plans offer broad-based index funds that give you access to 3,000 or 4,000 companies. Your employer may even offer a match on your investment, which is a valuable perk to utilize.
A target-date fund is a type of mutual fund that includes investments in other mutual funds. This gives you ample diversification with minimal effort. These funds track your retirement date and adjust accordingly, so you’re working with higher-risk investments earlier in life and minimizing your risk as you get closer to retirement. Many 401(k)s offer access to a target-date fund as an easy way to enhance your retirement investments.
There are many ways to approach your retirement investment plan, all of which carry some degree of risk. Consider your options, your timeline, and your available funds to find the perfect combination. Ideally, you will find a plan with the potential to turn whatever you can afford to invest into a livable income throughout your retirement. The sooner you begin investing, the greater your potential for a fully-funded retirement.
For more help on retirement investment, turn to Raging Bull. Hone your retirement investment strategies further with an informational webinar to help you better navigate the stock market, or get a free e-book to learn more about trading.