This article is part of our Better Investor series, in which The Motley Fool goes back to basics to help you improve your returns and be more successful with your investing.
Your retirement is the single largest financial event of your life. The money you sock away throughout your career for it will likely represent your largest investment, since it'll have to last as long as you do. And unfortunately, there are no do-over opportunities -- especially late in your retirement, it's hard to earn money to replace a depleted nest egg.
Social Security should help somewhat. On average, it covers 40% of a typical retiree's prior income, but that amount is expected to drop to around 30% when Social Security's trust fund evaporates in a few decades. For the rest of your retirement needs, unless you're one of the few who still has a decent and well-funded pension, you'll need to rely on your own investments.
4 keys to improve your success
There are four very important tactics available to help most people improve the odds of retiring comfortably. While not all of them might be available to you, the more of them you can put to work, the better your ultimate chances of success.
- Start early: The earlier you start investing, the longer your money has to grow. That gives you two huge advantages: You can invest less, get away with earning a lower rate of return, and still wind up fine.
- Defer taxes: If you save for your retirement inside a tax-advantaged plan like an IRA, a 401(k), or a 403(b), your money can grow without any taxes owed on dividends or capital gains while it's invested within the plan. Additionally, many of those plans also allow contributions with pre-tax money, which brings us to the third tactic...
- Take advantage of free money: Be it tax deferrals, employer matches, or some combination of both, qualified retirement plans can be a great way to get your hands on some extra dough. In fact, if you get both a decent match and a tax deduction for your contribution, you can instantly double your money in your retirement account, thanks to that free cash.
- Diversify intelligently: There are no do-overs in retirement investing, and there is also no such thing as a truly risk-free investment. That said, you can manage and balance risks, and one of the strongest tools in your risk management arsenal is diversification. Done right, in fact, it's the closest thing to a "free lunch" the market has to offer.
By putting all four tools at your disposal, you greatly improve your chances of a comfortable retirement.
Where and how to invest?
Many people concentrate retirement investing in their employer's retirement plan, thanks to things like:
- The convenience of automatic payroll deduction,
- The ease of signing up for the plan, and
- The potential of free money available from company matches.
All those are valid reasons to invest via your employer's plan. And since most traditional 401(k) plans let you sock away as much as $16,500 a year (or $22,000 if your 50 or older), that's a great place to get started.
The downside to most employer-sponsored plans, though, is that your choices are limited to whatever funds the administrator chooses. That said, even then you could have good options among those limited selections. Good things to look for include:
- Domestic stock index investments: Options like Vanguard's Total Stock Market (NYSE: VTI ) ETF give you instant exposure to more than 99% of the U.S. market. While that's great diversification within its class, it does still only cover stocks based in the U.S.
- International stock index investments: Options like Vanguard's Total International Stock (Nasdaq: VXUS ) ETF can own thousands of stocks in dozens of countries other than the U.S. That gives you exposure to stocks elsewhere around the world, improving your diversification not only by industry but geography as well.
- Inflation-protected bond investments: Options like the iShares Barclays TIPS Bond (NYSE: TIP ) ETF own bonds whose values adjust based on inflation rates, providing a measure of protection against rising prices.
Some companies also offer their own stock as part of their retirement plan. You'll want to proceed with caution. There's more risk in owning individual equities than diversified funds. Additionally, there's a potential "double whammy" of losing both your job and your savings if the company you work for and own happens to go bankrupt, like Enron did.
That said, it's never a good idea to turn down free money from a match, even if it does come in the form of your employer's stock. If you do find yourself holding a lot of appreciated employer stock in your retirement plan, there's a special strategy called Net Unrealized Appreciation, or NUA. That strategy can help you reduce the taxes you'd otherwise pay to withdraw that employer stock from your retirement account. It's a nice potential reward for a risky position.
What are you waiting for?
These days, the bulk of your retirement will very likely be based on your own investments. The sooner you get started, and the more you put time and the rest of those four key tactics to work for you, the better your chances will be to assure your golden years are truly golden.
Stay tuned throughout our Better Investor series and get the advice you need to succeed with your investments. Click back to the series intro for links to the entire series.