The new year is the traditional time to make resolutions on things we'd like to do better. And unless you're one of Warren Buffett's superinvestors and have already mastered the stock market, you may find that you have room for a resolution or two for improving your investment strategy.
Unfortunately, resolutions are notoriously hard to keep. If they weren't, we'd all be rich, thin, non-smoking marathon racers. But what if there were a way to get paid to keep your resolutions? Wouldn't that help motivate you, at least a little bit?
Fortunately, there often are ways to get paid from your investments, regardless of whether you're resolving to improve your ability to buy, sell, hold, or sock away more. This is the second article in a short series on how to do just that, and it focuses on how to essentially get paid to invest more.
How is that possible?
It's possible -- very possible, in fact -- if you've got a traditional 401(k) or 403(b) retirement plan at work and you aren't yet contributing the maximum allowed. And since the maximum just increased on Jan. 1 to $17,000 per year (plus an additional $5,500 "catch-up" for those 50 and older), chances are you've now got room to raise your contribution, even if you were at the maximum before.
Every dollar you put away in one of those plans is tax deferred. In essence, if you're in the 25% federal tax bracket, you get $25 back in the form of a lower federal tax bite for every $100 you contribute. Your state may also give you a break on its income taxes, too. Add to that the potential of an employer match, and you could essentially double your money, just by contributing more to the plan. That's one heck of a payday -- and some proper encouragement to keep your resolution to invest more.
Even if you don't get a match, traditional 401(k) or 403(b) investors get a tax break when contributing, tax-deferred compounding, and the simplicity of investing directly from their paychecks. Those benefits make those plans easy and smart places to start when looking to keep your resolution to invest more.
Where to invest
As great as those retirement plans can be, one of the common problems with them is that the program sponsors offer the plans, but typically very little in the way of education on where to invest once your money is in the plan. It really is an individual decision, based on where you are in life, your risk tolerance, and what the rest of your financial circumstances look like. Still, here are some fairly common options and the type of person who'd be interested in each of them.
- U.S. domestic stocks: Usually, plans will offer the option to buy an index fund that tracks U.S. stocks. If your plan offers SPDR S&P 500 (NYSE: SPY ) , grab it -- it inexpensively tracks the S&P 500 index of large U.S. stocks. This is an investment for someone with a fairly long time horizon, a desire to invest in America, and/or the willingness to take the short-term lumps of market volatility for the potential long-term gain that typically comes from stock ownership.
- Foreign stocks: Most plans will take the additional step of offering up international funds. Vanguard FTSE All-World ex-US (NYSE: VEU ) is a good choice here, again making a good investment for someone with a fairly long time horizon and the willingness to take on volatility for potentially better long-term returns. The key difference between this and the domestic fund is that with this fund, you're also hoping for faster growth overseas as the rest of the world catches up to the U.S. standard of living.
- Real estate: Less frequently, your plan will offer funds tied to real estate. The Vanguard REIT Index ETF (NYSE: VNQ ) invests in real estate investment trusts, or REITs, which own things like malls, office buildings, and hotels. Historically, these have been viewed as ways to get better income than standard stocks and better growth than bonds, and are geared toward investors wanting some appreciation with less volatility than stocks. That perception changed somewhat when the real estate bubble burst, but over the long run, real estate will likely revert to that traditional income-with-a-little-growth model.
- Bonds: Nearly all plans will offer bonds. The Vanguard Total Bond Market ETF (NYSE: BND ) is geared to more conservative investors who are willing to trade in almost all growth opportunities for the greater certainty that comes from coupon payments and a known value at maturity. Bonds also have the advantage of being higher up the capital chain than stocks, which gives them advantages if a company is headed for bankruptcy -- a "sleep at night" benefit for investors.
Even if your plan doesn't offer Vanguard ETFs, you may find similar mutual funds or ETFs that fill the same purpose. And of course, you can certainly invest in multiple options in your plan. There are benefits in diversification, as it's rare that those major asset classes all move in the same direction at the same time for very long periods of time.
Where to be cautious in investing
One place you should not invest too heavily in when it comes to your retirement is your own employer's stock. For instance, a study published shortly after Enron's collapse indicated that 72% of Home Depot's (NYSE: HD ) defined contribution plan assets were invested in the company's own stock. Home Depot is certainly no Enron, as the stock has actually found ways to perform well despite the slowdown in the home improvement retailer's financials during the recession. But a common scenario that often plays out is that a company's business slips, its stock tanks, and then it starts restructuring and downsizing to try to recover -- sometimes jeopardizing workers' retirement plans in the process.
If you find yourself in the crosshairs of such a downsizing effort with too much invested in your employer's stock, you could find yourself with both no paycheck and a substantially reduced nest egg. And that's not a comfortable place for anyone to be.
Still, if your investment resolutions include a desire to invest more for your future, your 401(k) or 403(b) plan is a great place to start. Between the tax breaks for investing and the potential of an employer match, it's both one of the easiest places to invest and the easiest way to essentially get paid to sock away more money.