Retiring with all the money you'll ever need isn't complicated, but it isn't easy, either. If you want to retire wealthy, you'll need to adopt these four critical retirement-saving best practices.
1. Consistently save enough money
That deceptively simple statement has two important components: "consistently" and "enough." Consistently means contributing to your retirement savings accounts month after month, year after year. And saving "enough" means you've figured out how much you'll need to invest in order to have a satisfactory retirement income, and you actually contribute at least that amount to your retirement accounts.
Of course, before you can contribute "enough," you need to know how much "enough" is. A retirement calculator can help you figure out how much you'll need to have in your retirement savings accounts when you retire and therefore how much you'll need to save to hit your goal. For most savers, the simple approach of contributing 15% of your income to a retirement savings account will also do the trick.
Whether you choose the custom approach or the off-the-rack method for determining how much you need to contribute, the next step is to actually contribute that much money on a regular basis. An automatic transfer is by far the easiest and most reliable way to guarantee that you'll make contributions on time, come hell or high water.
Nearly all 401(k) plans have automatic contributions built into them: You pick a percentage of your paycheck, and the HR department will stick that money into your 401(k) before it can even make its way into your paycheck. If you don't have a 401(k), you'll have to settle for making after-tax contributions to your IRA. Automatic IRA deposits are usually quite easy to set up with either your IRA trustee or your bank, and if you use a traditional IRA, you can then deduct your contributions from that year's taxable income (assuming you meet certain requirements).
2. Build a diversified portfolio within a tax-advantaged account
The benefits of using a tax-advantaged account for your retirement savings can't be overstated. Using a 401(k) or IRA instead of a standard brokerage account will likely save you thousands of dollars every year in taxes, either at the time you make the contributions (for traditional 401(k)s and IRAs) or at the time you take the money out (for Roth accounts).
For example, let's say you make $80,000 per year and you decide to save 15% of your income ($12,000 per year) for retirement. If you put that money into a 401(k) from pre-tax dollars, you reduce your taxable income for the year to $68,000. Assuming you're in the 25% tax bracket, your 401(k) contribution will save you $3,000 in federal taxes per year.
Once your contributions make it into your tax-advantaged account, the next step is to choose your investments. We'll go into this in more detail in the next two sections, but for now it's important to understand the need for diversification. Diversifying means spreading your investments across a variety of assets, thereby lowering your risk of losing huge sums of money in the event that one of those assets goes bust. At a minimum, you'll want to split your investments between stocks and bonds. A common and fairly reliable way to allocate retirement investments is to subtract your age from 110 and put that percentage of your money in stocks, with the remainder in bonds.
3. Adopt a long-term investing strategy
When you invest your retirement savings, you're preparing for an event that's likely several decades in the future. Early on, when retirement is still at least 30 to 40 years away, you can use that huge time window to your advantage by heavily weighting your portfolio toward stocks. Stocks are volatile, which makes them risky in the short term, as returns in any given year can vary tremendously. However, over long periods of time, stocks have produced higher returns on average than just about any other investment.
A buy-and-hold investment strategy is a good choice for any investor, but it's ideal for a retirement savings portfolio. Attempting to time the market usually results in much lower average returns than a simple buy-and-hold strategy. And when you can hold a particular stock or mutual fund for decades, you'll have a chance at tremendous growth. Best of all, thanks to your tax-advantaged retirement savings account, you won't have to worry about capital gains taxes once you do sell those highly appreciated investments.
4. Protect your investments from economic stressors
There are quite a few factors that investors just can't hope to control. You can't change the interest rate environment, the rate of inflation, or the direction of the stock market. What you can do, however, is build a portfolio that's robust enough to survive these economic complications.
The best way to protect your portfolio is to diversify it more extensively than just splitting your funds between stocks and bonds. Different types of stocks react differently to various economic events. For example, REITs react more like real estate than stocks to inflation and interest-rate changes, so putting some of your stock money into one or more REITs gives you some protection from the events that tend to reduce the value of your stock holdings. And building a bond ladder will give you considerable protection against rising interest rates. It's also wise to invest a percentage of your retirement savings in non-U.S. assets; specialized mutual funds and ETFs give you an easy way to invest in foreign stocks and bonds.
Retiring wealthy simply requires saving enough and doing the right things with your savings. But you don't have to be Warren Buffett to invest your retirement savings wisely; choosing a few index funds that diversify your holdings and sticking with those funds over the long haul can be all it takes to ensure a comfortable retirement.
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