We only endorse products that we truly believe in. Some of the links below may earn us some extra guac at no additional cost to you. Please pass the chips & thank you for feeding our habit.
It’s something we all need to think about as adults: Retirement. While it might seem like something that’s far off and decades away from worrying about, I can assure you that the sooner you start taking steps towards retirement the better off you’ll be!
Fortunately, there’s just one very important but very critical first step towards building your net worth. It’s called “paying yourself first”. According to self-made millionaire and bestselling author David Bach, this is one, proven, easy way to get rich.
So how do you take that first step? Here’s what you need to know about investing for retirement and the tools you can use that help give you the best returns possible.
Why You Should Invest Instead of Just Save
The first thing you’ll want to know about paying yourself first is that you won’t just be “saving” for retirement, you’ll be “investing”.
When most people talk about saving for retirement, they’re not talking about putting money in a regular old bank savings account like you probably did when you were a kid. Why? Because unfortunately, banks don’t pay high levels of interest (like they did in the past).
To really grow your money, you’re going to need to put it into assets that produce a higher rate of return and create something called compound interest. Compound interest is when money grows on top of the money you’ve invested plus any earnings that you’ve gained.
For example, you might think that saving $500 per month for the next 30 years would produce:
$500 x 12 x 30 = $180,000.
However, that’s not even close! Thanks to the magic of compound interest, $500 per month invested for an average market return of 10 percent over 30 years would have the potential to grow to $986,964!
(You can try this for yourself using this free online calculator here.)
To get returns like this, you’re going to need to invest in financial products that can keep up with the markets such as mutual funds or ETFs (exchange-traded funds). Generally, these types of funds are just collections of stocks, bonds, and other securities that have the potential to grow over the long-term.
Sounds good, right? So how do you get started?
Your Workplace 401k Plan
To begin investing for retirement, most U.S. workers don’t have to look much further than their workplace. Nearly 81% of companies now offer what’s called a “defined contribution” retirement plan to their employees through what’s known as a 401k.
How a 401k Plan Works
Investing in a 401k is simple. You decide how much of your paycheck that you’d like to put into it every time you’re paid. Then, when your company gives you a paycheck, before taxes are taken out, they will deduct this amount from your paycheck.
While that might sound like a small thing, it’s actually an extremely incredible deal. Think about if you saved $10,000 this year in your 401k. If you had paid taxes on this money, then you’d probably only have kept $7,500. But thanks to your 401k, you get to keep the whole amount!
If that’s not encouraging enough, many companies will also match your contributions, sometimes up to dollar for dollar. That’s just more tax-deferred money that you can use to invest and grow your net worth.
401k Investment Options
Most 401k plans are generally made up of various mutual funds for you to choose from. These can be funds that focus on stocks, bonds, real estate, or just about any other combination of securities.
Unfortunately, you are tied to only select from the funds that your 401k plan offers. Also, since there are thousands of 401k plan providers, every company’s investment options will be just a little bit different from the next.
What you choose to invest in is entirely up to you. Generally speaking, it’s a good idea to invest in a variety of different types of funds rather than just one specific type. This is what’s known as “asset allocation”.
Though there are lots of different opinions about the best way to practice asset allocation, one easy to follow rule of thumb is to take the number 120 and subtract your age. This is the percentage of your investments that should be in funds containing stocks. The remaining amount should be invested in funds that focus on bonds.
Your Tolerance for Risk
Another big consideration for investing is something called your “tolerance for risk”. This is more of a feeling about how well you respond emotionally to dips in the market.
For example, stock-based funds generally produce the highest returns. But they also have the greatest tendency to lose money in the short-term as the markets fluctuate. One extreme example of this is during the Great Recession back in 2008 when the stock market lost nearly 50% of its value.
If the thought of seeing your nest egg cut in half for over a year makes you sick to your stomach, then you may want to invest in safer, more conservative funds that focus on bonds or even cash-based assets.
Setting Up an IRA
Your 401k isn’t the only tax-advantaged tool you have at your disposal when it comes to investing for retirement. Most U.S. savers will also be able to use what’s called an IRA or Individual Retirement Account.
Similar to a 401k, IRAs give you the benefit of investing money tax-deferred for long-term, compound growth. However, the major difference is that you can set up an IRA with any financial institution of your choice. Your employer is not involved in the process whatsoever.
IRA Investment Options
Another big advantage of IRAs is that your options for investing are far greater than they generally would be with a 401k.
Because you get to pick the financial service, you can choose any number of different securities to fill your IRA. You can invest in mutual funds or ETFs just like you would with a 401k. Or you can select individual stocks, annuities, precious metals, and even real estate. The choice is yours!
Getting Help from a Robo-Advisors
If opening an IRA and picking from all of those investment choices sounds a little bit overwhelming, then don’t worry. Lately, there’s a new trend when it comes to investing that’s been gaining popularity: Letting a computer pick your funds for you.
So-called robo-advisors are simply computer algorithms that take some basic information about you, your risk tolerance, and investment goals, and then select the best type of funds for them to invest in.
Over the past decade, some well-known robo-advisors such as Betterment, Wealthfront, and M1 Finance have been making headlines as top choices for investing in IRAs among millennials. This is not just because they’re easy to work with, but also because they have a strong emphasis on customer support and making the process of investing as easy as possible.
Don’t Wait to Get Started
While there are lots of great ways to invest for retirement, the number one piece of advice I can tell you is not to delay. Whether it’s a 401k, IRA, or something else, pick one and get started as soon as possible. The sooner you start taking advantage of tax-deferred savings and compound growth, the better your chances of retiring with more than enough money to live comfortably for the rest of your life!
Contributor’s opinions are their own. Always do your own due diligence before investing.
- 5 Things You Can Do to Retire Early
- Investing: Why It’s Important and Why You Need to Start Doing It
- How to Start Investing