“The reason saving comes before investing is that you need to have seed before you can sow it in anticipation of a harvest.” – Rajen Devadason
Common sense reader mailbag: My wife and I are in our 30’s and haven’t started saving for retirement yet. We have no idea where to start. The sheer amount of choices out there scares us. Where do we begin?
This is a question I recently received from a reader, but I’m sure many others can relate. With the state of the savings rate in this country, this is not an uncommon occurrence. An EBRI study shows two-thirds of workers have less than $50,000 saved and 28% have less than $1,000 in savings.
The study also showed that only 14% of American workers are very confident that they will have enough money to live comfortably in retirement.
According to the Federal Reserve, the most recent personal savings rate for the country is only 2.6% of disposable income. That is down from 8-10% in the 60s, 70s and 80s.
You could read scary retirement stats all day long but it still won’t help with your particular situation. There are so many options available that people tend to get overwhelmed. What should I invest in? Do I buy stocks or bonds? Where should I open an account? I have no idea how to choose a mutual fund or ETF? What percentage of my salary is the correct amount to save?
I can understand why people freeze up when trying to come up with answers to these tough decisions that can have a huge impact on their financial freedom and future. If you are starting with a clean slate it can be difficult to know where to begin.
The most important thing you can do is to just start saving. You can worry about gaining more investment knowledge after you have set up your account to start putting aside money on a periodic basis.
The first place you should look to save is with your employer. If your employer offers you a retirement plan like a 401(k) plan you should start by at least saving enough to get your employer match. Up to 66% of employers that offer a 401(k) plan also offer a match with the average match being just north of 4%. So if you contribute 4% of your salary out of every paycheck the employer would also contribute 4%, giving you an 8% savings rate.
This is a great deal that far too many people aren’t taking advantage of. Many employees complain when they only get a cost of living raise in the 2-3% range. If that’s the case, how could you turn down an extra 4% in your retirement account every year? That’s the equivalent of turning down a 4% raise each year if you aren’t saving enough to get the match.
The other great thing about workplace retirement plans is the fact that the money is automatically taken out of your check every time you get paid. You don’t even have to think about making it a conscious decision. You set a percentage or an amount and it’s done by your payroll department before it even hits your checking account.
If your workplace doesn’t offer a retirement plan then your next option is opening an IRA. A Roth IRA is a retirement account that allows you to save after-tax money with the bonus that you pay no taxes on those funds upon retirement. With a traditional IRA you get tax breaks now as a write-off to your income but have to pay taxes when you retire. There are pros and cons to each so just pick the one that makes the most sense for your situation and start saving.
For this option, you will have to choose a fund provider. Keep it simple when looking for a place to open an IRA. They should be low cost, easy to open, easy to understand with good lines of communication and the ability to make your investments automatically.
Vanguard, Charles Schwab and T. Rowe Price all fit the bill in this case. All three offer low-cost index funds and keep things simple. They all offer help opening new accounts if you need it and it shouldn’t take you more than a half hour to do so. You simply enter in some basic personal information. Then they ask for your bank account details for funding purposes. Finally, you can choose your investments and make the contributions automatic.
Starting an investment portfolio can also be overwhelming so make sure you look at my post on how to build a common sense investment portfolio. I outline an easy to understand and implement portfolio which you can use to help determine your mix of funds (asset allocation).
Also make plans to take a look at your goals and contribution amounts on at least an annual basis. You can’t just set these amounts and forget about it. You need to slowly and systematically increase the amount you save every year to reach your goals. Don’t try to save an unrealistic amount right off the bat that you won’t be able to stick with. It’s better to take incremental steps and ease into the process to assure that you will keep saving over time.
Start saving early and let compound interest help your cause. If you haven’t started yet there is no better time than the present. Don’t worry if you have little knowledge on the markets or investments. How much and how often you save will have a much larger impact on your ending balance.
Pareto’s 80/20 rule states that 20% of the work results in 80% of the results (via The 4 Hour Work Week). Saving and asset allocation are the 20% in the retirement savings equation. Get these two decisions right and you can continue to learn more as you go.