It may be decades away, but pensions are few and far between in the private sector these days, which puts the responsibility of building your retirement nest egg squarely on you. Follow these simple tips to get started on the path toward financial security.
1) Create a Starting Point
Before you start investing, it is important to have a complete understanding of your overall financial picture, says Jean Wilczynski, financial advisor at Exencial Wealth Advisors in Old Lyme, Connecticut. Create a personal balance sheet that includes income, expenses, assets (your home, car, cash, investment accounts) and liabilities (student loans, mortgage, credit card debt). "Knowing where you are today financially is an important data point for setting your financial course for the future you want to have," Wilczynski says.
2) Build an Emergency Fund
It's hard to invest if you are living paycheck to paycheck and using your credit card for unexpected emergencies such as car repairs or medical bills. "Start by just trying to save $1,000 or $2,000 and have that in a savings account in case you have an emergency that comes up," says Ben Barzideh, wealth advisor at Piershale Financial Group in Crystal Lake, Illinois. "Eventually, try and beef up that emergency fund to cover at least three to six months of living expenses."
3) Pay off Your Debt
Paying off debt is a great investment, says Ann Minnium, certified financial planner at Concierge Financial Planning in Scotch Plains, New Jersey. "If you are paying down a 6 percent loan, you are earning a 6 percent return on your investment. This is especially meaningful in today's environment, where stocks are down 5 percent year to date," she says. "Debt continues to be a huge problem among people who want to retire. Plan to be debt-free, including that mortgage, by 65."
4) Set up Automatic Retirement Savings
Create automatic transfers to retirement savings through payroll deductions to your 401(k) at work, or to a Roth or regular individual retirement account if you don't have a plan at work, Wilczynski says. "Make sure that you contribute enough to get the full company match if there is one," she adds. Don't leave that money on the table.
5) Don't Count on Social Security
"Bad news: The three-legged stool of Social Security, pension and savings really only has two legs – Social Security and savings," Minnium says. "Even that Social Security leg may only be a fraction of a leg by the time 30- to 40-year-olds get old enough to receive it. It's more important than ever for 30- to 40-year-olds to be socking it away. I recommend saving at least 15 percent to 18 percent of salary for retirement."
6) Buy a Home
Owning a home offers the opportunity to build equity and earn tax deductions, Barzideh says. "If you can, put 20 percent down towards a house, as that will avoid having to pay for private mortgage insurance each month, which could be anywhere from $200 to $300 a month of additional cost for most homes costing between $200,000 to $300,000. Your mortgage payments, including property taxes, should not be more than 25 percent of your take-home pay," he says.
7) Explore Target-Date Funds
Not sure where or how to invest? No problem. The 401(k) and the securities marketplace is full of target-date mutual funds and allocation exchange-traded funds, Minnium says. "Consider investing in a target-date fund for the year of your expected retirement. This will enable you to achieve a balanced portfolio that will self-adjust as you age," she says. "Don't let your nest egg accumulate in cash, since inflation even at 1 percent or 2 percent will erode your purchasing power."
8) Don't Forget to Diversify
Diversification helps even out a portfolio's performance over time, says Derek C. Hamilton, certified financial planner at Indianapolis-based Elser Financial Planning. "In your 30s and 40s, history suggests you are wise to invest between 60 percent and 95 percent in stocks, with the rest in bonds and cash, depending on your goals and comfort with inevitable market ups and downs," he says. "Use low-cost mutual funds and ETFs to easily access hundreds of U.S. and international stocks and high-credit-quality bonds."
9) Invest in Whole Life Insurance
Explore life insurance options. Pamela Yellen, founder of BankOnYourself.com and author of "The Bank On Yourself Revolution," points to a type of dividend-paying whole life insurance policy that can be used as a savings vehicle. "It has riders or options included that make your cash value in the policy grow significantly faster than a traditional whole life policy, especially in the early years. These policies enjoy a predictable return that is dozens of times more than a savings account or CD is paying today," she says.
10) Start a 529 College Savings Plan
If you have children, start a 529 plan to save and invest for college. "The nice thing about 529 plans is that the money grows tax-free and comes out tax-free if it's used for qualified college expenses," Barzideh says.
11) Pay Attention to Fees
Yellen says you should avoid investing in any fund that charges annual fees of more than 0.25 percent. "You are likely paying 1 percent to 2 percent a year, which may sound insignificant. But the fees you pay in these plans compound against you over time," she says. "An annual fee of just 1 percent per year will devour 28 percent of your savings over the next 35 years, according to the Department of Labor."
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