This is Not an Investment Course.
Before investing, you should really consult several financial advisors to deciding on a course of action. What I would like to do here is to give you the advice that I give my tax clients when they ask me my view on retirement. It involves two basic points. Where do you get the best return for your money. How do you take advantage of matching and shelter part of it from tax liability. This will enable you to know enough to tell if the financial advisors you are interviewing have your best interests in mind.
First of all, contrary to sensationalism the national news media dishes out about the stock market, as a long term investment it has averaged just below 12 percent return on investment throughout its history. Ibbotson Research says that 97 percent of the five-year periods and 100 percent of the ten-year periods in the stock market's history have made money.
The first thing you have to do is stop worrying about the news media reports of doom and gloom, and how people are being totally wiped out every time the market makes a correction. It may sell papers, but the smart investor knows it is just part of the process in a free market.
The safest way to invest in the stock market is with growth-stock mutual funds. They are lousy for short-term investments because of the way the market goes up and down, but great for investments of over five years. You get more security if you spread you investing across several different segments of the economy. I know this works because several years ago, we reallocated the funds in our retirement plan to spread the risk. When the market fell in 2008 and we kept talking to and hearing about people whose investments had plummeted, we were almost scared to look at our account. When we finally did, we found that we had actually made quite a bit of money in the midst of the turmoil.
Mutual Fund Considerations
Open Book traversal links for Mutual Fund Considerations configuration options
So, how do you find a good mutual fund? Here's the short version. First of all, they should have a good track record of winning for more than five years, ten years is even better. Ignore their one-year to three-year statistics, because we are talking about long-term investing here. Then spread your investments evenly across at least four types of funds. Here are some recommendations:
- Growth and Income funds (sometimes called Large Cap or Blue Chip funds.)
- Growth funds (sometimes called Mid Cap or Equity funds, or S&P Index fund.)
- International funds (sometimes called Foreign or Overseas funds.)
- Aggressive Growth funds (sometimes called Small Cap or Emerging Market funds.)
Mutual funds spread the risk over several companies and diversifying your funds spreads the risk over all segments of the economy. Even in a recession, there are other areas of the economy that are prospering.
The second part of the equation is to decide what type of plans to put your mutual funds into. I first recommend that if people have access to a 401K plan with employer matches, to put into the amount that the employer matches. For instance, if the employer matches the first four percent of what you put into your 401K, then put into the 401K four percent of your fifteen percent to invest.
Next, you and your spouse should each fund a Roth IRA (Individual Retirement Account.) You can invest up to $5,500 per year, per person into a Roth IRA. (Your tax advisor can telling you how much you qualify to invest.) The great thing about the Roth is that your money grows tax-FREE if you leave it in the account until at least age 59 1/2. For example, if you invest $3,000 a year from 30 years, and your mutual funds average 12 percent, you will have invested $90,000, but have a total of $873,000 in your account. This entire amount may be withdrawn at retirement without you paying any taxes on it. In fact, it is one of few places in the U.S. tax code where you can get a decent return and pay no taxes.
Once you have gotten any match you can get, and then have fully funded your Roth IRAs, put the rest of the fifteen percent into your 401Ks, 403Bs, 457S, or SEPPs (for self-employed). One other thing you should look for. Congress recently passed legislation that created Roth 401K plans. Be sure and find out if your employer offers this type of plan yet and take advantage of it if available. It gives you the opportunity to also grow your 401K tax-free.
Let's look at an example. Using the average American income of $40,816 per year, taking fifteen percent of that would be about $6,000 a year or $500 a month. (Remember that you no longer have a car payment to suck up that amount each month.) If you were to invest $500 a month into a Roth IRA from age thirty to age seventy at an average 12 percent growth, you would have $5,882,386 in tax-free retirement funds!
How big does your next egg need to be at retirement? If you want to live off of the interest of your retirement money, then you should be able to live off of eight percent of your amount accumulated. If your investments make 12 percent growth, and inflation takes four percent, then that leaves eight percent you can take out without touching the principle. With no payments, if you can live on $40,000 a year, you would need a nest egg of $500,000.
Anyone can live their dream retirement if they just make a plan and follow through on that plan.