Unless you are independently wealthy, saving money today to ensure that you have enough money for retirement years down the road is not an option—it is a requirement.
Unfortunately, inertia is a powerful force, and the transition from not saving to saving can be intimidating for most people. Much financial and investment advice is geared toward individuals who have already begun saving and investing for the future. The following are some strategies for those interested in initiating the process.
- The most critical step toward saving for the future is to begin saving.
- The government and many businesses provide incentives to save, such as IRA or 401(k) accounts that allow account holders to accumulate savings tax-free for an extended period.
- Employer contributions to retirement accounts are effectively free money and should be maximized.
Establishing a Retirement Account
If you earn money, you must pay Social Security taxes, but the Social Security Administration projects that the funds used to pay Social Security benefits will run out in 2034. As a result, it is unknown how well its benefits will cover actual living expenses. Consider today’s debate over chained CPI, a newer method of measuring inflation, and the implications for the value of future benefits.
Additionally, it is critical to note that the government (as well as many businesses) provides incentives to save. Saving money in a qualified retirement plan, such as an individual retirement account (IRA) or a 401(k), reduces a taxpayer’s tax bill in the year the money is saved and allows the money to accumulate tax-free for decades. 2 (5) Similarly, many employers will contribute funds to an employee’s retirement account if the employee contributes to one. Employer contributions are effectively free money, and most financial advisors would advise their clients to take advantage of this opportunity.
Most people who are not already saving believe they do not have enough money to cover their daily expenses, let alone save anything. However, paying yourself should be just as important as paying others. Of course, defaulting on loans or allowing bills to become past due is irresponsible, but who will look after you if you don’t?
There will be months when you are unable to save anything. Additionally, you may discover that your investment options are limited. It is critical to avoid becoming discouraged and save as much as possible, as frequently as possible.
The personal finance industry is structured to cater to the wealthy—virtually every bank and brokerage would rather deal with ten millionaires than ten thousand people with $1,000 each. Nonetheless, your retirement and savings plans should be guided by your needs, not those of financiers.
To that end, even a tiny investment of $250 or $500 in retirement savings is worthwhile. Protection of any kind establishes a habit and a process. Numerous brokers now offer no-fee, no-minimum retirement accounts. Consistency is critical when it comes to retirement savings. It should be a life-long habit.
Thus, it is advantageous to position yourself for success. For instance, avoid scrambling to raise funds for a last-minute IRA contribution in April, just before you file your tax return. Rather than that, set aside a small amount each month, ideally through an online savings account, and use it only in extreme emergencies.
Most of these online accounts allow you to automatically deduct a specified amount from your regular account each month. If your employer offers a 401(k) plan, you can arrange for automatic deductions from each paycheck.
We should choose brokerage firms based on their fees and the ETFs and mutual funds they offer.
How to Choose a Brokerage Firm
A growing number of large, nationally recognized, well-known (they advertise on television) brokerage and mutual fund firms are willing to open small accounts without charging fees or requiring minimums. It’s a good idea to open accounts with these larger firms. They frequently offer a diverse range of investment options (mutual funds, exchange-traded funds, or ETFs), as well as the most transparent and affordable fees.
Additionally, these large firms have the infrastructure necessary to provide you with additional services (including personal investment advisors) as your needs evolve.
It is critical to take the time to make an informed choice. If not all, the majority charge a fee for account transfers, and switching firms repeatedly will eat into your savings. Concentrate on their prices and the variety of ETFs and mutual funds they offer. Would you mind not getting too caught up in the trading tools and services they offer, as trading is not a prudent use of funds when you’re saving and have limited funds?
Be Afraid of Risk
Individuals who are just beginning to save for retirement must also factor in investment risk. While academics and investment professionals struggle to define and quantify risk, most ordinary people do: What is the probability that I will lose a significant portion of my money (the term “substantial” varies from person to person)?
I recommend that novice savers and investors be risk-averse. While any amount of savings is beneficial, small sums of money will not generate livable income in the future. This means that investing in fixed-income or other conservative investments at the outset makes little sense. Similarly, you do not want to invest your initial savings in the riskiest sectors of the market, so avoid biotech, bitcoin, gold, and leveraged funds, among others.
A fundamental index fund (one that tracks a popular index, such as the Dow Jones Industrials or the S&P 500) is an excellent place to begin. While there is a risk that the price will fall, the odds of a complete wipeout are nearly zero, favoring moderate growth.
The best initial investments are mutual funds and exchange-traded funds, which are low-cost and low-effort.
As a new saver/investor, your initial investments will undoubtedly be in exchange-traded funds (ETFs) or mutual funds. ETFs and mutual funds enable you to invest almost any amount of money (from a small amount to a large amount) with minimal effort and expense. With a mutual fund or exchange-traded fund, you can take $500 and buy tiny stakes in dozens (if not hundreds or thousands) of stocks at once, increasing your chances of seeing positive returns and minimizing significant losses.
Index ETFs have grown in popularity over the last few years. For a low initial commission and a small annual fee paid or deducted automatically from the shares, an investor can effectively purchase the entire S&P 500 or other popular indexes. A growing number of ETFs enable investors to invest in broad categories such as “growth” or “value,” which mutual fund investors have had for decades.
Mutual funds, on the other hand, continue to have a place. They frequently provide investors with the benefits of active management by a fund manager, who makes daily decisions to earn higher returns. By contrast, most ETFs operate on autopilot, holding a predefined list of stocks (typically matching an index) and changing only in response to changes in the index.
When evaluating mutual funds, consider the fees and expenses (the lower, the better), as well as the performance. Ideally, you want a fund that has not only outperformed its peers on average but has also lost less money during periods of market weakness.
Consider two or three ETFs as your initial investments. Because most mutual funds require a minimum investment of $1,000 or more, they may not be an option at this time. Consider purchasing one or two of the following exchange-traded funds:
- Total Stock Market Vanguard (VTI)
- S&P 500 SPDR (SPY)
- Appreciation of Vanguard Dividends (VIG)
- Vanguard Asset Management (VTV)
- Vanguard Development (VUG)
- Vanguard FTSE All-World Excluding the United States (VEU)
- Invesco Dynamic Value Large Cap (PWV)
- Dow Jones Industrial Average SPDR (DIA)
- S&P Dividend SPDR (SDY)
- S&P 500 Pure Growth Invesco (RPG)
If you can afford two or three, make an effort to obtain a good mix. For instance, one large market fund (VTI, SPY), one international fund (VEU), and one growth fund (VUG, RPG) or one value fund (VTV, PWV), depending on your personal preferences.
The recommended amount of retirement savings to have before investing in stocks.
Hopefully, the habit of saving will develop over time. Additionally, you may discover that your earnings increase, allowing you to save more. As you do so and your initial investments grow in value, you will notice an increase in the number of investment options available to you.
With more money to invest, mutual fund minimums may be less restrictive, allowing you to own a greater variety of funds and ETFs. Additionally, you may discover that you can afford to take more risks (by investing more in growth stocks or more aggressive growth equities) or concentrate your investments on specific asset classes (investing in particular sectors or geographical areas). If this occurs, exercise caution to avoid excessive diversification. It is far preferable to have five excellent ideas than fifteen mediocre ones.
Some readers may be wondering when they can begin investing in individual stocks at this point. There is no hard-and-fast rule here, but $5,000 in total savings is a good starting point. There is nothing wrong with investing $1,000 in one or two individual stocks and the remainder in funds or increasing the allocation to individual stocks if you are comfortable.
Investing in individual stocks is very different from investing in mutual funds or exchange-traded funds (ETFs). It entails taking on greater responsibility for your investment decisions, which requires considerable time and research. While the rewards may be more significant, without the ability to invest the necessary time on an ongoing basis, it is prudent to invest in long-term funds and ETFs.
As your earnings increase and you have more money left over at the end of the month, maximize your annual contributions to your 401(k), IRA, SEP IRA, or other available savings vehicles. Contribute up to the maximum yearly amount permitted by law. 6
Saving in organized retirement accounts is one way to save, but there are numerous other ways. The government imposes specific rules and limits on the amount of money held in tax-sheltered accounts each year. However, there are no restrictions on the amount of money you can save in ordinary taxable brokerage accounts. While dividends may be taxed and capital gains may be taxed, you are still holding and building wealth. 88 89
The most critical aspect of any savings or retirement plan is to begin. There is no one-size-fits-all approach to saving money or investing. You will make errors along the way, and eventually, the value of some (if not all) of your holdings will deteriorate.
While this is unwelcome, it is natural. What matters is that you continue to save, learn, and work to build wealth for the future. If you develop the habit of saving money each month, invest it wisely, and patiently allow your wealth to grow, you will make significant strides toward securing your financial future.