Your Retirement Plan Isn’t a Scary Monster
Retirement plans are a common source of stress and confusion for employees. Picking investments for your plan is a task most people would rather leave to professionals, but are often forced to do themselves. Studies show that the more investment options your employer provides, the less likely you are to participate in the retirement plan.
I don’t want you to get overwhelmed by this. There are other more important things to be overwhelmed by, specifically the threat of nuclear war and Rachel choosing Bryan over Peter (Ed. note: Sob!). I want you to have the confidence to pick investments for your retirement accounts. If you are tasked with choosing mutual funds and index funds without the assistance of a financial professional, here’s what you need to do:
Know Your Risk Tolerance
Risk tolerance measures your ability to take on investment risk without losing sleep at night. Theoretically, the younger you are the more risk you can take on. If you have 30 years until retirement, you have the ability to withstand more of the market ups and downs. You’ll also have more time to let your money grow. As you get older and closer to retirement age, you’ll want to lower your risk to preserve your earnings. How much risk you start with, live with, and end with is dependent upon the person. You don’t want to be too aggressive, but you also don’t want to be too conservative either.
There are risk tolerance questionnaires available online if you aren’t sure where on the risk spectrum you fall.
Don’t delay another day
The most important aspect to investing is time. The more of it you have, the more your money will grow and multiply. Waiting to get started is by far your greatest risk. If you wait 5 or 10 more years to get started, you’ll cost yourself tens, and maybe even hundreds of thousands. Get enrolled in your retirement plan as soon as possible.
Know how long you have before retirement
This is simple. It’s important to know whether you’re 5 years away from retirement or 25 years. Of course, your life situation can change, and you’ll adjust your investments accordingly, but your retirement plan should be based on the amount of time you have to let your money accumulate.
How does it fit into your overall financial plan
Your retirement accounts have a place in your overall financial picture. The amount of risk and allocation within your retirement plan should fit in to your overall investment strategy. You’ll also want to take a look at any Roth option available in your 401k.
How much will you contribute
Ideally, you want to save 15 percent of your paycheck in your retirement account. If you can’t achieve that level of savings right now, contribute enough to earn any company match and then increase your contribution rate by 1 percent each year.
Compare available funds
I know it’s terrifying to look at the available funds for your retirement plan and know what you pick will affect your future money. Don’t let this scare you. You will have to do a little research, but you can pick the right mix of funds for yourself. Remember, you aren’t tied down to these funds forever, so if you feel you need to make a change and rebalance, you can do that.
Start by listing the available funds and their corresponding expense ratios. This is the amount charged to run the fund and is easily found on fund info sheets or online fund descriptions. Expense ratios eat away at your returns over time. Keep them as low as possible. I suggest choosing funds with expense ratios lower than 1 percent. There are plenty available.
You’ll also want to take a look at past performance, allocation, and the goals of the fund (growth, growth & income, etc.). A great way to get all this information is to check out Yahoo Finance or Morningstar. Not all funds are created equal, so you’ll want to see which ones are the highest rated.
Find a good mix
You’ll see terms like growth, income, and balanced when mutual funds are described. These terms explain the overall goal of the fund. Aggressive is the most risky, but with the most potential reward. Income funds are generally the least risky, but have lower annual returns. Based on your risk tolerance, you’ll want to pick a few funds that’ll provide you both growth and/or are income-appropriate for your age and goals.
For example, I’m 30 and have another three decades before retirement. I would put more into aggressive and growth because my time horizon is long and I know I can withstand the volatility of the market over the years. As I get older I’ll scale back and begin putting more into growth and income and balanced funds. My dad, who is retiring very soon, has a much more conservative approach than me right now.
Target funds, which chooses and rebalances its investments based on the year you want to retire, are a good start for your 401k. It’s an umbrella approach to retirement investing and not personalized to your needs, but it’ll provide a good foundation upon which to further diversify and allocate according to your risk tolerance and goals.
Know your fees
Again, keep your funds’ expense ratios as low as possible. You’ll also want to find out what your retirement plan is charging annually in fees. Expenses and fees diminish your returns; it’s important to know so you can adjust accordingly. Retirement plans aren’t free.
Don’t overcomplicate it
A mix of a few good funds should give you the diversification you need to accomplish your financial goals. You don’t need a thousand funds in your accounts to be successful. Keep it simple, keep it passive, keep it long-term. Honestly, it doesn’t take more than 3-5 funds to satisfy your retirement savings needs.
The market goes up and down every single day. It also goes up and down for extended periods of time. When the market is low, don’t panic. You don’t lose any money until you decide to sell. When the market is down view that as an opportunity to purchase investments at discounted prices. Downturns in the market is where the real money is made for those who know it’s the best time to buy.
Revisit and rebalance annually
Your age changes along with your goals and overall financial picture, which is why it’s important to occasionally review your retirement accounts and rebalance them when needed. Generally, it’s recommended you review your retirement accounts annually.
Ask a professional
If you still are unsure and have lots of unanswered questions regarding investments and your retirement accounts, ask a financial planner!
Be accountable to yourself
The onus of saving for retirement is on you. Be accountable to your future self by getting your financial shit together now. Don’t cost yourself a secure financial future because you were too scared or overwhelmed to to get started.
Let me help you! Pre-order the ebook version of my book, The Millennial’s Guide to Getting Your Sh*t Together, for only $2.99 on Amazon.
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