You don’t have to be a genius, a math brain or know anything about the stock market to invest your money well and retire comfortably.
Most people don’t think of themselves as investors. But just about anyone with a fourth-grade education can get key money decisions right — like feeding a 401(k) or IRA regularly — and retire with a stash that’s large enough to last until you’re in your 90s. But you have to be deliberate.
So today, as I write the final installment of this advice column, I want to leave you with some crucial basics. Get these right, and a lot of money matters fall into place.
Straight talk about college
We’ve all heard about recent graduates so buried in student loans they don’t feel like they can have children, buy homes, or leave a good-paying job for the job they really want. But most people struggling with college debt didn’t finish college or got a degree that wouldn’t lead to a career lucrative enough to cover their student loans.
So be deliberate about college decisions. When you are 18, it’s impossible to see your future precisely, but if you are drawn to art, social work, early childhood education and other jobs paying maybe $25,000 a year, you don’t want $40,000 in loans. Follow this rule of thumb: Don’t have total college loans that exceed your annual gross income. This means researching your likely career and its expected pay.
If college isn’t for you, consider an associate degree in a technical field that pays well. About 28 percent of people with two-year educations earn more than the average bachelor’s degree graduate, according to Georgetown University’s Center on Education and the Workforce.
Parent’s dilemma: College or retirement?
After struggling to pay off their own student loans, many parents don’t want their children to experience the same pressure. So parents start setting aside money in a child’s college fund while skipping or scrimping on their own retirement savings. This is backward. The rule of thumb: Save 10 percent of your pay for retirement starting with your first job. Miss starting in your 20s, and you will need to save 12 to 15 percent in your 30s.
If there’s not enough money to save for both college and retirement, it’s the college fund that should get shorted. While parents don’t want children to have to borrow for college, no bank is going to give a loan to a 75-year-old who has run out of savings and needs food, medicine and electricity. How do parents know if they’re saving enough for retirement? Try the ballpark estimate at www.choosetosave.org.
Failed savings strategies
In a survey by the Employee Benefit Research Institute, 70 percent of people said they could save more, but they didn’t. The trouble is that too many people make financial commitments that sabotage their ability to save adequately. They decide on a house, apartment or car they like and maybe a gym membership or activities for the kids. The result: They are tapped out from the start, with nothing left over to save and credit card bills that never get paid off.
Instead, they need to follow some rules of thumb to keep them out of a financial straitjacket. Among them: Spending only 28 to 30 percent of their income on housing — whether they buy or rent. Spending no more than 10 percent of monthly pay on a car, and taking a car loan only up to four years.
Consider a 50-30-20 budget. For necessities, you spend only 50 percent of the pay you have after paying taxes. Necessities include the mortgage or rent, insurance, food, utilities, student loan payments, etc. Thirty percent goes to wants, like gyms and vacations, and 20 percent goes into savings. Save automatically for retirement in a 401(k) at work, or an IRA outside of work, and in an emergency fund to get you through six months if you lose your job.
Never pay twice
People have become wiser about taking on debt since the 2008 recession, but some still use credit cards without realizing how much they waste.
Consider the consumer who spends $5,000 on furniture. She puts the purchase on a credit card with an 18 percent interest rate and pays the minimum of 3 percent a month. She pays month after month, spending a grand total of almost $9,000 by the time all is paid off in 34 years. She might not have liked the furniture as much if the original price tag had read $9,000, not $5,000.
If you have a 401(k) at work you are fortunate, and if your employer offers to match a portion of your contribution, make sure you get every penny of that free money.
Consider a 25-year-old making $35,000 and working for a company that will give him free money if he saves for retirement. If he saves 6 percent of his annual pay in the 401(k), his employer will match half of that. So the 25-year old puts $2,100 into the 401(k) and the employer adds $1,050. Assume this same process happens year after year as the employee receives 3 percent raises a year and the investments gain 8 percent on average annually. At age 65, he would have about $1.2 million for retirement. The free money from the employer ended up providing almost $400,000.
If a person doesn’t have a 401(k) he should be putting money from each paycheck into an IRA outside of work. Investing is easy with what’s known as a target date fund. The fund is based on the date you expect to retire, and the investments are calibrated based on the number of years you have until retirement.
Manage the stock market
The stock market has been on a roll, growing about 12 percent this year. But it won’t last. Scary times in the stock market, known as bear markets, happen on average about every 3.5 years, although there hasn’t been one since the 2008 recession.
In a bear market stocks decline on average about 38 percent and the downturn lasts an average of 19 months, according to The Leuthold Group, a financial planning firm.
During scary times people flee the market, but in doing so they lock in losses and can’t ever recover if they stuff their remaining money in a savings account. No one is ever sure in a bear market when stocks will recover, but they have after every scary market that’s occurred. The stock market has gained more than 260 percent since the last bear market.
Instead of trying to time the market, pick a mixture of stocks and bonds and stick with it. For young people, advisers often suggest keeping 70 or 80 percent or more of your money in the stock market. Often advisers suggest that those early in retirement invest half in stock and half in bonds, and those late in retirement invest 25 percent in stocks.
Making the money last
When you retire, a key issue is making your money last. Almost half of married women live to 90.
Before retiring, calculate what you expect to spend each month. Once you know what you will need, see if your savings will provide it.
There is a rule of thumb applied to retirement money: Take only 4 percent of your savings out the first year of retirement and increase the sum just slightly each year to cover inflation. If you ignore the 4 percent rule, there’s a strong risk that you will run out of money too early in retirement. The withdrawals are based on the assumption that you have about half invested in stocks and half in bonds.
So if you have $1 million saved in a 401(k) or IRA, you remove $40,000 for the first year of retirement and tweak it slightly each year to cover inflation. It’s not a perfect approach, because market conditions can disrupt the plan, but you can adjust by cutting spending during a bear market.
Get reliable advice
Retirement planning is complex. While I believe in do-it-yourself saving while young, it pays to see a trained financial planner before retiring to make sure you have adequate savings, that you have timed retirement to maximize Social Security, and that you will withdraw your funds in a tax-efficient way. For this job you want a financial planner who is also skilled with tax planning.
Find a certified public accountant who is also either a certified financial planner or a personal financial specialist. Beware of designations that sound close, but aren’t the real thing.
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