Simple and Quick Ways to Invest
This chapter is intended for those who don't want to spend a lot of time worrying about where to put their money for retirement. Assuming you've got an emergency fund established at the bank or credit union, there are many easy and quick options for retirement savings. We will review a few affordable “all-in-one” choices for retirement investing, and later the book will discuss some other investment options.
By “all-in-one,” I am referring to mutual funds having target dates: the year you plan to start drawing money to pay for your life in retirement. These funds split your lump sum into multiple types of investments, which are contained within the fund. You put money into this one target date fund, and they automatically diversify, or split up this this money, based on the risk level that your target date would normally call for.
Diversification is a topic that will be covered later in the book, in case you'd like to know more about what these funds are doing. For now, just remember that it's spreading the risk, on the premise that different parts of the market don't usually all go up or down at once, but generally go up in the long-term as a whole. It also involves dividing your money between lower risk and higher risk investments, depending on your individual needs.
Each year, the mix of investments is changed so that its less risky than in prior years. When the fund reaches the “target date,” or the year you need to start spending the money, then its underlying investments are put into stocks or bonds intended to generate income. If you're already retired and need income from your investments, then you would probably select a Retirement Income fund, rather than a target date fund.
Each mutual fund company has a different method for doing this, which means these types of funds may react somewhat differently to market events. The fund companies may have different philosophies regarding the best way to split up this money. Here is an example of how a family of target date funds might divide your money differently, depending on the year you select:
2040 fund:
2030 fund:
2020 fund:
Retirement income fund (drawing money from it now):
As you can see, the percentage going to very low risk investments, the US Treasury bonds, increases dramatically as you get closer to your target date. As the years go by, the 2030 fund will look a lot more like the 2020 fund, and then automatically turn into the Retirement Income fund. This all occurs without you having to move money between funds, which is a primary benefit of the target date funds. Having the low risk Retirement Income portfolio means you hopefully wouldn't lose too much principal to stay retired if the stock market goes down. By that time, the bulk of your money will be in low risk investments, just hoping to keep up with inflation rather than grow much more.
Some companies may also charge additional fees, having a higher than normal annual management fee or fees you're charged upon purchasing or selling shares. You will generally want to avoid these funds unless you've identified a compelling reason to invest in them. On the other hand, firms charging almost nothing are usually investing in stock index-based investments, rather than fund management staff screening and selling stocks on a continuous basis. Your investments would be on “automatic pilot” for the most part. Most active management fund managers have great difficulty beating the stock indices, but there are some standouts that you should consider before going for the one with the lowest management fee. Later in the book, I will describe how to research this.
In selecting a fund company, you will need to decide whether to use an investment firm that is only online, one that also has a branch office near your home, or a fund for which there is a stock brokerage that will buy and sell you shares at a reasonable cost. Some mutual fund companies, such as Fidelity and Schwab, have hundreds of offices across the country in case you'd rather not use their website to invest. I would personally avoid using a fund or brokerage requiring a transaction fee in order to purchase or sell shares in a fund. This can make a major dent in your investments over a long period of time. They are already earning their pay through the annual management fee, which should hopefully be less than 1% on domestic stock funds or below 1.5% for international funds. Some would say this is too high, but I'd also take into consideration how well the fund is doing relative to its peers and to the stock index it tracks. If its fee is 0.3% more than a low-cost fund, but consistently beating the cheaper fund by 3% high return each year, then I'm not as worried about the management fee.
Once you decide the year of your retirement, or “the target date,” how do you figure out what the best target date fund is for you? Some of the top names in the target date mutual fund business are American Funds, Fidelity, T. Rowe Price, and Vanguard. As with banks, the internet has lots of information available to help you decide which fund is right for you. Here is a comparison of the “target date 2030” funds from these four companies:
Beyond the differences shown above, they each differ in regards to the types and amounts of investments make over their lifetimes and other important areas. People who're concerned about their portfolio being too risky may want to consider the amount being put into stocks versus government bonds and high grade corporate bonds. You can compare them using any of the free stock information websites discussed later in chapter 4 and by reviewing their prospectus. Another option is to diversify your investments between two, three, or four funds having the same target date, rather than putting everything with one fund company. There are differing opinions on the use of target date funds, but they can provide a diversified, simple and relatively low cost way of investing for retirement.
If your employer has established a 401k plan or other tax-deferred retirement plan offering access to target date funds, then you should review the fees associated with these funds, and the benefits of investing in them. Sometimes it makes sense to invest in your employer's plan if they offer to match your contribution. In other cases, the fees can be much more costly than what's available from a different mutual fund company. These 401k plans usually offer a higher amount of tax deferred savings than what's available from Individual Retirement Accounts (also called “Arrangements”) at a mutual fund company, which is one of their main benefits.
The rules for contributing to workplace employment plans and IRAs can be complex if your income exceeds certain thresholds. You may want to consult the Internal Revenue Service's website or your tax professional before contributing to both. Generally speaking, you may contribute up to $18,000 in tax deferred income to your employer's 401k plan. This money goes in without taxes being taken out, but you pay income taxes on any withdrawals after you retire.
On top of this $18,000, most people earning less than $118,000 per year may also contribute $5,000 in post-tax income to a Roth IRA. This type of IRA allows for the tax-free growth of this money after you pay taxes on the principal.
You may also contribute as much as you can afford to taxable accounts, where the invested amount is post-tax dollars and you also pay taxes on dividends, capital gains, and other earnings. Funds can sometimes generate capital gains in a taxable account, even if you haven't sold any shares of the fund, but most capital gains taxes will be due after you've sold shares at a profit.
If you're investing in target date funds for the long-term, with the goal of living off this money in retirement, then “Dollar cost averaging” is a good idea. This means putting in regular amounts every month, depending on what you can afford and also depending on your retirement plans. There are many online investment calculators that can give you an idea of how much money you'll need to save in the future to help meet your retirement objectives, such as:
Generally speaking, if your financial situation allows, you should save or invest at least 10% of your income starting at a fairly early age. If you're getting a late start, then you may want to consider investing a larger percentage of your income. If you have a complex financial situation, then other considerations may need to be made, such as the amounts and types of insurance you have. A Certified Financial Planner or Registered Investment Advisor could provide independent advice to assist you with making your decisions. Another good resource is a financial literacy website created for the public by the American Institute of Certified Professional Accountants: http://www.feedthepig.org.