Develop your retirement plan
Now that you have defined your goal, developed or updated your budget, and assessed your financial situation, it is time to develop your retirement plan. This entails four steps:
- Allocate amounts to the most appropriate type of savings plan(s)
- Select the specific plan(s)
- Define the appropriate investment vehicles within the plan(s), if applicable
- Document your plan
Define which type of plan(s) and how much to save
When you defined your goal, you identified how many years you have to achieve this goal. Hopefully, this time frame is 20 or more years, and preferably 30 - 40 years. At this point, there are two key principles to understand. First, there are no get-rich-quick schemes. It takes many, many years to save for retirement. While you can increase your risk and hopefully the interest rate that you earn on your investments, risk also means a greater potential for having a poor performance from time to time. Second, for most people, mutual funds held within a retirement vehicle [such as a 401(k) or an IRA] are the best investment choice. Sure, there are lots of stories about how someone got rich buying stock in a start-up company, but the truth is that there are many more stories about people losing fortunes by investing in stocks (remember Enron?).
In selecting your investment options, begin with the obvious. If your employer has a plan, such as a 401(k), this plan is the best place to start your investing. First, your money will be invested pre-tax, meaning that you are automatically making at least 15% on your investment (depending on your tax bracket). Second, many employers provide matching funds up to a certain percentage of your salary if you invest. For example, they might match 50% of your investment up to 6% of your income. That means that if you put in 6% of your income, they will put in another 3% of your income. You have just earned an automatic 50% return on your investment, plus your pre-tax savings.
If you have contributed the maximum to your employer's plan, or at least that amount for which your employer provides matching funds,and you still have money left over that you can invest, you can choose another tax-deferred option. You could invest more money in your employer's plan (up to the maximum annual contribution) which provides the pre-tax savings, or you can invest in a personal IRA.
Only after you have maximized your contribution to your employer's plan and a personal IRA, should you consider investing in stocks, bonds or mutual funds that are not held in a retirement account. For most people, this will never happen. There are, however, some people who started investing early and are planning on retiring before they can begin accessing their retirement accounts. For those few people, we suggest you contact a financial professional to determine your best options.
Select the specific plan
If you are investing in your employer's plan, then the choice of plan has already been determined for you. If your employer does not have a plan, or if you are investing additional funds outside your plan at work, then it is time to do your homework.
Your first choice should be an IRA, either the traditional IRA or a Roth IRA. If you are not sure which is the best for you, reexamine the choices by using the links on the left side of this page. In either case, we recommend that your IRA consist of mutual funds rather than a brokerage account that allows you to purchase stocks and bonds. The specific mutual fund family will be your choice. There are lots of sources on the Internet that can provide information and advice. If this doesn't help, or if you are totally confused, talk to your family and friends, but be careful that they know what they are talking about. If you still don't know where to begin, we suggest that you contact Vanguard to review their choices.
Identify the appropriate investment vehicles within the plan
Once you know which type of plan you are investing in, how much you are investing, and what company you are investing with, it is time to make decisions regarding what type of investments you want in your retirement account(s). For investments in your employer's plan, the available investment choices will be defined for you. It will be your job to evaluate the choices and decide which ones to invest in, and how much to invest in each. For this, there is no simple answer. Some people look at historic returns and invest in 2 - 4 funds with the best return (with no guarantee that this will continue). Other people use available sources to determine their risk and then choose a number of funds designed to equal that level of risk. Still other people like using lifestyle or age-based plans that modify the holdings over time for you. Finally, some people believe that index funds are the best choice for a decent return while minimizing risk. For those just beginning, or those who are not sure what to do or do not have access to sound advice, we suggest one of the last two choices, lifestyle (or age-based) or index funds.
If you are investing in an employer-provided plan, they should have some documents prepared that address the varying levels of risk versus return and recommend types of funds. If you are investing on your own, and are not certain what to do, there are websites that offer free advice (see CNN links in the right column).
As a final guide, you might consider beginning with one or two funds and increasing this number as the amount of your investment portfolio grows. As it gets larger, you will also consider having funds from more than one family of funds (e.g., Vanguard and Fidelity), not only to diversify and decrease risk but also because it becomes more difficult to find additional good funds in one family. A possible allocation is as follows:
Number of Funds
|$2,000 to $5,000
||1 or 2
|$5,001 to $20,000
||2 to 4
|$20,001 to $50,000
||4 to 6
||1 or 2
|$50,001 to $250,000
||6 to 10
||2 to 3
|$250,001 to $500,000
||10 to 15
||3 to 5
|$500,001 to $1 million
||15 to 20
||5 to 10
Please note that having multiple fund families doesn't imply that each family has the same amount of funds or dollars allocated to it.
Document your plan
Once you have made all the decisions outlined above, make sure that you write down the details on a piece of paper. This should include how much you intend to invest, where the money is coming from (i.e. budget changes), what type of plan you are choosing for your investments, your investment allocation, etc. When you review your plan results a year from now, you may not remember exactly what your plan was, so having it documented will allow you to easily review your status and make any necessary changes.
If you prefer, you can try developing a retirement roadmap using the tool available at CNNMoney. They also have an asset allocation wizard and a recommended mix of funds that might help you in developing your plan.
Step 6 - Make Your Changes Now