Starting a Retirement Plan

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Starting a Retirement Plan

 

The ideal time to start a retirement plan is early in your working career, before expenses such as marriage, a mortgage, and a family come along. If you’re like most people, however, you weren’t the most responsible investor when you were young. How many people have retirement on their mind when they’re 22? But don’t worry: If you haven’t started saving and find the prospect of a retirement account frightening, it’s not too late to get started. The next-best time to start a retirement plan is right now. It can seem like a daunting task, but even a modest investment of a couple of thousand dollars, properly managed, can start earning some interest and help you build a nest egg for the future. If you’re fortunate to have liquidity in your savings account beyond what might be necessary for emergencies, it’s time to move some of that money and earn more than the slim 0.2% your bank gives you. There are many retirement investment vehicles, and it’s best to research them all before deciding which plan is best for you, your loved ones, and your collective future.

Why Starting a Retirement Fund Is Important

Global circumstances can change quickly, and financial markets can respond unpredictably. That’s why a stable retirement account is a must: to hedge against market volatility. Starting a retirement account earlier in your work life is beneficial because you can take advantage of compound interest, as many retirement funds do. Compound interest means that interest earned on the principal is reinvested after a certain period, allowing it to also earn interest. Compound interest is important for retirement accounts because getting an earlier start in establishing your retirement fund could mean exponential gains by the time you retire.

Steps in Starting a Retirement Fund

The first step in starting a retirement fund should be sitting down and putting a basic plan down on paper. This can be done at home or with a financial advisor. Calculate how much you can afford to invest initially, how much you can realistically invest each year, and how much you would ideally like to invest. How much will you need for retirement? Is it just you, or do you have a spouse? Do both of you work? At what age do you want to be able to retire comfortably? Are you going to be splitting money between your retirement accounts and college funds for your children? These are all questions that need to be asked, and consulting a financial planner is strongly recommended.

Calculating How Much You Need to Save

Now that you’re ready to get your retirement fund established, determine how much you should be putting away each year. One popular suggestion is to follow the 50/15/5 rule. In this breakdown, 50% of your salary is dedicated to essential bills, 15% is directed to your retirement fund, and 5% is kept on hand for emergencies. Although it’s not always feasible to strike this balance, it’s a good place to start when budgeting with retirement in mind. Remember to build some flexibility into your budget as well, as circumstances and incomes can quickly change.

Retirement Plan Options: 401(k), IRA, Roth

IRA, and Brokerage Accounts

There are a variety of options when choosing your retirement plan. Many people enjoy the convenience of a company-sponsored 401(k) plan, which deducts directly from your paycheck. Although these plans are convenient, your options are usually limited by your employer’s choice of 401(k) management company. However, some companies that offer a 401(k) plan also offer to match contributions up to a certain percentage of your income, which is a good deal if you can get it.

Unless you are fortunate enough to have an employer with a good retirement plan, which is increasingly rare these days, many individuals may need to establish an individual retirement account, or IRA. Having an IRA allows you to choose the management and investments for your retirement portfolio. Once you’ve established an IRA, you can choose to be a passive investor or an active investor. You can also choose either a traditional IRA or a Roth IRA: With a traditional IRA, you’ll deposit pre-tax money and be taxed on the money you take out later, but with a Roth IRA, you deposit post-tax money and can withdraw it tax-free later on. Some individuals saving for retirement may also go even further and start a brokerage account, which is essentially a stock portfolio you manage. You’ll want to consult a financial planner to help you decide on the right options for your retirement savings.

Start Investing

If you’re ready to start managing your retirement investments personally, it’s best to know some of the terminology associated with the markets. One term you’ll hear a lot is “ETF,” or exchange-traded fund. ETFs are similar to mutual funds in that both are investment securities built on pooled assets; however, ETFs can be traded like stocks, unlike mutual funds. These ETFs can be very diverse, so if you plan on investing in ETFs, consult with a financial advisor who has experience in this area.

Passive Investing vs. Active Investing

With a passive investment strategy, your retirement fund follows one of the already-defined indexes, such as the Dow, Nasdaq Composite, or S&P 500. The benefit here is less risk in exchange for smaller, more consistent returns. In active investing, you and a financial planner actively target stocks and options to grow your retirement portfolio. Although this has the potential for a higher return, the risk is greater. Ultimately, you’ll have to decide how much risk you’re willing to live with in your retirement portfolio.

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