Seven Principles of Retirement Investing

This article is intended to share the basics of retirement investing for someone who wants to get started. Retirement investing is a lot easier than you may think. Even basic financial knowledge can make a big difference in your retirement savings. I’m not a professional investor, but investing and financial literacy are my passions. My goal is that this article will help put more money in your pocket.

Photo by Sharon McCutcheon on Unsplash

Principle 1: The only person that cares about your money is you.

The financial industry makes a killing from our financial ignorance. Financial advisors get paid a lot of different ways, and some of these ways conflict with making money for you. A broker may be paid a higher commission if they recommend a poor performing fund. Relying on your employer’s default 401k option may not be the wisest investment option. The only person that really cares about your money is you. Paying attention and asking the right questions could mean an additional million dollars in your account by the time you retire.

Principle 2: Compound interest is the 8th wonder of the world.

Here is where the fun comes in. Compound interest can be magical. It can add up significantly over time, so the sooner you get started, the better, but any amount of time is better than none. Because compound interest will compound your accumulated interest, the average return and the length of time the interest compounds matter a lot.

  1. Example 2: You start saving for retirement 5 years later when you’re 30. You save $500 per month until you retire at age 63, and you invest your money in the S&P 500 index fund that has an average rate of return of 10%. You’ll have about $1.5M when you retire. Lesson: the time when you start investing makes a big difference.
  2. Example 3: For the same scenario above, all things being equal, if you paid a financial advisor to manage your investments for a 1% fee, you would have about $1M in retirement. Half a million dollars would go to the financial advisor. Lesson: With compound interest, those seemingly small fees can really add up over time and eat into your earnings. Sometimes referred to as the “tyranny of compound interest.”
  3. Example 4: You start investing when you’re 30. You save $500 per month until you retire at age 63, and you invest your money in your employer’s default option for your 401k plan. Data shows that the average return for a 401k is around 5%. You’ll have about $500,000 when you retire — $2M less than Example 1. Lesson: the annual rate of return and the length of time the money is invested are the most significant contributing factors to your net worth at retirement. So, start early and invest wisely.
  4. Example 5: You start saving for retirement at age 18, and you save $100 per month, every month until you turn 63, investing in an S&P500 index fund, you will have over $1 million when you retire. Lesson: With enough time and a decent annual return, anyone can be a millionaire even when saving small amounts each month.

Principle 3: Invest in Index funds.

You’re ready to get started, but where should you invest your money? There is a simple answer to this question, and it’s called an index fund.

  • Choose a fund with no transaction fee: Some index funds have a transaction fee you pay when buying into the fund, and some do not. Choose a fund without a transaction fee.
  • Choose a fund with a low expense ratio: The expense ratio of a fund can vary. The higher the expense ratio, the worse your earnings will be. There are plenty of index funds with expense ratios below .05%, so choose one of these.

Principle 4: Diversification can be simple.

It’s important to diversify to hedge your bets and guard against risk. It’s fun to pick individual stocks, just like playing Roulette can be fun, but it’s a gamble.

Principle 5: The market always comes back.

The basic rule of investing is to buy low and sell high. Seems easy enough. But as the market goes up and down, no one knows where the bottom or top is, so it’s impossible to time it perfectly. People who try to predict the ups and downs of the market to buy and sell at the right time tend to lose more than they make. It’s best to buy and hold your investments over the long run.

Principle 6: Choose a Roth IRA and Roth 401k over the traditional.

Most employer-sponsored retirement savings programs have traditional 401k or Roth 401k options. If you have an individual retirement account, you’ll also have the IRA or Roth IRA options. The Roth version of these accounts will usually result in fewer taxes over your lifetime.

  1. A Roth 401k or IRA gives you tax shelter on the earnings in your account which can be far great than your original contribution. This is a point that is most often missed in the traditional vs Roth discussion.

Principle 7: When you change jobs, roll your 401k to an IRA.

If your employee offers a 401k, it’s a good idea to max out your 401k (choosing the Roth 401k option of course). At a minimum, you should always contribute enough to qualify for your employer’s match, so you don’t miss out on this benefit. 401ks offered by employers have higher contribution limits than an IRA, so it’s great to take advantage of these. However, employer-sponsored 401ks usually have fewer investment options and sometimes high hidden fees than an IRA you open yourself.

Other resources to get started

Director of Product Management at Degreed. Passionate problem solver.

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