BY CHRIS HEERLEIN
Very few Gen Xers (those born from the mid-1960s to early ’80s) and Millennials (Generation Y, those born in the 1980s and ’90s) are saving for retirement. For Millennials, retirement is a far distant horizon. Most of this age group are so plugged into today that tomorrow doesn’t appear real to them. Gen Xers are a little better in this regard.
There are simple steps younger investors can take to help ensure they will be able to retire, including taking advantage of 401(k) plans. If you are in your 20s, 30s and 40s, staying on top of your 401(k) allocations can save you thousands of dollars during your working career. If you signed up for a 401(k), you are to be commended. You did a smart thing, especially as there is no guarantee Social Security will pay out the full amount of benefits you’ve contributed to by the time you retire. As it stands currently, the benefits Millennials might expect are likely to be a much-diminished version of what they are today.
Younger investors should embrace risk. You have probably heard of the investing “rule of 100.” Take the number 100, and then subtract from it your age. That’s a good starting point for how much of your assets you should have allocated in risk-based investments. The rest should be put into conservative allocations or more stable accounts. Some shorten it to simply putting a percent sign after your age. That means if you are 25, 75% percent of your assets should be aggressively invested and 25% should be in more conservative allocations – probably in a healthy emergency fund. This will vary, of course, if you are one of the lucky few who has a pension or some other substantial source of steady, reliable income.
Get over your stock market fears
Members of Gen X and Gen Y have witnessed the tech wreck of 2001 and the Great Recession of 2008. I can understand their apprehension about putting a lot of money in the stock market. They don’t want to see what they have worked so hard to acquire go down the drain. They reason, “The markets have recovered, but all it takes is a little political hiccup on the other side of the world, like Great Britain exiting the European Union, to send the market into a tailspin. With the markets that volatile, maybe I should just park my money on the sidelines and prepare to weather the storm.”
However, when you are in your 30s and 40s, you are in your accumulation years. You should put as much as you can into your savings plan and invest somewhat aggressively. You have time on your side. Economic downturns are called corrections for a reason. The market dips, sometimes severely, but it has always rebounded. Time is the key factor. I don’t care how sizable your retirement or savings accounts are, your time and your health are the greatest assets you have. If the recovery period is long and drawn out, and you are in your 50s and 60s, you may not have time to recoup your losses. But if you are in your 20s, 30s and 40s, based on history you almost certainly will have time.
When you are in accumulation mode, you need to pack in as much into your coffers as possible. Invest in it on a regular basis – at least monthly. Then, when you get in your 50s and 60s, it’s all about preserving what you’ve got – taking chips off the table so that, when you retire, you will have the resources you need.
Think about it. If you were investing in your 401(k) in 2008, losing only 5% to 10% in that account would have been considered a minor miracle, right? But what I see is that a 5% to 10% correction gets people’s attention fast. It makes them think about their risk tolerance. That’s a good thing because it makes investors re-evaluate where they are. Investors with $100,000 to $200,000 in their portfolios lost an average of 21% during the 2008 financial crisis, while those with more than $200,000 lost more than 25%, on average. But the averages, of course, don’t tell the whole story – some investors lost even more. It all depended on their level of exposure.
The market losses happened so quickly that they scarred some investors, to the point that when they see a 5% to 10% correction, which is normal market behavior, they get that sinking feeling in the pits of their stomachs, thinking it’s 2008 or 2001 all over again. I’m not faulting people for that, but, if you are between the ages of 20 and 50, be careful not to let the news headlines drive your investment decisions. You have time on your side. This is especially the case if you are steadily contributing to a 401(k)-type plan.
Dollar-cost averaging can smooth out the bumps
Any investment will have ups and downs, good days and bad days. If you have committed to a monthly contribution, then dollar-cost averaging will help you – if you keep putting in the same amount each month, increasing your contributions when you can. Dollar-cost averaging is an investment technique of buying a fixed dollar amount of an investment on a regular schedule, regardless of the share price. The investor purchases more shares when prices are low and fewer when prices are high. Of course, it’s never fun to see our money evaporate when the market is falling, even for 20- or 30-year-olds, but they can rejoice in the knowledge that their investment dollar has more purchasing power on a down cycle. Those skinny shares will fatten back up in time.
A key to a healthy 401(k) is rebalancing the funds annually. Whatever you do, don’t look at your account every day. Doing so won’t give you the true picture. Second, you are too busy for that. If you are a young investor, you’re probably raising a family along with working hard and building a career. Do that. You need to be having your morning meditation, not staring at a stock market ticker. Put confidence in dollar-cost averaging and continue investing through thick and thin, up and down. Evening things out over time can allow you to stay on track toward your retirement goal.
Can’t touch this: Why you need more than just a 401(k)
Too many Gen Xers and Millennials make the mistake of limiting their savings to their employer-sponsored retirement plans. Your 401(k) or 403(b) is great, but there are many different options out there. If you are a younger saver and investor, and your 401(k) is your only savings focus, you are putting all your money into a bucket you shouldn’t touch for 20 to 30 years. Money in tax-deferred retirement savings plans – unless through one of a few exceptions – cannot be accessed without penalty until you are 59A1/2 years old, based on current tax laws. If you are 25, 30, 35 years old, and contributing the maximum at current contribution limits for those under 50, you are putting in approximately $18,000 a year, and it’s essentially off-limits to you for decades.
In addition, there are tax ramifications you will face in retirement with 401(k)s, which helps explain why Roth IRAs and Roth 401(k)s are becoming more and more popular. With them, you pay the tax on the front end and get it over with. Then your investment is not taxed as it grows, nor is it taxed when you withdraw it. You don’t want to end up in a higher tax bracket in retirement than when you were working.
As we are mapping out where and how to save for the future, we need to be looking at 401(k)s and IRAs. While these pre-taxed retirement accounts are fine, you will want to have balance in your portfolio, including pre-tax and post-tax accounts which can provide true tax diversification, come retirement.