When it comes to opening a new retirement account, starting out on the right foot is crucial. It doesn't matter if this is your first ever retirement account or your 17th; or if it's a traditional 401(k) or a Roth IRA. Picking the right account trustee, types of investments, and contribution schedule can make all the difference between hitting your savings goals or missing them by a mile.
Choosing an account trustee
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A retirement account trustee is the entity responsible for providing and maintaining the account, and is usually a bank or brokerage firm. For employer-provided retirement accounts such as 401(k)s, you probably don't have any input into the choice of trustees. However, if you complain loudly enough about a bad trustee and perhaps get your coworkers to complain as well, you may just be able to convince HR to make some changes. With IRAs, fortunately, you have an enormous group of potential trustees to choose from, and the decision is entirely up to you.
Things to look for in a trustee include a large number of investment options, low fees, easy access to the account, solid contribution options, and decent customer service. 401(k)s generally only offer the option of contributing from your pre-tax paycheck, but it's nice to be able to adjust your contribution level right on the trustee's website instead of having to fill out paperwork with HR every time you want to make a change.
Of all these factors, low fees are probably the most important, followed by a decent number of investment options. An account that's perfect in every other way but inflicts high fees on you will eat into your returns, forcing you to save even more money in order to fund the account adequately. These days it's fairly easy to find IRA trustees who will charge you absolutely nothing to open and maintain an account; some brokers will even waive commissions on transactions as long as you're buying the broker's own mutual funds and ETFs. For 401(k)s, your employer may or may not pay the account fees for you. It's important to know which is the case for your own 401(k), so that if necessary you can factor these fees into your retirement savings plans.
Choosing your investments
When it comes to retirement savings, stocks and bonds should make up the lion's share of your portfolio. Stocks offer very high average long-term returns, but suffer high volatility as well (meaning that the value of your stocks can bounce up and down unpredictably). Bonds have lower average long-term returns than stocks do, but are much less risky (assuming that you stick to treasury securities and high-quality investment grade corporate bonds).
Allocating your money between stocks and bonds can be as easy as subtracting your age from 110 and putting that percentage of your money in stocks, with the remainder in bonds. For example, a 40-year-old using this formula would have 70% of his retirement savings invested in stocks and the remaining 30% in bonds. This simple formula gives you a pretty good starting place for asset allocation, but you can also tweak it to suit your own preferences. For example, if you have nerves of steel and don't mind a little extra volatility in exchange for higher returns, you might bump up your stock allocation 5% or even 10% higher than the formula suggests and reduce your bonds accordingly. On the other hand, if taking risks with your retirement funds makes you queasy, you could reduce your stock holdings by 5% or 10% instead.
Retirement portfolio examples
You can make retirement investing as simple or as complicated as you prefer. For those who prefer a totally hands-off approach, a good target date fund can be an excellent option. However, before you commit to such a fund, check the prospectus to see how it's allocating its investments between stocks and bonds to confirm that it meets your own preferences. If you want a bit more control over your investments but still prefer to keep things simple, consider putting your stock money in an S&P 500 index ETF (the Vanguard S&P 500 ETF (NYSEMKT: VOO) is considered an industry leader thanks to its low expense ratio) and your bond money in a well-diversified investment-grade bond index ETF (the Schwab U.S. Aggregate Bond ETF (NYSEMKT: SCHZ) also has an exceedingly low expense ratio and offers a wide exposure to a variety of treasury securities and high-quality corporate bonds). For those who enjoy getting their hands dirty with their investments, it's still best to choose a stock index ETF and a bond index ETF as the core of your retirement portfolio and then supplement them with any other investments of your choosing.
You've probably heard this a thousand times, but I'm going to say it again -- the sooner you get started with retirement contributions and the more you contribute early in life, the faster your retirement savings will grow. If you've already missed the boat on early contributions, however, all is not lost. You'll just need to contribute a bit more to catch up on the years that you missed.
How much you should contribute depends on how much income you'll need to generate from your retirement savings, which in turn depends on how you plan to spend your retirement. If you plan to live frugally in your (paid-off) house, you can get by with a lot less retirement income than if you want to visit every major world capital and generally live the high life. As a rule of thumb, contributing 15% of your income to retirement savings accounts will result in a decent level of income. If you're starting late, you may need to bump up this percentage a bit further to catch up. And if you can't afford to contribute 15% right now, start with what you can afford and gradually bump up the percentage until you reach the desired level. Contributing a little is definitely much better than contributing nothing at all. Just remember, the money you're saving today will buy you a comfortable future when you retire.
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