It may seems as thought it’s too early to begin thinking about retirement, especially if you’ve just finished school, got married recently you’re a new parent. It’s easy to assume that retirement is for old people, and that you’ll plan for that later. With rent, student loans, credit card bills, and car payment, it may seem impossible to save any money for anything, especially retirement, but it doesn’t have to be so complicated. If you start saving while you’re young, you will get in the habit of living within your means and you won’t have to save as much each month. The earlier you invest the more your money can grow and you can riskier investments with higher returns because you won’t need the money immediately. This article will give you some tips on how to begin preparing for retirement and where you can put your money.
CREATE A BUDGET
Before you begin planning for retirement, you need to know how much money you can save. The first step is to create a monthly budget by determining how much you must spend each month on fixed expenses such as rent, car payments, student loans, grocery bills, and other expenses. In addition to these, you will want to try and calculate any other expenses you may have during a given month. Ideally, you should be saving about 10% of your income each month, but even before you save for retirement it’s wise to have at least three months salary saved in case of emergency, that way you won’t be tempted to take money from you retirement fund and use it for other purposes. When planning for retirement, you should consider your future plans, such as buying a house, marriage, having children, or returning to school. All these decisions will affect how much money you’ll be able to save. Also, be realistic about the lifestyle you would like to maintain once you are retired and be sure that you are saving enough to maintain the lifestyle you’ve grown accustomed to during your working years.
BANK ACCOUNTS
If you don’t have both checking and savings accounts, it’s time to set them up. Checking accounts feature conveniences such as direct deposit of your paycheck, automated withdraws for retirement plans and other payments, and online banking. You should also open a savings account to temporarily place you money in case of an emergency, while earning some interest on your money. Generally savings accounts don’t offer very high interest rates and sometimes don’t keep up with inflation, so they are not great for long term investment, but give you easy access to your savings when you need it.
Besides checking and savings accounts, you may want to consider opening a Money Market account, which is a hybrid of the two. Money market accounts have higher interest rates than savings accounts and you can also write checks. Depending on the bank, you may or may not have a check writing limit, but it’s better not to use this feature unless you have a pretty high monthly income. Most accounts require that you keep a $1,000 minimum balance; otherwise you’ll be required to pay a monthly fee. Yet if you can maintain the minimum balance, Money Market accounts can be a great alternative to savings accounts.
THE STOCK MARKET
The stock market probably brings up images of Wall Street, with men in suits following a ticker tape with number while taking on a cell phone. Yet with a little information nearly anyone can invest. Believe it or not, stocks are not exclusive to those with M.B.A’s. Although there are risks involved, now is the time to take risks when investing your money. A stock is simply an instrument that signifies an ownership position (called equity) in a corporation, and represents a claim in the corporation’s assets and profits.
In the United States, there are three major stock exchanges: New York Stock Exchange (NYSE), which is in fact located on Wall Street, American Stock Exchange (AMEX), and National Association of Securities Dealers Automated Quotation System (NASDAQ). The NYSE is one of the oldest and most respected stock exchanges in the United States and includes more than 100 of the largest and most well known companies. It’s the undisputed king of stock markets, with requirements for a company’s place in the market changing every year. AMEX is known for mid-size companies and is often called the NYSE’s little brother. Presently the future of AMEX is unknown, as it may be merged into an existing stock exchange or acquired outright. Finally, there’s the NASDAQ, which is made up of over 3,000 stocks ranging from mega companies like Microsoft, to struggle micro-companies. NASDAQ is known for its small companies, some of which have grown up on the NASDAQ and are now large enough to take there place on a larger stock exchange.
MUTUAL FUNDS
Investing in the stock market may seem risky and complicated, and sometimes it can be, but mutual funds are a great option for someone who doesn’t have a great deal of money to invest but would like to give it a try. A mutual fund is a collective investment that pools money from money investors who invest in stocks, bonds, short term money market instruments, and other securities. The proceeds are then passed on to individual investors. The funds are adjusted by a fund manager and administered through a parent management company.
The biggest advantage of mutual funds is that it allows someone to buy more stocks that he or she could not afford otherwise and these funds are professionally managed. Mutual funds also allow diversification, meaning stocks come from many different types of companies from different sectors. This lowers the amount of risk you are taking and allows for better returns on your investments. It’s easy to invest regularly in mutual funds and they are easy to research. Just search mutual funds’ on the internet and you’ll find plenty of websites. You can also buy and sell stocks over the phone. Mutual funds are liquid, so you can easily access the money you’ve invested and you can invest in either short term or long term funds, depending on your financial needs and goals.
Although there are several types of mutual funds, stock funds are the best choice when you’re young because when you start out you should focus on growth instead of stability. You won’t need the money any time soon, so it’s alright to take risks. One type of stock fund is known as Aggressive Growth Funds, which are stocks of new companies and industries, and speculative markets, which maximize capital gains. Another type is Growth Funds, or stocks of more stable companies, whose earnings steadily increase and have growth rates that beat inflation. These funds are categorized based on their capitalization, meaning the size of the company. There are four types of Growth Funds: Large cap, which are multinational companies such as Coca Cola, McDonald’s and Intel and have a market capitalization between $5-10 billion; Mid-cap, which are companies with capitalization between $1-5 billion, and while they are smaller than Large cap, these companies usually have recognizable names like Outback Steakhouse, or Autozone; and finally, Small-cap, whose earnings are expected to steadily increase, like Steel Dynamics, a mining company.
When determining which mutual funds to select it is important to ask several questions. What is the object of the fund? What is the minimum investment? What fees are required? What is this fund’s performance? Who is the manager, and how much experience does the manager have? How do you purchase and redeem shares? All of these questions can be easily answered. Often times it’s as simple as finding the information online. You also want to know the investment style of the mutual fund. Does it focus on value stocks or growth stocks? If a mutual fund focuses on value, it’s made up of low price stocks with slower growth but if a mutual fund focuses on growth, it’s made up of higher priced stocks in rapidly growing fields like technology and health. Growth stocks are the best choice when you start investing. You should also know the capitalization of the companies involved, or the size of the company and the industry concentration, which is usually determined by the type of stock. After you choose the mutual funds, you should determine the correlation between your funds. The fewer the similarities between the groups of funds you have chosen, the more diversity you’ll have.
After you’ve researched the mutual funds you are interested in, you’ll need to determine how much you want to invest and the percent you want to invest in each fund. You should select funds based on your financial goals, your means, and the fund’s performance record. It’s also important to know the fees involved. The best choice is a no load fund. This means that there’s no fee when a fund is purchased, you only pay on commission on your earnings.
Now it’s time to open an account. Opening an account is easy. You can invest directly, use a fund company, or hire a broker to open an account. An easy way to invest in several mutual funds at once is through a Fund Network. Fund Networks are made up of multiple fund families with one network such as Charles Schwab, Fidelity, Jack White, and many others. Be sure to keep up with your records, as money earned though a mutual fund is taxed, as well as the performance of your funds, which can usually be found online. Increase your investments regularly.
401(k)’s, 403(b)’s and 457 (c)’s
A 401(k) is a retirement account offered through your employer, and is made up of pre-tax money from your own paycheck. If your employer offers a 401(k) plan, you should certainly take advantage of the opportunity. The same plan is known as a 403 (b) if you work in the non-profit sector and if you work for a government agency it’s known as a 457 (c). You decide how much money to take out of your paycheck and it’s automatically deducted. The contributions are made before federal and state taxes (except in Pennsylvania) so you save more money and there is a smaller effect on your take home pay. Another advantage to the 401 (k) plan is that the money isn’t taxed until you are 59 or when you decided to take money out. The maximum amount you can invest in a year is $10,000 and some employers will match the amount of money you contribute. You also chose how to invest within the plan, usually selecting from a menu of mutual funds.
INDIVIDUAL RETIREMENT ACCOUNTS (IRAs)
Anyone can invest in an IRA, which can easily be opened through banks, credit unions, mutual fund companies, brokerage firms, and insurance companies. An IRA is a great option for someone who may or may not have access to a 401(k) plan and doesn’t have much money to put away for retirement. You can invest multiple times a year, with a maximum of $5,000 per year, and your income must equal at least the amount you contribute to the IRA. You can contribute every month or contribute a lump sum once a year and your contributions are tax deductible. If you open an IRA, leave your money in there because you will be required to pay a 10% penalty if you withdraw any money before age 59 ., and you’ll will be required to begin withdrawing money at age 70 .
A popular version of the IRA is the Roth IRA, which allows you to invest as long as you are working and you are not required to make withdraws at any age, but you can not withdraw money before the age of 59 without a penalty, just like a regular IRA. A Roth IRA isn’t taxed and you can accumulate an unlimited amount of money. Contributions aren’t tax deductible, but Roth IRAs allow tax free growth and after the age of 59 you can withdraw money without paying taxes on it.
Another version of the IRA is the Roth 401(k). It combines features of a traditional 401(k) and a Roth IRA. It is an after tax account without the limits of an IRA. Contributions and withdraws are not taxed if you withdraw after the age of 59 and have held the account for the past five years. Unlike the Roth IRA, distribution of funds must begin at age 70 .
If you are an employee of a small business or are self employed, there are other IRA options available as well. Small business employees can invest in either a SIMPLE IRA or a SEP IRA plan. The SIMPLE stands for Savings Incentive Match Plan for Employees. This is an easier method for employers to plan for retirement and contribute to employees’ retirement. Contributions are made before taxes and are made directly to individual retirement accounts. The SEP, or Simplified Employee Pension is an option for anyone who is self-employed, or if you are the sole proprietor or a business or in a partnership. SEPs are also an option if you have a side job in addition to other employment and any other retirement account you may have. If you are a small business owner, you must establish a separate account for each employee and you are required to contribute the same percentage to each employees account as well as your own based on the wages reported in your W-2 forms. SEPs are tax deferred until the money is distributed and no annual contribution is required. Contributions can be made until the time you file taxes. They are also easy to set up because the IRS doesn’t require annual reports to be filed.
ADDITIONAL INFORMATION
Mutual funds, 401(k)s and IRAs are just a few options available investing your money when you prepare for retirement. Your financial goals, financial means, and future goals will all help you determine how to plan your retirement. There are many options available depending on your needs, and remember it’s never too early to save for retirement. If you want more information about retirement, here is a list of website and books to provide you with additional information:
The Commons Cents Money Management/Workbook, Judy Lawrence
Money, Banking, and Credit Made Simple, Merle Dowd
Bankrate.com
Mutual Fund Fact Book
Keys to Investing in Mutual Funds, Warren Boroson
Fundamentals of Investing, Lawrence J. Gitman and Michael D. Joehnk
bloomberg.com