How to Choose Funds for Your Retirement Account

Selecting funds for your retirement account can be frustrating. You’re faced with an overwhelming amount of financial jargon, paired with tremendous pressure to make the best decision given the importance of your retirement investments. Several of you have asked me to take this topic on directly, so let’s explore how to navigate retirement account fund selection!

Before we dive in: If you’d like a quick orientation to investing, explore how to start investing in four steps. And, if you’d like clarity on 401(k)s and IRAs, review this overview of the main differences in these common retirement accounts.

So, how do you choose funds for your retirement account? I’ll take you through four steps:

  • Decide how much of your retirement investments will be in stocks (versus other investment types)

  • Identify mutual funds that might meet your needs

  • Select the funds that are right for you (low-cost and with a strong performance history)

  • Invest (consistently and automatically) according to your asset allocation

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Let’s start with the first step - identifying the portion you’d like to invest in stocks. When you contribute to a retirement account, you need to decide how that money will be invested. This is referred to as “asset allocation.” How much will you invest in bonds (which are generally lower-returning but more stable)? How much will you invest in stocks (which tend to return more, but can be riskier)?

The asset allocation decision can seem overwhelming to many of us, who want to get the answer “just right.” However, like so much with investing, there is no perfect strategy. I suggest using one of two methods to derive your answer.

Rule of thumb. Many advisors suggest that subtracting your age from 110 provides the percentage of your portfolio you should keep in stocks. For example: If you are 29, 81% of your portfolio should be in stocks, and the remaining 19% should be in less-risky investments like bonds or cash. (Note: Advisors used to subtract from 100; I now see many shifting to 110 or 120 given longer lifespans.)

Online questionnaires. Financial institutions have easy-to-use questionnaires that help assess your risk tolerance, investment time horizon, and other elements in order to provide you with a recommendation. These questionnaires will provide a suggestion for you to consider regarding your asset allocation.

Note that most employer-sponsored retirement accounts will not permit you to invest in individual stocks. Instead, you can purchase large groups of stocks at one time by buying mutual funds. I generally like this limitation, as I do not believe the average person (or even most investment professionals) can outperform a well-designed, low-cost mutual fund. Therefore, once you determine the percentage you’ll be investing in stocks, you’ll usually be purchasing mutual funds (made up of stocks), instead of individual company stocks themselves.

Next, you need to identify the mutual funds available in your retirement plan that might meet your needs. Typically, most employer-sponsored retirement accounts limit your investment options, providing you with a list of mutual funds to select from. You can learn more about mutual funds here; since mutual funds allow us to buy many, many investments in just one purchase they are a very convenient way to invest.

When you are provided with a list of mutual funds, it will typically include the fund name and the ticker symbol, so you can easily research it. This is another step that can feel very overwhelming, and I recommend four steps to narrow your list of mutual funds down:

  • Look for index funds that mirror the market. I’ve mentioned before that my favorite mutual funds mirror a large, diverse market. One example is the Vanguard 500 Index Fund (ticker symbol: VFINX).

  • Avoid mutual funds that bet on an industry or sector. If you not 100% certain that a specific industry is going to over-perform all others, why would you place your valued money in that mutual fund? I avoid any funds that overemphasize a particular industry or region.

  • Explore target date funds if you like to keep things simple. Target date funds are designed to make asset allocation (which we discussed in the first step) easier. They are designed to get less risky as your retirement date nears, shifting from stocks to bonds. Note that, generally, their returns also drop over time (as they shift from higher-returning stocks to lower-returning, but more stable investments). Target date funds are named with the retirement year - so, if you’re 30 and plan to work until you’re 50, you add 20 years onto today’s date and select the fund with that year in the title.

  • Call your retirement account provider. Many retirement account providers (like Vanguard, Fidelity, and Charles Schwab) also offer support in identifying and exploring investment options. Taking some time to speak with them may provide additional clarity.

I suggest considering 3 - 6 mutual funds, with no more than two bond (or fixed-income) funds. Fewer funds reduces complexity and allows you to better understand what you’ve decided to invest in.

At this point, you have a list of several funds, and need to finalize your investments by checking costs and performance histories. Before investing, you should examine the 3 - 6 mutual funds you’ve identified to confirm they are low-cost and have a strong performance history relative to benchmarks.

I recommend you check at least three things; All should be available via your financial provider, but you can also search the funds on an industry site like Morningstar.

  • What's the expense ratio? This is how much the company that manages the fund charges you for their work. An average expense ratio is around .6% - meaning, for every $100 you have invested, the fund rakes in 60 cents. Sounds small - but tiny fees make a meaningful difference in your wealth over the long term. Vanguard’s average expense ratio is .12% - meaning, for every $100 you invest in a Vanguard mutual fund, they charge 12 cents. That’s much, much lower, and lets you keep more of your hard-earned money.

  • Are there other fees? It can be costly to create fancy, actively-managed mutual funds. So, look carefully for purchase or redemption fees, or 12b-1 fees (marketing or distribution fees.) Ask, ask, and ask again about fees before investing!

  • What's the 10-year return? If you’re investigating a stock fund, you’ll want to explore how it performed over the last decade, compared to the S&P 500. The S&P 500 is a very common performance benchmark because it includes the 500 largest U.S. companies. If the mutual fund seriously underperformed the S&P 500, it may not be worthy of your hard-earned money.

You’ll also want to compare each investment you are considering to one other; if an investment has a particularly high expense ratio, or low return relative to others in your short list, you may decide it isn’t worth investing in.

Finally, invest (consistently and automatically) according to your asset allocation. Remember your asset allocation? Well, now that you have your 3 - 6 total mutual funds, you will need to determine exactly how to invest across each fund.

Let’s say you have selected three funds, an S&P 500 index fund, a broader market index fund, and a bond fund. Further, let’s assume you’ve already determined you’d like to invest 10% in bonds and 90% in stocks. Then, your only remaining decision is how to divide that 90% between the two stock funds (the S&P index fund and broader market index fund) - as 10% will go to the bond fund. In a situation like this, my suggestion is keep is simple - so, start with a 50/50 split between the two stock funds, unless there is a compelling reason to do something different.

Most retirement account providers will allow you to allocate your investment dollars on a percentage basis. Typically, this is done online or by calling the customer service department. Importantly, unlike regular (non-retirement) investment accounts, employer retirement accounts aren’t subject to taxes when you change your investment allocations. For this reason, I suggest reviewing your investments at least once a year to ensure you’re comfortable with how your retirement money is invested.

I hope this overview helps you make your retirement account investment decisions faster and with greater confidence. Remember - there’s a lot of jargon that the financial industry uses - I’m here to help you cut through the clutter and grow your wealth!

xoxo,
Ms. Financier

Investing for Beginners: 21 Things You Need to Know

Investing is defined as, “the outlay of money usually for income or profit.” The idea behind investing? Put your money to work for you, in something you believe will increase in value over time. Investing your money in the stock market may seem like a foreign concept; How do you know which funds to invest in? How does trading actually work? And what the heck is a mutual fund?

There are some gender differences, too. Men are generally more confident about investing, while women are more goal-directed and trade less. Women tend to keep 10% more of their savings in cash than our male counterparts. Millennial women report a lower level of financial comfort. On average, we are less likely to feel “in control” or “confident” about our financial future. And, women generally have a smaller total invested when we retire - because we earn less.

Where to start? I’ve got you - the items below serve as a beginner’s guide to investing.

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1. Investing builds wealth

Is there anything more powerful than the idea of your money making money for you, without you lifting a finger? That’s at the heart of investing.

The power of compound interest means that the earlier you invest, the sooner your investments start growing and making money on your behalf. This builds your wealth far more rapidly than saving in a checking account.

2. The market is where companies go to attract investors

When people talk about investing in “the market” what are they referring to? Today’s markets are largely exchanges - like the New York Stock Exchange (NYSE) - that allow us to buy and sell investments to others. You’ve seen photos of business executives and celebrities “ringing the bell” to open the NYSE, but it’s not the only market; others include the NASDAQ, London Stock Exchange, and many others.

The market is a general term for spaces where companies go to attract investors, and where investors buy and sell with each other.

3. Investing allows you to own a portion of a larger business

Buying stock is like purchasing a little slice of a company. Say you buy stock in consumer goods company P&G (manufacturer of Tide, Crest, Dawn, Tampax, and many other household names); that stock costs $90.98 per share at the time of this writing. If you buy that share, you are betting that P&G will continue to grow and make money. P&G uses your $90.98 to invest in its business; open new locations, fund new products, hire new staff.

4. Owners make money when the businesses they own make money

Companies like P&G that offer stock to investors often give investors some of the money they earn. Every three months, these companies tell investors how they are doing by issuing financial statements.

If they are doing well (taking in more money than they spend, which is called profit), they will often give a portion of the money to investors. These payments, called dividends, can be re-invested or cashed out by investors.

5. You need an investment account to invest in the market

Investment accounts are offered by financial services companies (like Vanguard, Charles Schwab, and Fidelity) and allow you to buy stocks and other investments. Once you’ve determined what to invest in, it’s easier to select the right investment account.

6. Investment accounts come in several forms

There are several types of investment accounts, designed for different purposes.

Retirement accounts are for the future, and include 401(k) and IRA accounts. These typically include penalties if you access them before retirement age, and the government often gives you tax breaks on them to encourage investing.

Regular investment accounts are often referred to as brokerage accounts. These aren't necessarily for retirement, so you can add or withdraw your money as you see fit. These don't have special tax benefits (unlike many retirement accounts.)

7. 401(k) accounts are provided by your employer help you save for retirement

Retirement accounts, like a 401(k) or 403(b), can only be offered through your employer. They are named for the section of the Internal Revenue Code that outlines how they work.

401(k) plans can be offered by private companies. Similarly, 403(b) plans can be offered by public education employers, some non-profits, and the like.

8. IRA accounts are for you to save for your retirement

While 401(k) plans are offered by employers, a Roth or traditional IRA is available to anyone that earns an income. This helps those that work for companies that don't provide a 401(k) benefit, as well as those who want to invest more for their retirement.

You have to open this account for yourself at a qualified bank or broker, like Vanguard or Fidelity.

Traditional IRAs are funded with wages that you have already paid taxes on. However, depending on your income, you may be able to deduct your contributions from your taxes.

9. Some IRA accounts (Roth IRAs) allow you to access money in the future, without taxes

Roth accounts are funded with money that has already been taxed, so you do not owe the government any taxes when you access it in retirement.

Some people prefer Roth accounts because they like the predictably of knowing they will not be taxed in the future. Regardless of whether you prefer a Roth or Traditional IRA, the most important step is to begin investing. Either would be better than neither!

10. You need to fund your investment account in order to buy investments

Once you have selected both the type of account you are focused on (IRA, 401(k), brokerage) and the financial services provider (Vanguard, Fidelity, Charles Schwab), you need to fund the account by putting money in.

If you are just starting to invest, you can call the financial services provider or go to their website to send them your money and open your account. This money will sit in the investment account in cash until you decide which investments to purchase.

11. It is very, very hard to pick the right stock to buy.

All this knowledge is useless if you don’t put your money to work for you by selecting an investment. This is where many women, wanting to know all the details can face analysis paralysis.

Since a stock is like purchasing a little slice of a company, many people like to analyze company information (financial performance, industry trends, competitive landscape, emerging regulations), and then buy the companies they think will win.

A caution: this is very, very difficult to do. If you are buying individual stocks, it is very challenging to consistently make money.

Think about it; as an individual investor, you need to be educated enough to buy only the stocks that will continue to pay dividends OR buy (and sell) the right stocks at the right time, when they increase in price. And you’re competing with everyone else who watches the market - including professionals.

One of the money mistakes I made was trying my hand at purchasing individual stocks. I have shared how that worked out - disastrously - for me. There are over half a million companies you can invest in on public exchanges. How will we pick the right ones to buy stock in? Read the next steps to learn how.

12. Mutual funds allow you to buy many companies in one purchase

Mutual funds are one investment vehicle that allows us to buy many, many stocks in just one purchase. I prefer these to individual stocks because you can own hundreds of companies in each share.

Many retirement accounts only allow mutual funds, given they offer more companies in each purchase and are generally seen as less risky than stocks.

13. ETFs are like mutual funds, but cheaper

ETFs are my favorite type of investment. ETF stands for Exchange-Traded Fund. Like mutual funds, ETFs allow investors to buy many companies in a single share. They are nearly identical to mutual funds, save for some technical differences (how they are traded and regulated, for example).

I like these better than individual stocks and even mutual funds because they are generally less costly to the investor and have low expense ratios, as I explain in the next step.

14. Investments have costs

What's the expense ratio? This is how much the company that manages the mutual fund or ETF charges you for their work.

An average expense ratio is around .6% - meaning, for every $100 you have invested, the fund rakes in 60 cents. Sounds small - but tiny fees make a meaningful difference in your wealth over the long term. Vanguard’s average expense ratio is .12% - meaning, for every $100 you invest in a Vanguard mutual fund, they charge 12 cents. That’s much, much lower, and lets you keep more of your hard-earned money.

Are there other fees? It can be costly to create fancy, actively-managed mutual funds. So, look carefully for purchase or redemption fees, or 12b-1 fees (marketing or distribution fees.)

You can find these fees easily online when you research your potential investments, because companies are required to publish expense ratios and 12b-1 fees to their prospective investors.

Fees are taken directly out of the investment, so you do not see a “line item” of how much they are when your money is invested. This is convenient for expensive funds with high fees.

15. Returns help investors compare performance

Returns are indicators of how well (or poorly) investments perform. They help investors easily compare performance across different investment vehicles. Returns are expressed in percentages.

For example, if I invested $100 in an ETF that achieved a 4% one-year return, I would have earned $4 in that time period.

You can compare any range of time when looking at returns and compare your potential investment to a few big benchmarks.

Investment returns are from past performance and are not a guarantee of how well they will do in the future. However, they are a useful indicator.

15. Benchmarks like the S&P 500 help compare performance

How did this fund perform over the last decade, compared to the S&P 500? The S&P 500 is a very common performance benchmark because it includes the 500 largest U.S. companies. If the mutual fund or ETF seriously underperformed the S&P 500, it may not be worthy of your hard-earned money.

16. Review the 10-year return to compare performance

There are many ways to evaluate investment performance. I recommend using the 10-year return because I like a longer view into performance.

Compare your investments 10-year return to the S&P 500 10-year return so you can see if you are buying something slightly better than, or worse than, the performance of that group of companies.

Candidly, I keep my investments very simple and largely buy ETFs and mutual funds that match the S&P 500. That works well for me.

Investment experts like Warren Buffett recommend this approach for individual investors and studies show it is very difficult to beat “the market” consistently (meaning, a large benchmarked group of companies like the S&P 500).

17. Target date funds can make investing for retirement easy

Many financial services providers offer “target date funds” which are designed to help you save for retirement by adjusting over time. These funds buy less risky investments as the target date gets closer.

If you are planning on retiring in 30 years, you would buy the target date fund that is dated 30 years from today.

Keep an eye on the expense ratios and other fees associated with these funds. Many are modest, but I have seen some that are far higher than the average mutual fund (which is .6% industry-wide but .12% for Vanguard funds).

18. Investing is easier when you do it automatically

I strongly recommend a regular, automatic transfer timed with your payday. Start with whatever you can afford today, and aim to steadily increase it over time.

Automatic investing will ensure you’re always paying yourself first. Let’s take advice from Warren Buffett one more time. He says, “Do not save what is left after spending, but spend what is left after saving.”

19. Investments pay you through dividends and growth

Investments like mutual funds and ETFs make money for investors in two basic ways.

First, the company may perform well, create profits, and pay stockholders dividends from those profits as I outlined above. Dividends are a financial “thank you” for investing in the company.

If you choose to reinvest the dividends you receive, and buy more shares, you are creating a powerful wealth-building cycle.

Second, you can make money by selling your stock to someone else. Then, you profit (or lose) the difference.

20. The best day to start investing is today

Is there more complexity we could examine? Sure. But, these basics will put you ahead of most that are hesitating to get started due to lack of knowledge or analysis paralysis. Don’t let that be you. Are you ready to get started? You've got this!

xoxo, Ms. Financier

This post also appeared on the Fairygodboss blog - I love their mission to improve the lives and workplace for women, through transparency.

Saving for Retirement: The Beginner’s Guide

When you’re starting your career, you’ve got a ton on your “must do” list: impressing your boss on your first solo assignment, successfully navigating workplace politics, preparing to ask for your first raise, curating the perfect work wardrobe...the list goes on and on.

There’s another, critical, financial to-do that you need to accomplish. You need to start investing for retirement.

Why should you care about investing for retirement? Fair question - retirement can seem like a hazy event in the future, making it feel far less urgent than other life priorities. However, let’s learn from others - not saving early enough for retirement is the number one financial regret of Baby Boomers in America. In contrast, I have never heard anyone say they regret saving too much for retirement, too early.

Further, investing a modest amount today can be more powerful than investing a larger sum later in life. The power of compound interest means that the earlier you invest, the sooner your investments start growing and making money on your behalf. You can never, ever recapture time. Starting today with smaller amounts will build financial momentum in your investment accounts.

Finally, women should care about investing for retirement because we face a retirement gender gap. We tend to live longer, face a wage gap over the length of our careers, and spend more time out of the workforce than men. On average, we need to save $1.25 for every $1 saved by men.

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What type of account is best - an IRA or a 401(k)? Once you’ve decided to invest, it’s time to identify the best type of account for your retirement investing. Let me be clear: either an IRA or a 401(k) is better than doing nothing. Both are fabulous options that are set up to encourage investing. Don’t spend months trying to make the perfect choice; you’ll lose valuable time where your money could be in the market, growing for you.

If you’d like to learn more details about investing, here’s how to start investing in four steps. I’ve also created a very simple summary of what investing in the market really means. Here’s a summary of the main differences between an IRA and 401(k):

Traditional 401(k) Account: Offered by your employer, this account allows you to invest a percentage of your wages for retirement.

  • 401(k) accounts are funded with pre-tax wages. This means you pay less in taxes to the IRS. It also means you’re investing a larger amount of money (since you’re investing a full dollar earned, not just the portion remaining after taxes are paid).

  • Many employers will “match” a portion of your savings. This is free money; never pass up free money!

  • You pay taxes on the money when you withdraw it in retirement.

  • In 2017, you can save up to $18,000 annually in a 401(k) - more if you are over 50.

  • Generally, you cannot access the funds in a 401(k) account without paying steep penalties until you reach retirement.

  • 401(k) is the subsection of the Internal Revenue Code that defines how these accounts work, hence the name of this retirement vehicle.

Traditional Individual Retirement Account (IRA): You have to open this account for yourself at a qualified bank or broker, like Vanguard or Fidelity.

  • Traditional IRAs are funded with wages that you have already paid taxes on. However, depending on your income, you may be able to deduct your contributions from your taxes.

  • You pay taxes on the money when you withdraw it in retirement.

  • In 2017, you can save up to $5,500 annually in an IRA - more if you are over 50. The limit is far lower than 401(k) limits in most cases.

  • Funds in an IRA account are for your retirement, but certain qualifying expenses allow you to skirt tax penalties. These include higher education expenses, a first-time home purchase, and medical costs.

In addition to the differences above, 401(k) and IRA accounts may come in two flavors: Traditional and Roth.

  • Traditional accounts have been funded with money that hasn’t been taxed, so you pay taxes on the money when you access it in retirement. (Traditional IRA investments receive a tax deduction, which makes it the same as a pre-tax 401(k) investment.)

  • Roth accounts are funded with money that has already been taxed, so you do not owe the government any taxes when you access it in retirement.

So, which is the right type of account for you? Like many financial answers, it depends. In general, I recommend prioritizing a 401(k) account, because it often includes both employer matching funds, and you can save far more money for your retirement, in one place.

That said, the best advice I can give you is to make an informed decision quickly, and start investing (or, increasing your investing). Every day that passes without your money in the market is another day that you’re missing out on the amazing power of compound interest. You’ve got this!

xoxo, Ms. Financier

This post originally appeared on Victori Media, a site dedicated to helping millennial women live life victoriously. I love the site’s mission and am inspired by its creator, Tori Dunlap, who built her first business at age nine and is an award-winning digital marketer, entrepreneur and blogger.

Do Women Need To Save More Than Men for Retirement?

I have been thrilled to read recent reports that millennials are out-saving other generations. On average, we save 19% of our income, which is 5% more than Gen Xers and Baby Boomers, who average only 14%.

Many of us are focusing our saving on near-term objectives, like housing, or to live a certain lifestyle. It is equally important that we save for retirement. Investing small amounts regularly can build tremendous wealth, due to the amazing power of compound interest. But, does your gender matter in your retirement planning?

I’m disappointed to say it does, because the data suggests women need to save more than men. We face a retirement gender gap. The first reason is a positive one; women tend to live longer. This is the case without a single exception, in all countries. Because of this difference, we need more money to sustain our longer lives.

The other reasons contributing to the retirement gap are frustrating. Women face a persistent wage gap over the length of our careers and spend more time out of the workforce than men. On average, we need to save $1.25 for every $1 saved by men.

A recent article in the Journal of Accountancy addressed this topic and highlighted the health care penalty that women face;

“With longer lives, women also have more years of healthcare to pay for. According to HealthView Services, a company that publishes healthcare cost research for financial advisers, a healthy 55-year old woman can expect to spend $79,000 more on healthcare in retirement than a man of the same age. And women are much more likely to need long-term care, too...It's no coincidence that over 70% of the residents in nursing homes are women.”

The article also noted that, in heterosexual couples, "Statistically, men tend to go first, and it's their wives who had to take care of them.”

The retirement gap that exists between men and women may be frustrating, but it is important to understand now, in our working years, so we can take action. Here are some practical steps that you can take to address your personal retirement gap:

  • Redirect money from lower-importance categories. Look out for the sneaky ways we spend more than we mean to. These small expenses can add up; reducing them creates wiggle room for more saving.

  • Increase your retirement saving. If you have a 401(k) at work, you can invest up to $18,000 tax-free. Your employer may match a portion of that, which is like free money.

  • Start talking more frequently about money with the women in your life, because knowledge is power. A Fidelity study found that 92% of women want to learn more about financial planning, but eight in 10 “...confess they have refrained at some point from talking about their finances with those they are close to.” Women report that talking about money is “too personal.”

  • Encourage other women to save for retirement. Be the woman at work that encourages HR to host retirement savings webinars with your 401(k) provider, and talks openly about how excited you are to increase your 401(k) contributions. Your positive, non-judgemental approach will inspire others.

  • Grow your income. This may not happen overnight, but it is the surest path to close your personal retirement and wage gap. At a minimum, you should ensure HR has verified that there is no wage gap between you and your male peers. But I know you can do even more than that to build your wealth.

While data tell us we need to save more than men, I’m hopeful that our generation will be able to apply our tendency to save towards retirement investing. I’ve never met a retiree that regretted saving too much for their future. Let’s start building wealth now, so we can live our Golden Girls life in style, just like Blanche, Dorothy, Sophia, and Rose.

xoxo,

Ms. Financier

What’s the Difference Between an IRA and 401(k)? Why Does it Matter?

Saving for retirement can be daunting...and the finance industry’s love for confusing acronyms doesn’t help. So, what’s the difference between an IRA and a 401(k)? And, do those differences even matter? Let’s explore the basics, to prepare you to build wealth.

Why should you care about investing for retirement? Fair question - retirement can seem like a hazy event in the future, making it feel far less urgent than other life priorities. However, let’s learn from our parents - not saving early enough for retirement is the number one financial regret of Baby Boomers in America. In contrast, I have never heard anyone say they regret saving too much for retirement, too early.

Further, investing a modest amount today can be more powerful than investing a larger sum later in life. The power of compound interest means that the earlier you invest, the sooner your investments start growing and making money on your behalf. You can never, ever recapture time. Starting today with smaller amounts will build financial momentum in your investment accounts.

Finally, women should care about investing for retirement because we face a retirement gender gap. We tend to live longer, face a wage gap over the length of our careers, and spend more time out of the workforce than men. On average, we need to save $1.25 for every $1 saved by men.

What type of account is best - an IRA or a 401(k)? Once you’ve decided to invest, it’s time to identify the best type of account for your retirement investing. Let me be clear: either an IRA or a 401(k) is better than doing nothing. Both are fabulous options that are set up to encourage investing. Don’t spend months trying to make the perfect choice; you’ll lose valuable time where your money could be in the market, growing for you.

If you’d like to learn more details about investing, here’s how to start investing in four steps. I’ve also created a very simple summary of what investing in the market really means. Here’s a summary of the main differences between an IRA and 401(k):

Traditional 401(k) Account: Offered by your employer, this account allows you to invest a percentage of your wages for retirement.

  • 401(k) accounts are funded with pre-tax wages. This means you pay less in taxes to the IRS. It also means you’re investing a larger amount of money (since you’re investing a full dollar earned, not just the portion remaining after taxes are paid).

  • Many employers will “match” a portion of your savings. This is free money; never pass up free money!

  • You pay taxes on the money when you withdraw it in retirement.

  • In 2017, you can save up to $18,000 annually in a 401(k) - more if you are over 50.

  • Generally, you cannot access the funds in a 401(k) account without paying steep penalties until you reach retirement.

  • 401(k) is the subsection of the Internal Revenue Code that defines how these accounts work, hence the name of this retirement vehicle.

Traditional Individual Retirement Account (IRA): You have to open this account for yourself at a qualified bank or broker, like Vanguard or Fidelity.

  • Traditional IRAs are funded with wages that you have already paid taxes on. However, depending on your income, you may be able to deduct your contributions from your taxes.

  • You pay taxes on the money when you withdraw it in retirement.

  • In 2017, you can save up to $5,500 annually in an IRA - more if you are over 50. The limit is far lower than 401(k) limits in most cases.

  • Funds in an IRA account are for your retirement, but certain qualifying expenses allow you to skirt tax penalties. These include higher education expenses, a first-time home purchase, and medical costs.

In addition to the differences above, 401(k) and IRA accounts may come in two flavors: Traditional and Roth.

  • Traditional accounts have been funded with money that hasn’t been taxed, so you pay taxes on the money when you access it in retirement. (Traditional IRA investments receive a tax deduction, which makes it the same as a pre-tax 401(k) investment.)

  • Roth accounts are funded with money that has already been taxed, so you do not owe the government any taxes when you access it in retirement.

So, which is the right type of account for you? Like many financial answers, it depends. In general, I recommend prioritizing a 401(k) account, because it often includes both employer matching funds, and you can save far more money for your retirement, in one place.

That said, the best advice I can give you is to make an informed decision quickly, and start investing (or, increasing your investing). Every day that passes without your money in the market is another day that you’re missing out on the amazing power of compound interest.

I’m curious if you have any other questions about the differences between these accounts. Which have you prioritized? Let’s get investing - you’ve got this!

xoxo,

Ms. Financier

This post also appeared on the Fairygodboss blog - I love their mission to improve the lives and workplace for women, through transparency.

How To Create Your Retirement Budget

I get incredibly excited about the idea of creating a retirement budget. It is a chance to imagine my life at a point when I no longer have to work and can fill my time as I choose. I think about my retirement budget as a “financial freedom budget;" I aim to stop working a traditional job (or before) I reach the age of 45. Those that know about my goal of financial freedom ask about my budget. In this post, I’ll share how I think about my future spending.

I created my first financial freedom budget in 2013 when I started exploring the FIRE community (Financially Independent, Retired Early). Before that, I'd always thought, “Retirement is so far away, I can’t imagine what my budget will look like.” I had never considered how I’d be living when I stopped working; it was always “off in the future” and so “far away.” I could figure it out later, right?

My thinking changed once I was bitten by the bug to achieve financial independence. I became inspired to figure out exactly how much Mr. Financier and I would need to save to become financially free. A key part of that is how much we’d be spending, so modeling our future budget became critically important. 

At first, thinking about the expenses we’d incur for the rest of our lives was overwhelming. There are so many variables and assumptions. So, I began in the most obvious place - with our current household budget. I reviewed our annual expenses from 2012 and began making adjustments from there. The first adjustment was easy; I immediately deleted my two largest monthly expenditures. These were our mortgage (which we plan to pay off before we stop working) and our retirement savings. That change immediately reduced our monthly expenses by 59%.

Are you surprised that we were spending nearly 60% of our income on retirement and our mortgage?  Two things to keep in mind: First, we refinanced our generously-sized home (and associated generously-sized mortgage) into a 15-year loan that we pay extra on each month. Second, in 2011 and 2012 we had already optimized our budget to remove extra expenses in order to invest more our income.

Note that many mortgage payments include property taxes and homeowners insurance payments; these won’t disappear once your loan is paid off. If you plan to pay off your mortgage before retirement, include your taxes and insurance payments in your retirement budget.

Next, we reviewed our entire budget and made adjustments to reflect what we expected to spend once in the future. Like any budget, ours is a best guess and a living document that we keep coming back to and modifying over time. Here is a summary of the major changes we made.

Home Maintenance Saving: We added a dedicated line item equivalent to 1% of our home’s value to save each month for repairs, since we would not have salary and bonuses to help pay for any big expenses out of upcoming cash flows.

Health Insurance and Healthcare: We increased costs for health and dental insurance for us both, estimated based on visiting online sites and getting quotes (pretending we were 55.) We assumed we’d be paying more for healthcare as we age and increased spending in that category.

Auto Insurance: This line item decreased, as we’d sell one of our two cars in retirement (no more dual commuting) and we’d also be driving fewer miles annually, without the daily trip to work.

Travel: I love exploring, so this line item went up significantly. I increased our travel expenses three-fold. Right now, Mr. Financier and I are very time constrained and don’t travel as much as we’d like given our careers. I look forward to “slow travel” when we’re financially free - weeks or months in one location, living more like a local.

Clothes & Dry Cleaning: This went WAY down, as we wouldn’t need to be in our professional work gear every day. I still plan to buy shoes, but perhaps not quite as many new pairs each year!

Food, Wine, Dining: We increased these slightly; business travel subsidizes some of our fine dining today and we do plan to enjoy going out weekly in our financially free days. I’m also a wine enthusiast, and I’d like to explore it even more in the future.

Hobbies: We increased our hobby expenses, though not by much as we have pretty inexpensive hobbies (reading, running, hiking, camping, and yoga). I did add in additional costs for classes and seminars; there are so many amazing programs in the D.C. area and I regularly can’t participate because of my work schedule.

With these adjustments, Mr. Financier and ended up with a total monthly requirement that is far lower than our expenses today. When I did the math, I was stunned that we could have the lifestyle reflected in this retirement budget, for so much less than we were living on.

What about inflation? Many prefer to include inflation in their modeling. I do all of my calculations in today’s dollars.  Yes, inflation is real, but we never intend to move our entire portfolio out of the market, so we expect that keeping our money in the market will combat inflation - just like it does for us today.

Is my retirement budget perfect? Like any model, I know it isn’t. However, it is a starting point that allows me to explore how much income I’ll likely need to replace when I stop working full time. Many that approach financial freedom begin to live on their post-retirement budget a few years before they stop working. I like this idea as a way to reality-check and pressure-test the budget.

Have you built a budget that reflects your expenses post-career? If so, how did you do it? What feedback or suggestions do you have for me?

xoxo, Ms. Financier

The Magic Number Behind Financial Freedom

To me, financial freedom is the most glorious phrase - even better than free Manolos. What is financial freedom? It is the point at which our assets (investments and income from real estate, for example) produce enough regular income to cover our expenses. I find the idea magical! Financial freedom means we’ve invested so much that our own money has turned into our primary source of income. At this point, we no longer “need” to work for income.

At first, financial freedom sounds impossible. Only for the very wealthy, or for the tremendously lucky. I acknowledge that this magical concept isn’t accessible to everyone. However, the cold, hard math suggests that far more of us could achieve financial freedom if desired; it is a choice that requires us to prioritize growing our wealth.

You may aim to achieve financial freedom in order to retire in your 60s (or later). Or, you might be driven towards an earlier date; your 50s, 40s, or even 30s. I've shared that my goal is to reach financial freedom by 45 (or earlier). If the idea of a “work-optional” life appeals to you, there is one key number you need to understand. This number makes it possible to eliminate the need to work in a traditional career, or stop working all together! So what is it?

Four percent, which refers to the 4% safe withdrawal rate (also called the 4% rule). Why 4%? Several studies have confirmed that retirees can safely withdraw 4% of their nest egg every year, without the risk of running out of money, and without adding to their savings. While the returns on investments will vary (some years more than 4%, some years less than 4%), if you consistently withdraw 4% annually, you’ll avoid the risk of completely depleting your funds. Here’s a roundup of some of the most relevant research.

The most well-known exploration includes the Trinity Study, which originated at Trinity University. Professors explored market data between 1925 and 1995, seeking to understand what withdrawal approaches wouldn’t exhaust the retiree’s nest egg. They wrote, “Withdrawal rates of 3% and 4% are extremely unlikely to exhaust any portfolio of stocks and bonds during any of the payout periods [15- or 30-years].”

Even before that research, William Bengen’s 1994 study, Determining Withdrawal Rates Using Historical Data, analyzed and tested various withdrawal rates against historical market data. The maximum rate that retirees could withdraw without depleting their savings? You guessed it - 4%. One important assumption in this study is that 50% of the portfolios were in bonds. (It is common for retirees to place large amounts in lower-risk investments like bonds. I personally plan to have a longer retirement and will put far less than 50% in bonds).

Finally, Michael Kitces, a financial expert and lifelong learner who has many professional designations in the world of finance (see them all here), also examined periods of time going back to the 1870s - and he found that there isn’t a 30-year period in which a 4% withdrawal rate was too high. His fascinating post is here.

You can find endless information on the 4% rule and it is important to explore the studies, in order to understand the relevant assumptions. Importantly, if you believe the studies (which I heartily do) you can do some serious planning for financial freedom.

Let’s play along: if your living expenses are $75,000, you’d need to have $1.87M in order to fully cover your expenses. (You would withdraw 4% of $1.87M, which is $75,000.)

But, let’s say you spend some of that $75,000 on your mortgage (which you will pay off before becoming financially free), saving for retirement, and investing in a college fund for your niece (who goes to college next year). Then, these are expenses you won’t have to account for in the future; you might really spend only $50,000 each year! This lowers your investment requirement to $1.25M.

If you’re like me, you probably have lots of questions.

What about inflation? Simple answer: keeping some of your money invested in the market will fight inflation.

What if you want to spend more when you're financially free? That’s great; just up your budget appropriately and re-calculate the nest egg required.

What if 4% feels too risky for you? Change your withdrawal rate. Use 3.5%, 3%, 2.5%...whatever you feel comfortable with.

How can you know what your future budget will be? Short answer: create your best model based on your current budget. Longer answer: check out my next post.

In summary, the 4% rule gives you a tangible, specific number to work towards in order to achieve financial freedom. You may think the amounts required to generate income to cover your expenses sound impossibly big. You might ask yourself, “How the heck will I ever save $1.25M?!” I’ll tell you - one dollar at a time. The magic of compound interest will help you grow your money at a fast rate over time.

There’s plenty of discussion on whether the 4% rule still holds true today, as time in retirement lengthens. I encourage you to explore alternative models and determine what would work for you.

One thing I can promise? You’ll never get there if you don’t get started. Your path to wealth all depends on what you do with the space between your income and your expenses. If you grow that space, by increasing your income and reducing your expenses, you give yourself a greater opportunity to achieve freedom earlier.

I'm also a big fan of starting small and persistently increasing your investments over time. Figure out the best estimate of your target nest egg and get investing. I’ll see you in financial freedom!

Do you believe the 4% SWR? If not, what withdrawal rate do you prefer? Let me know!

xoxo, Ms. Financier