Retirement Investing Advice: The Coming Revolution

Retirement investing advice is about to change, with new strategies and considerations for those planning their retirement. The traditional advice is to replace 70% to 90% of your annual pre-retirement income through savings and Social Security. However, with people living longer and healthcare costs rising, there is a growing emphasis on starting retirement planning early and understanding the various options available for retirement savings accounts and investments. This includes defined-benefit plans, 401(k)s, IRAs, brokerage accounts, and taxable accounts, each with different tax implications and benefits. Additionally, individuals are encouraged to calculate their net worth regularly to ensure they are on track for retirement and to make a plan to pay off any debts. Seeking advice from financial professionals can also help navigate the complex world of retirement investing.

Understand your retirement account options

Understanding your retirement account options is a critical step in retirement planning. There are various tax-advantaged and taxable accounts available, each offering different benefits. Here's what you need to know:

Tax-Advantaged Accounts:

These accounts are structured to provide tax benefits, either by deferring taxes or offering tax deductions. The most common tax-advantaged accounts are 401(k) plans and Individual Retirement Accounts (IRAs).

K) plans are typically offered by employers and provide tax incentives and, in some cases, matching contributions. For 2024, contribution limits are $23,000, or $30,500 if you're 50 or older.

IRAs offer tax-deferred investing, meaning you don't pay taxes on contributions or earnings until withdrawal during retirement. For 2024, the contribution limit is $7,000, or $8,000 if you're 50 or older.

Taxable Accounts:

These accounts are funded with after-tax dollars, and taxes are paid on any investment income or capital gains in the year they are received. Most brokerage and bank accounts fall into this category. While these accounts don't offer tax breaks, they can still be used to hold tax-deferred investments such as annuities.

Defined-Benefit Plans:

Also known as pensions, these are employer-funded retirement plans that guarantee a specific benefit based on salary history and employment duration. They are less common today, mainly found in the public sector.

Rollover IRAs:

If you change jobs, a rollover IRA allows you to consolidate savings from previous employers into a single account, simplifying your retirement savings.

Types of Investments:

Within these accounts, you can invest in various vehicles such as annuities, mutual funds, stocks, bonds, and exchange-traded funds (ETFs). Annuities, for example, provide a steady income stream during retirement, while mutual funds offer a professionally managed pool of stocks, bonds, and other instruments.

Where to Open an IRA:

You can open an IRA at a bank, brokerage firm, mutual fund company, or even a life insurance company.

Employer-Sponsored Plans:

If you have access to a 401(k) or similar company plan, it's often a good idea to start there, especially if your employer offers matching contributions.

Combination of Accounts:

You don't have to choose just one type of retirement account. You can contribute to both a workplace plan and an IRA, maximising your tax-advantaged savings.

Understanding your retirement account options is essential for effective retirement planning. Each type of account has unique features and benefits, and you can combine different accounts to meet your retirement goals.

Start saving early

Starting to save for retirement early is a great way to ensure you have a comfortable retirement. While it can be tempting to put it off, there are many benefits to starting now.

Compound Interest

The longer your money is invested, the more it will grow. Even if you can only afford to save a small amount, compound interest means that your savings will grow exponentially over time. The earlier you start, the more time your money has to grow, and the less you will have to save overall.

More Disposable Income

Starting early means you can save less each month and still achieve the same results as saving aggressively for a shorter period. It also means you will have more disposable income to spend on other things, such as buying a home or going on holiday.

A More Relaxed Transition

Planning for retirement early means you can look forward to a more comfortable retirement. You can create a comprehensive wealth management plan, so you don't have to worry about finances when you finish working.

The Power to Make Choices

Saving early gives you more options later in life. It could mean you are able to retire early, or it could mean you have the financial freedom to reduce your hours or change careers. It also means you won't have to rely on Social Security, Medicare, or your relatives for financial support.

It's Easier When You're Young

When you're young, you may have fewer financial commitments, such as a mortgage or family, so it's a great time to start saving. It's also a good idea to get into good financial habits early, so you don't spend 100% of your paycheck.

Calculate your net worth

Your net worth is a snapshot of your current financial position. It's calculated by subtracting all liabilities from all assets. Assets are anything you own that has monetary value, and liabilities are debts or other obligations that deplete resources.

Here's a step-by-step guide to calculating your net worth:

• Make a list of all your assets. This includes cash in checking, savings, and retirement accounts, the market value of any properties you own, the value of any securities such as stocks or bonds, and the market value of any vehicles or other valuable possessions.
• Total up the value of all your assets.
• Make a list of all your liabilities, including any loans, mortgages, credit card balances, student loans, car loans, outstanding bills, and taxes that must be paid.
• Total up the value of all your liabilities.
• Subtract your total liabilities from your total assets to get your net worth.

A positive net worth means your assets exceed your liabilities, indicating good financial health. A negative net worth is a sign that you may need to focus on reducing your liabilities and increasing your assets.

It's important to note that your income is not included in the net worth calculation. A person with a high income can have a low net worth if they spend most of their money, while someone with a modest income can have a high net worth if they invest in appreciating assets and save prudently.

Calculating your net worth is a useful step in retirement planning. It helps you understand your financial position and make informed decisions about saving, investing, and paying off debts.

Keep your emotions in check

It is normal to feel emotional about investing, but letting these emotions drive your decisions can cause you to do the wrong thing at the wrong time. Here are some tips to help you keep your emotions in check when investing for retirement:

Automate Decisions

Automating investments by making regular contributions to retirement plans or setting up automatic withdrawals if you're already retired can simplify the process and remove emotions from the equation. This approach, known as dollar-cost averaging, has been proven to be successful over time and allows you to avoid emotional responses to market events.

Steer Clear of Financial Media During a Crisis

Staying glued to financial media during a crisis may work against you. You'll hear from market commentators who may be feeling emotional as they see their investments decline, and this could cause you to sell stocks at the wrong time. It's better to stick to your plan and ignore the news until things calm down.

Know Your "Why"

Understanding why you're investing in the first place can help you stay calm when markets get crazy. Keep a list of investment goals and refer to them during times of market stress. Placing assets into different "buckets" can also help; if you know the money you need for emergencies and the next few years is in safe investments, you're less likely to panic when stocks fall.

Avoid Market Timing

A common emotional reaction is to sell stocks when the economy is deteriorating. But this is extremely difficult to do successfully. It's better to think about various scenarios and position your portfolio based on the most likely ones. People who sell for emotional reasons often struggle to get back in.

Hire a Financial Advisor

If you don't feel confident about managing your investments without making emotional decisions, consider hiring a financial advisor. Advisors can help keep you on track and provide well-reasoned advice when you become emotional.

Take a History Lesson

Reading up on previous market cycles can help put things in perspective. Even in the slowest recovery in recent history, after the dot-com crash and the September 11 attacks, the market did eventually recover and create a lot of wealth for those who kept investing in the down years.

Distract Yourself

Learn to recognise when you're about to make a knee-jerk reaction to news or market behaviour, and then distract yourself. Get in the habit of pausing before you trade, and if the move doesn't fit your plan, log out of your investment account and take a walk, read a book, meditate, or listen to music.

Consult an Expert

Consulting a financial expert will help you evaluate the accuracy of your thinking and give you something valuable: time. If you can't afford a financial advisor, at least speak to someone before making an investment decision—as long as they're not panicking too!

Pay attention to fees

Paying attention to fees is crucial when planning for retirement. Investment fees can significantly impact your overall returns and the value of your investment portfolio over time. Here are some essential things to keep in mind regarding fees:

Understand the Types of Fees

Investment fees can be structured as one-time charges or recurring fees. Common types of fees include loads or sales commissions, management fees, advisory fees, broker fees, and trading or transaction fees. Loads are commissions paid to investing professionals when you buy shares in a mutual fund. Management fees cover the costs of fund management by professionals. Advisory fees are charged by fee-only advisors, who may charge a flat fee, an hourly rate, or a percentage of the assets under their management. Broker fees are charged by brokers or investment platforms for executing trades or providing other services. Trading or transaction fees are charged every time you buy, sell, or exchange shares. Understanding these fee types will help you make informed decisions about your investments.

Evaluate the Impact of Fees on Returns

Investment fees directly impact your returns. For example, if you assume a 5% net return, you actually need to achieve a 7% return if you have a 2% annual fee. As fees accumulate, they can eat away at your returns. Over time, even a small difference in fees can make a significant difference in your overall investment performance. Therefore, it is crucial to consider the long-term impact of fees when evaluating investment options.

Compare Embedded Fees

Embedded fees are not always visible day-to-day, and you may not realize how much you are paying. For instance, on a $10,000 portfolio, embedded fees can amount to $200 to $250 per year. As your portfolio grows, these fees can increase substantially. Be mindful of embedded fees and don't hesitate to ask questions to understand them better.

Assess Active Management Fees

Investments with higher fees often justify these costs by claiming to employ active management strategies, where professionals actively buy and sell to beat market benchmarks. However, it is important to note that most active managers do not outperform the indexes. Therefore, you may be paying higher fees with a low probability of achieving the desired returns. Lowering fees can significantly increase the probability of higher returns.

Focus on Long-Term Value

When deciding which investment fees are worth paying, consider the long-term value of the investment. Paying a higher commission upfront and having lower ongoing fees can be more advantageous for long-term investments. Look for funds with reasonable expense ratios, strong track records, and good management. Remember that paying a small fee here and there may seem insignificant, but these fees can add up and affect your investment performance over time.

Frequently asked questions