What to Do if You Want to Retire with Enough Money

I have family members who are missionaries in Mexico.  They once told me about a concerning problem about standard financial planning in Mexico: there is no real financial plan for just about anyone in the country.  Most people rely on their children to care for them in their golden years, and it has been that way for generations.  The problem is that it only takes one generation to decide that taking care of their parents isn’t their responsibility for a whole generation to die broke and homeless.  

Unfortunately, that’s exactly what’s happening now.  

If you want to retire with dignity, not be a burden to your children, and be able to contribute to your family’s financial legacy, you need to understand how to save for retirement.  

Would you like to know some surprising facts about retirement planning?

Fact #1: It’s boring.  The majority of millionaires just steadily invest in good growth stock mutual funds in their 401(k) or IRA for 30 years.  What?  No Bitcoin?  No amazing stock picks?  Nope, just steady investing and compound growth over time.  

Fact #2: It’s simple, but not easy.  The average millionaire has an unsophisticated retirement plan.  They may only have three or four different mutual funds, but they are good funds with long track records of steady growth.  The hard part is to not pull your money out and chase the next quick win.  

Fact #3: Everyone needs to do it, but most people just don’t.  The average person in America can’t write a check to pay off a $1,000 emergency.  The average worker in America has less than $10,000 saved for retirement, regardless of age.  We all need to do it, but most people just don’t.  

Before we tackle the specifics, we need to touch on four key principles of investing.  If you understand these financial fundamentals and apply them, it’s a mathematical certainty that you will retire with enough money to live comfortably and support your family.  

Key investing principles

    1. Live beneath your means.  This is the most important principle to understand.  If you constantly spend more than you make, you will be broke and desperate your whole life.  This may mean you have to increase your income, but it almost always means that you need to cut back your lifestyle.  Take a look at my posts on budgeting to learn more about creating a budget that helps you reach your financial goals.  
    1. Money comes from work.  We are not entitled to money without earning it. 
    1. Avoid debt.  As Chris Hogan likes to say, “Interest you pay is a penalty, interest you earn is a reward.”  You work too hard to give your money to others in the form of debt payments.  Make debt elimination a priority for your household.  
    1. Track your money.  As they say, failure to plan is a plan for failure.  If you don’t know what your money is doing and the state of your assets and debts, how can you plan effectively?

Money Truth: 80% of personal finance is controlling your behaviors that prevent you from winning.  It’s not about the math, it’s about promoting spending and saving habits that cause you to win with money, regardless of income level.   

 

Golden Rule for Investing: The #1 predictor of success in investing for retirement is rate of savings, not rate of return or investment vehicle choice.  The more you save, the more you’ll have.

 

A few more basic concepts before we talk about IRAs and 401(k) plans.  

    1. Give up trying to time the market.  No one can beat the stock market consistently.  Stocks and bonds are so efficiently priced that the majority of investors will not outperform an unmanaged index fund after transaction costs.
    2. A good rate of return is 7-10%, but some funds can earn 12-14%.  You probably won’t be able to consistently get over 15% long-term.
    3. Don’t make investments you don’t understand.  
    4. Don’t make investments you can’t afford.  
    5. Have a diversified portfolio.  Find investments that don’t always move in the same direction at the same time.  
    6. Keep it simple!!!  The S&P 500 index fund beats 70% of all actively traded funds every year.  A simple strategy is to contribute to a few diversified funds consistently for decades.  If you do this, you will retire with dignity. 
    7. Costs matter: keep expenses as low as possible.  
    8. Good investments are tax-advantaged.

 

Silver Rule for Investing: The goal for investors is to maximize real returns after taxes and fees.

 

So, how do we create a tax-advantaged retirement portfolio?  We turn to IRAs and other tax-advantaged accounts.  Let’s take a look.

Individual Retirement Arrangement (IRA): An IRA is an account that allows you to invest in a tax-advantaged way.  Inside of the IRA, you can buy a variety of investments, such as individual stocks, bonds, mutual funds, or shares of real estate investments.  The IRA is how the investments are treated for tax purposes.  

Think of it like this: 

Imagine you put your investments in the bed of a pickup truck.  The truck carries your investments, but it’s open to the rain, hail, wind, and other elements.  Imagine the weather is like taxes.  When the truck is outside, all of your investments are exposed.  Now, if you put your truck in a garage, you protect the investments in the truck from the tax storms.  That garage is like your IRA.  The garage protects the truck as well as what’s in it.  Likewise, the IRA protects your investments by sheltering them from the taxes that could be hitting them. 

Who can open an IRA?

Anyone with an earned income can open an IRA.  Also, if your spouse has an earned income, you are eligible to open an IRA as well.  

Personally, I have used Vanguard for several decades for most of my personal mutual fund investing, including my IRAs, but there are many reputable companies out there.  

What are the restrictions?

The maximum allowed annual contribution (as of 2019) is $6,000 per person ($12,000 for a married couple) if you’re younger than 50, or $6,500 ($13,000 for a married couple) for people over 50.  

If you withdraw money before age 59 & 1/2, withdrawals are taxed at ordinary income rate + 10% penalty!!  So, don’t put money in unless you’re leaving it there for a long time!

Mandatory withdrawals start at age 70 & 1/2.  

What’s a Roth IRA/401(k)?  

Ok, here’s where things get interesting.  A Roth account vs a traditional account describes when taxes are taken out.  The Roth account works the same for an IRA, 401(k), 403(b), TSP, etc.

If your account is a Roth account, it means that the money goes in “after tax”.  That is, the money is taxed the year you invest it.  Then, when you withdraw the money, it comes out tax-free.

In a traditional account, the money goes in “pre-tax.”  You can deduct the amount invested from your taxes the year you invest it.  Then, the money in the account is taxed the year you withdraw it.  

So, which is better?  Roth or traditional?

This question could start a rumble in an online personal finance forum.  There are a lot of opinions on this, and I’ll give you mine, but I encourage you to read what others have written on the subject so you can decide for yourself.  

In general, Roth is best in your lower income years.  Once you’re in the highest tax brackets, tax-deferred growth will play more of a role.  In your early years (medical/dental school, residency, fellowship, early career, etc.), Roth is better, so take advantage of it while you can.

Eligibility phases out with increasing income levels.  Singles can’t contribute directly to a Roth IRA if their income is over $137,000 per year.  If you’re married filing jointly, you’re ineligible to directly contribute to a Roth IRA if your annual household income is over $203,000.

If you are over those income limits, you can still contribute to your Roth 401(k) or Roth 403(b), and you could also do what’s called a “backdoor Roth IRA,” but direct contributions to a Roth IRA wouldn’t be allowed.  

Why is Roth better?

When you start saving early, say in your 20s or 30s, somewhere between 75 and 90% of the money you have in your retirement accounts by age 65-70 will be growth, not direct contributions.  That’s money that has never been taxed.  

If you have that money in a Roth account, it comes out tax-free.  If that money is in a traditional account, it gets taxed at your ordinary income rate.  

For example, if you have $3M in a Roth account, maybe $2.5M will be growth and it comes out tax-free.  That same amount in a traditional account will get taxed at your ordinary income rate.  We don’t know what taxes will be in the future, but it’s safe to assume that it’ll be more than 0%.  If the tax rate is low, say 25%, that’s a $750,000 tax bill that you would owe (if you withdraw it all).  

So, in general, Roth is better, particularly in your lower income years.  Again, I encourage you to read other writers on the subject, and I’ll have more to say in future articles, but most people agree that you should invest in Roth accounts as long as you can, especially when you’re early in your career and have lower tax rates.  

What about my 401(k)?

The 401(k) is different from your IRA.  Remember, the “I” in IRA stands for “individual,” meaning you set it up on your own.  The 401(k), 403(b) and 457 are examples of retirement savings options through your employer.  

Your employer-sponsored plan may have Roth and traditional options, or they may only offer the traditional option.  If you have a Roth option available, I generally recommend going with the Roth option for the same reasons outlined above with regard to the Roth IRA.

If your employer will match your contributions, this is a huge benefit!!  Have you ever heard the expression, “Always take free money.”?  To incentivize savings, many employers offer to contribute extra money directly to your 401(k) up to a certain amount, usually a percentage of your income.  This is commonly referred to as a “match.”

For example, if you have a 5% match and your salary is $100,000 per year, your employer will put in a dollar for every dollar you put in your 401(k) up to 5% of your salary.  So, if you contribute $5,000 to your 401(k), your employer will contribute $5,000 to your 401(k).  That’s a 100% return on day 1!  

Always, always, ALWAYS take advantage of the match!

That’s a lot of options.  What should I choose?

Start by determining how much money you need to save each month to reach your retirement goals.  Check out my article on setting reachable financial goals to get started.  

Once you know your monthly savings goal, this is the strategy I would follow:

    1. Contribute the maximum amount to your 401(k) to get the match.
    2. If you don’t have a match, or if your monthly savings goal exceeds the amount needed to get the match, then contribute the remainder to your Roth IRA and/or Roth 401(k). 
    3. If you max out options 1 and 2 and you still have money left over to invest, then max out any traditional 401(k) or other tax-advantaged accounts.  

Using the example above, let’s say your goal is to contribute $12,000 per year to your retirement savings.  Your company will match $5,000, so contribute $5,000 to your 401(k).  With the remaining money, you could contribute $6,000 to your Roth IRA and then $1,000 to a Roth 401(k) or to your spouse’s Roth IRA.  

What does a good investment portfolio look like?

There are hundreds of opinions on this subject, and again I encourage you to get multiple viewpoints.  I currently only invest in good stock mutual funds.  My current allocation is:

      • 25% in small-cap or aggressive growth funds
      • 25% in mid-cap or growth funds
      • 20% in large-cap or growth/income funds
      • 20% in international funds
      • 10% Real Estate Investment Trusts (REITs)
  • Bonds: I am not currently investing in bonds because their values drop in rising interest rate markets.  There are many who argue that bonds should be a part of a diversified portfolio regardless, but I do not currently plan to buy new bonds for the foreseeable future.
  • Single stocks: I don’t recommend you invest in single stocks because of the risk of having too much money invested in one company.  
  • Real estate: I plan to invest in income-producing real estate eventually, but I’m building a more diversified base of mutual funds first.  Don’t make the mistake of buying rental properties that are leveraged with high amounts of debt.  This is a really bad financial strategy, especially when you’re first starting your investment journey.
  • Specialty stocks or sector funds: Minimize your investment in specialty stock funds (like health care or tech stock mutual funds) to no more than 10% of your portfolio.  Avoid investments in gold or other precious metals.  

Summary

It’s easy to get paralyzed by constantly trying to find “the best strategy,” but remember the Golden Rule of Investing: The #1 predictor of success in investing for retirement is rate of savings, not rate of return or investment vehicle choice.  

You just need to get started, and get started today.  Buy mutual funds or other investments that you understand and can afford, minimizing taxes and fees using the techniques listed above.  If you do that consistently for 20-30 years (or more, if you’re starting early), you WILL retire with enough money to live comfortably.  

Keep learning, keep reading, and keep improving your understanding of retirement investing.  It’s not that complicated, it’s just hard to have the discipline to save every month for decades to reach your goals.  I believe in you, and I’ll help you out as much as I can.  

Leave a comment below if you have any questions about retirement investing or if you’d like to know more about a specific topic.  

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