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Investing for Retirement

     The idea of retiring may be the reason why many people are unprepared for it.  We live for today and need the money it requires. Retirement is a concern for tomorrow so many do not plan for it, can not envision what it means for them, do not even want to think about it, and that is a problem.  If you do not have a vision of your future, you do not have a goal, and without a goal saving for retirement lacks commitment.  You may delude yourself into thinking Social Security and your employer’s pension will be enough, but you know it will not.  Begin your retirement planning now and work out the financial resources needed to live the life you want before it’s too late. 

     There are three basic tasks to accomplish in a retirement plan.  The first is to determine your retirement goal.  Even if it is vague and changing your vision of retirement will eventually become the goal.  A goal creates a desire for action to achieve it, which in this case means saving part of your earnings.  But saving is not enough; it’s just cash in the bank.  To get to your goal you need enough wealth to finance the lifestyle you envision, and to create wealth you need to invest the cash.  If you commit yourself to these tasks your vision is achievable.  Retirement is a life goal you need to believe in and become passionate about.  If you feel this way about it you are more likely to act.  

1.  Retirement Goal 

     A retirement plan begins with a retirement goal.  What does “retirement” mean for you?  Creating a vision of your life after retirement is an evolving process, and necessary for establishing a goal.  A good way to examine your future lifestyle and the financial resources necessary to maintain it is to use an online retirement planner.  There are many available, but I found ETrade’s QuickPlan to be an excellent resource (https://us.etrade.com/e/t/plan/retirement/quickplan). 

2.  Saving

     The federal government begins your retirement plan for you as soon as you start paying into Social Security.  The FICA tax rate, which funds Social Security and Medicare, is 7.65% for 2010.  The self-employment tax rate is 15.3%.  Your employer may also have a defined benefit plan (pension), or defined contribution plan (401k) for your retirement.  Both the government and your employer, however, can only partially fund your retirement.  The rest is up to you.  You need to make a conscience effort to contribute a part of your earnings to both your employer’s 401k plan, and an IRA, if you want to have any chance of achieving your retirement goal.  Social Security, the 401k plan, and the IRA form the financial foundation of your retirement plan.   

     Whether employed or self-employed start making periodic contributions to an IRA that is at least equal to the FICA tax withholding.  As your earnings increase your contribution should increase to the maximum allowable ($5,000)*.  If your company has a 401k plan contribute enough to obtain your company’s maximum matching contribution.  As with the IRA, when your earnings increase your contribution should also increase (maximum $16,500)*.   

*2010 annual maximum for those under 50 years of age.
 

3.  Investing

      a)  The IRA Portfolio 

     Where do you invest your IRA contributions?  There are basically two places to invest cash for long term capital growth, the credit (bond) market, and the equities (stock) market.  In my opinion, the best way to participate in these markets is by investing in the markets themselves.   

      The cash market, credit market, and equities market must each be represented in your IRA portfolio.  The investments you need are broad-based market index mutual funds.  Since these funds provide wide diversification across all markets, they are the only three investments the portfolio needs.  Once invested and continuously funded, the only regular task for the investor to perform is to maintain the portfolio’s proper allocation by periodically monitoring market risk (see below).   

     b)  Investment Allocation 

     The following represents a $100,000 IRA portfolio invested in 3 mutual funds as described above, and allocated for moderate risk exposure: 

                Cash   10%
   $10,000  Vanguard Prime Money Market Fund**

                Bonds  30%
   $30,000  Vanguard Total Bond Market Fund**

                Stock   60%
   $60,000  Vanguard Total Stock Market Fund**

 $100,000  Total
Portfolio  
               
      
  

     The portfolio’s allocation can be maintained at the same level, or actively managed.  When actively managed, the portfolio is re-allocated when market conditions indicate an increase or decrease in risk.  If you intend to actively monitor your portfolio’s exposure to market risk you may want to visit http://capitalmarketsinvestor.com/5952.html to learn a basic way to manage risk and keep your portfolio correctly allocated.

     Passive allocation is another way to respond to market risk.  As you get older and become more concerned about the portfolio’s exposure to market risk you may want to modify your allocation. Passive allocation pegs age to allocation using nine 5-year allocation periods.  After you reach the appropriate age you re-allocate the portfolio to the next allocation period.  Passive allocation, as shown in the table below, provides a planned approach to reducing your portfolio’s exposure to market risk over time: 

                          Age                Passive Allocation    

                        20-24               80% Stock /20% Bonds  
                
       25-29               75% Stock /25% Bonds

                        30-34               70% Stock /30% Bonds
                  
     35-39               65% Stock /35% Bonds

                        40-44               60% Stock /40% Bonds
                        45-49               55% Stock /45% Bonds
                        50-54               50% Stock /50% Bonds
                        55-59               45% Stock /55% Bonds
                        60-retirement     40% Stock /60% Bonds 

     c)  The 401k Portfolio                            

     The 401k plan is a defined contribution plan funded by your contributions, company matching contributions, and profit sharing.  The investment choices provided by your employer may not be the same as those available for your IRA, but if you follow the IRA Portfolio setup above, then the same will apply for the 401k Portfolio.  Select 3 similar funds from those available and use the same market risk monitoring routine.  

     The key to reaching your retirement goal is a financial plan that can support your life-style.  Maintain contributions to your IRA, 401k, or both.  Contribute whatever you can, and don’t stop.  The effects of compounding, capital growth, and risk management will do the rest.  

**Alternative to Vanguard funds:
Fidelity Cash Reserves
Fidelity U S Bond Market Index Fund

Fidelity Spartan Total Market Index Fund


Disclosure: Long VMMXX, VBMFX, VTSMX at the time of writing.