Four home runs for your 401(k) or IRA
Reprinted courtesy of MarketWatch.com
Published: April 3, 2013
To read the original article click here
Baseball players dream about hitting home runs. Most investors do the same.
Today I’ll tell you how to hit four homers with your retirement savings. Every one leads to a predictable win. In fact, one of them produces three wins all by itself. Together, they can add up to a winning season.
This article is based on the four pieces of advice I most often give to young investors, the actions I believe will have the biggest impact on their financial futures.
Here, I call them the Four Home Runs:
Home Run No. 1: Start saving and investing as early as possible
Even if you have to put off buying a house or a new car, even if you must make only the minimum payments on your student loans, start early.
To see this home run in action, assume you are 25 years old and you can invest $5,000 a year. If you do that for 40 years, until you’re 64, and earn a return of 8%, you’ll wind up with $1,295,000 when you reach the traditional retirement age of 65.
Now imagine that you have a friend who waits until age 35 to start saving $5,000 a year. By age 65, earning the same 8% return, she will have only $566,000.
Here’s where it gets interesting: The difference between your retirement account and your friend’s retirement, $729,000, came exclusively from the $50,000 you invested in the first 10 years, from age 25 to 34. This is because, from the age of 35 onward, you and your friend did exactly the same thing.
Think about that number once again. Although you saved at a constant rate for 40 years, more than half of what you wound up with at age 64 came from your savings in the first 10 years. That’s how you get a home run from starting earlier.
And from this single homer, you achieve three “wins.” First, you more than double the nest egg you have at retirement. Second, your retirement income is more than twice as much. Third, your heirs will likely have two to three times as much at the end of your life.
Home Run No. 2: Postpone investing in bond funds until you’re at least 40
The annual return in the last example, 8%, was based on my assumption that the bond part of your portfolio would gradually increase over time. One common rule of thumb, for example, is to have your age determine the percent of your investments in bonds, then hold the rest in equities.
However, if you invest 100% in equities for the first 15 years, I think you can earn 10% annually during that time. If we assume that you earn 8% after that, your nest egg at retirement would be $1,453,000, an increase of $158,000. This isn’t quite a Grand Slam, but it’s certainly a win.
Home Run No. 3: Turbocharge your equity portfolio
Do this by adding another nine asset classes that have a long history of outperforming the Standard & Poor’s 500 Index SPX, -0.17%. (My return assumptions above are based on only the S&P 500 Index.)
As I spelled out last month in “10 ways to turbocharge your 401(k),” these additional asset classes include U.S. large-cap value stocks, U.S. small-cap stocks, U.S. small-cap value stocks, U.S. real estate stocks, international large-cap stocks, international large-cap value stocks, international small-cap stocks, international small-cap value stocks, and emerging markets stocks.
If you invest the equity part of your portfolio in equal proportions of those asset classes plus the S&P 500 Index, I think you’re likely to increase your return by two additional percentage points up to age 40 and by one percentage point after that.
The result: You wind up with $2,030,000 at age 65. That’s an extra $577,000, and it didn’t require you to save even one extra penny.
Home Run No. 4: This could be the play that hits your return right out of the park
Delay your retirement and keep adding to your savings for another five years.
Last year in a column called “Double your retirement income in five years,” I said this could effectively double your retirement income. By continuing to add $5,000 a year and leaving your money to grow at 8%, you wind up with a nest egg of $3,012,000 at age 70. Your portfolio will have five fewer years during which it must support you, so you can take out more without any additional risk of running out of money. This will certainly be a win for you and your family.
It takes a young person to hit all four of those home runs. What if you’re no longer in your 20s, or even in your 30s? No matter what your age, you can hit Home Run No. 3 by diversifying your equities. And if you haven’t retired yet, you can consider Home Run No. 4.
Even if for some reason you can’t hit these homers, I am sure you know some young person who could benefit from this sports advice. I hope you will pass this along.
As they say at the stadium, “Let’s play ball!”
Richard Buck contributed to this article.
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