I started my website Just Start Investing in 2019 to help everyone invest without sacrificing other money goals, whether that is financial independence or early retirement, saving up for a new house, or simply being able to pay for things you enjoy like a new bike and premium coffee.
One of the biggest investments you can make is your retirement fund, but retirement saving was one of the areas that many people struggled with over the last year. One in 5 Americans reported that they expected to delay their retirement as a result of the pandemic, according to a recent study from Northwestern Mutual.
Even if you aren't sure what your retirement will look like in the future, the good news is that you don't have to have all the answers now.
Personally, I don't have a set retirement age or goal I am trying to hit. I am simply trying to save enough money to give myself flexibility, with an eye on financial independence in my 40s. For me, financial independence means that I will have more freedom and options for how to spend my time and use my money down the line.
When I started seriously investing for the future after I graduated from college, asking myself these three questions really helped put things in perspective. Answering these questions can help show anyone the path it would take to retire on their own terms, and even retire early.
Even before the pandemic, the idea of saving for retirement could be particularly daunting. General benchmarks offered by 401(k) providers are based on your income and age: By the time you are 40, for example, they suggest that you have 3x your annual salary saved. But those goals can feel tough if not impossible to meet for a variety of reasons.
So the first important question to ask yourself is, "When do I want to retire?" If you don't have an exact answer to this question, defaulting to age 67 is fine for now, as that is the age your full retirement benefits will start to kick in. You can always change this answer later.
You also need to answer the second part of that question, "With how much money do I want to retire?" Again, if you don't know the answer here, that's OK. But there is a quick way to get a rough estimate: the 4% rule.
The 4% rule states that you can safely withdraw 4% of your nest egg every year in retirement while having a low probability of ever running out of cash. So if you have $1 million in retirement savings, you can safely withdraw $40,000 per year. This was my starting point.
You can also use this guideline in reverse to calculate how much money you need to retire by taking your annual living expenses and multiplying them by 25. For example, if you spend $50,000 per year, you will need roughly $1.25 million. At this point you can also factor in any additional cushions you might need.
It's also good to keep in mind that while many experts say that $1 million is what you will need to live comfortably after you leave the workforce, even a seemingly sizable figure like that may not go as far as you think, depending on where you live.
From there you have enough information to work backwards with your end in mind. And it's a lot easier to track your goal to save $1.25 million by age 55, for example, than it is to broadly "save for retirement."
Video by Ian Wolsten
Once you have a retirement goal set, you need to figure out what investment accounts you will use to hit that goal. The three most common types of retirement accounts are a 401(k), traditional IRA, and Roth IRA.
If you have access to all three accounts, there is a simple and effective order of operations you can walk through. This is how I'm approaching my retirement savings.
- Get your employer match in 401(k): If your employer offers a matching program (i.e., matches the first 3% that you contribute), I would take advantage of it, because it is free money.
- Max out your IRA: Next, you can max out your IRA. An IRA is a favorable account when compared to a 401(k) because it does not have administration fees that some 401(k)s have, and it also offers a wider variety of investment vehicles. You may be able to choose either a Roth or traditional IRA depending on your income and predicted tax consequences now and in the future. I opted for the Roth IRA.
- Go back and max out 401(k): Since your 401(k) has a higher contribution limit than an IRA ($19,500 versus $6,000 in 2021), you can then go back and max out your 401(k) after maxing out your IRA, if you are able to comfortably do so.
There are also some things I do before maxing out my 401(k) that you can consider as well. We will call these actions steps 2b and 2c.
Step 2b: Determine if you are eligible for a health savings account (HSA). If you are, maxing out this triple-tax advantaged account is a helpful move.
Step 2c: Also consider what other goals you have outside of retirement. For example, if you want to save for a house a few years down the line, you can use a more flexible investment account, like a brokerage account.
Video by Courtney Stith
A brokerage account can also act as a bridge account for anyone who wants to have access to capital gains prior to the traditional retirement age of 60. If you are like me and want the option to retire before age 60, you could also invest in a brokerage account in step 2c for "general wealth building."
You will lose out on some tax benefits by doing that before maxing out all of your retirement accounts, but you will gain some flexibility with your money in return.
Finally, you need to determine what investments to make in each investment account.
This is an important step, because many people don't realize that depositing money into a Roth IRA or brokerage account isn't enough. You need to invest that money as well, which you can do by buying stocks, bonds, mutual funds, index funds, ETFs, and other investment vehicles.
Personally, I opt for investing in index funds and ETFs because they are easy to manage, are cost-effective, and can provide ample diversification. To find index funds and ETFs that work for me, I look at two primary metrics:
- The index: If I want an equity investment, I'll look for an S&P 500 index fund or broad market index fund. If I want to invest in bonds, I look for a diversified bond fund. What I tend to avoid are funds that are more narrow in scope, like biotech growth funds.
- Expense ratio: I look for fees to be as close to 0 as possible. Most expense ratios on the funds I invest in are below 0.05%.
Video by Courtney Stith
For your nonretirement goals, determine if an aggressive equity-based plan works for you, which is what many standard retirement plans are, or if you want to be more conservative in your approach. This depends on the timeline in which you want to use your money.
For example, if you are 25 and investing to build wealth and have access to money 15 to 20 years down the line, but before you can access your retirement accounts, then investing in equity likely makes sense. However, if you are investing to buy a house in five years, you might want to opt for a more conservative investment, like bonds.
Once you have answers to all three questions above, you can put together a retirement plan that works for you while also balancing your various money goals. You can back into how much you need to save in your various accounts in order to hit your goals, depending on the return on investment you expect to see.
If you want or need a little extra help when finalizing your plan, there are plenty of resources out there. I'm a fan of robo-advisor platforms like M1 Finance, Betterment, or Wealthfront to help invest on your behalf in low-cost funds. Other options are consulting a fee-based financial advisor to provide coaching and advice and continuing to read and research online.
In my opinion, having a plan is half the battle, and answering these three questions can help you get there.
Kevin Panitch is an experienced personal finance writer and founder of Just Start Investing, a personal finance website that makes managing your money easy. Just Start Investing has been featured on Business Insider, Forbes, and US News & World Report, among other major publications, for its easy-to-follow writing and informative articles. You can follow Kevin and Just Start Investing on Twitter at @juststartinvest.
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