Turning your savings into a nest egg
Chances are that as soon as you start investing, you’re thinking about retirement. If you aren’t, you should be. There are few, if any, financial goals that require more legwork than saving and investing for retirement. Which means there are few, if any, financial goals that should come before investing for retirement. But putting retirement at the top of your to-buy list is not enough to guarantee you’ll reach it fully funded. The good news is that investing for retirement is more science than art, with time-tested guidelines to help you through it. Here are financial experts’ best tips for retirement investing to help turn your savings into a retirement income-producing nest egg.
Stick to your plan
Investment plans can be like diets: You enter into them with the best of intentions, but as soon as things get uncomfortable (or a buffet walks in), it’s back to couch pants and potato chips until you feel better. But successful investing requires sticking to your plan in good times and bad. “Though successful investing is generally the accumulation of many small decisions, one wrong step in a volatile market can take years to recover from,” says Ben McGloin, head of advice, planning and fiduciary services at BNY Mellon Wealth Management. As we saw firsthand earlier this year, “financial markets are susceptible to extreme volatility and drastic price reevaluations.” The S&P 500, for instance, lost 35% of its value between Feb. 20 and March 23. During these times, remind yourself that your plan is designed to withstand such volatility, but it can’t do that if you jump off the ship at the first wave.
Start investing as early as possible
The earlier you begin investing for the future, the more you’ll have when retirement day finally arrives, says John Deglow, a fiduciary investment advisor at Unified Trust Co. He gives an example of two investors, Amy and Jackie. Both invest $5,000 per year until age 65, and both get an average annual return of 8%. The only difference is Amy starts at age 25 and Jackie at age 35. By the time they’re 65, Amy has more than twice as much money as Jackie, $1.3 million to Jackie’s $566,400. “By harnessing compound interest, where interest is applied to accumulated growth in addition to the original investment, Amy’s money grew much more than Jackie’s by simply starting 10 years earlier,” Deglow says.
Understand all your available options
Utilizing your full balance sheet is key to making your money work for you,” McGloin says. This can mean tapping more areas than just the asset side of your balance sheet. “Historically, the return on equities and fixed income has often been in excess of the cost to borrow, unless the economy is in recession,” McGloin says. “Investors can take advantage of this spread, and grow their assets or avoid liquidating portfolio securities to meet living expenses.” Since 2000, the return on a portfolio that was 60% equities and 40% bonds has exceeded the cost of borrowing two-thirds of the time, he says. That said, borrowing money to invest increases your risk. Borrowing “should only be considered in a well-timed, prudent manner,” McGloin says.
Turn your HSA into a pseudo-IRA
Borrowing is not the only outside-the-box option for retirement investing. You can also look to investment accounts beyond your 401(k) and individual retirement account, such as a health savings account. HSAs are tax-advantaged medical savings accounts available to employees enrolled in a high-deductible medical plan. “Investing in your HSA is a great way to potentially grow HSA funds for a nest egg in retirement, while still keeping some funds available for current medical expenses,” says Chad Wilkins, president of HSA Bank. These accounts offer “a triple-taxed advantaged account, meaning funds are contributed tax-free, grow tax-deferred and can be withdrawn tax-free to pay for IRS-qualified medical expenses.” Funds roll over year after year and can be withdrawn for any reason without penalty, the only caveat being if you use the funds for nonmedical expenses, you may be subject to income tax on the withdrawal.
Have a spending and saving plan
There is a simple math equation at the core of investing for retirement. It goes like this: How much you have to invest equals how much you can afford to save, which equals how much you earn minus how much you spend. In short, “the more you spend, the less you have available to save, and vice versa,” McGloin says. And the less (or more) you can save, the less (or more) you have to invest for retirement and, ultimately, the less (or more) you have when you do retire. “Developing good saving habits early builds an asset base that can compound over longer periods of time, increasing the odds of achieving financial success,” McGloin says. Controlling your spending is a habit that will be even more important in retirement, when much of your income will likely come from your investments. “When most spending is sourced from portfolio assets, very small increases in spending over time can rapidly erode future assets,” he says. “This reasoning is twofold: Spending reduces the assets available for reinvestment, and in depressed markets, spending can exceed income generated by a portfolio and decrease investment portfolio principal.” Learn to minimize your spending now so you can optimize it in retirement.
Focus on returns net of fees and taxes
Your lifestyle expenses are not the only thing that can erode your retirement investments; investment fees and taxes can also take a bite out of your portfolio. “The fee and tax drag for most major asset classes can range from 1.6% to 2.7% per year,” McGloin says. “This can equate to 20% to 40% of total returns.” He says you can minimize investment fees by using passive investment options in efficient asset classes, and mitigate taxes by keeping your less tax-efficient investments, like corporate bonds, in tax-exempt accounts. There are times, however, when higher investment fees can be justified, such as in less efficient asset classes like emerging-market equities and certain bond strategies, which may warrant active management, he says.
Pay attention to how your fees are paid
“While it is important to understand how much you are paying in fees, it is equally important to understand how your fees are being paid because not all fees are equal,” says Michael Samford, digital advice manager at Unified Trust Co. “Most retirement plan participants pay the bulk of their fees indirectly through investment management fees deducted from investment returns.” When possible, look for an employer retirement plan where fees are billed directly to and paid by your employer, circumventing you entirely, he says. “That is a very advantageous plan fee structure for participants and should be carefully considered when choosing to keep retirement assets invested in the retirement plan or moving them into an alternative type of retirement account.” Make sure you take into account the cost differential between an IRA and your employer plan before rolling retirement investments over.
Don’t leave free money on the table
Speaking of employer-sponsored retirement plans, this tip had to make the list: “One of the best ways for individuals to jump-start savings and wealth compounding is to take full advantage of an employer-matching program,” McGloin says. Employer matches are essentially free money. If your employer matches dollar for dollar up to 5% of your contributions, that means every 5% you save becomes 10% total contributions. You wouldn’t turn down your quarterly bonus, so why forgo your free 401(k) match? Not taking advantage of your company match means you’ll have to save more to fund your retirement, McGloin says.
Consider a Roth conversion
“If you expect your tax rate to be higher in the future, utilizing a Roth IRA to pay tax liabilities today could make sense,” McGloin says. He suggests considering the tax consequences of the tax-deferred benefit of a traditional IRA or retirement account: “As these accounts grow in size, so too do the tax liabilities that must be paid, often when the funds are being withdrawn for retirement,” he says. “If you think your tax rate could be higher in the future, you may want to convert the assets and pay Roth conversion taxes at lower rates now since qualifying Roth IRA distributions can later be withdrawn tax-free.” Roths offer the added benefit of not having required minimum distributions, so they can continue to grow tax-free until you or your heirs decide to withdraw.
For self-employed individuals, simple is not always better
David Weinstock, principal at Mazars USA Wealth Advisor, tells self-employed retirement investors to look beyond simplified employee pension plans or SIMPLE IRAs for their retirement. “For some, these plans make sense, but often the benefits of alternatives outweigh the added complexity and cost,” he says. While these plans have low administrative burdens, they also both require treating all employees equally and must provide immediate vesting. Likewise, the deductible contribution limit on a SEP is 25% of compensation up to $57,000 in 2020. “In contrast, the deductible contribution to a defined benefit or cash balance plan for a self-employed individual can exceed $300,000,” he says. “A small business with few employees can combine this with a 401(k) plan to satisfy much of the discrimination testing without giving away the store and may not have to treat all employees the same.”
Partner with a retirement planning specialist and fiduciary
The retirement investing tip that caps off most investing tip lists is to get help if you need it, but when it comes to retirement investing, not just any help will do best. Tony Walker, a retirement planning specialist and author of “Live Well, Die Broke,” says retirement investors should look for retirement planning specialists who are also fiduciaries. The reason for that is that many financial advisors focus on accumulation. This is, of course, an important part of retirement investing, “but what good is saving all that money unless you have a plan to use and enjoy it without the fear of running out of it?” Walker asks. Unlike traditional financial advisors who may not think beyond growing your wealth, retirement planning specialists are experienced in helping you plan for how you’ll “use and enjoy that hard-earned money before it’s too late,” he says. And if they’re also a fiduciary, you can rest assured they’ll put your best interest before all else.
Follow these tips for retirement investing:
- Stick to your plan.
- Start investing as early as possible.
- Understand all your available options.
- Turn your HSA into a pseudo-IRA.
- Have a spending and saving plan.
- Focus on returns net of fees and taxes.
- Pay attention to how your fees are paid.
- Take full advantage of your company 401(k) match.
- Consider a Roth conversion.
- For self-employed individuals, simple is not always better.
- Work with a retirement planning specialist and fiduciary.
