Noelle writes in:
I finally decided to start saving for retirement using the 401k at work. I’m 39 years old. I have been trying to read up on retirement savings choices and it all seems so overwhelming. Even just opening up the 401(k) at work seems overwhelming. Help!?
Congratulations. That is the biggest, most important step for your retirement. The choice to have a little less money in your checking account right now in order to have some put aside for retirement is a challenging one, one that many Americans simply avoid until it’s too late to really make a difference. You stepped up, and that’s commendable.
Now comes another challenge, one that seems to be an incredibly confusing one. When you sign up for your workplace plan, you’re going to be asked – or already have been asked – where to invest that money (most of the rest of the application is easy – personal information, mostly). The human resources officer at your company that’s working with you on this might have suggested an option or two, but you’re not sure if that’s the right option. There are tons of numbers and documents and other things to look at and it feels more than a bit overwhelming.
Right here is the point where many people lock up. They essentially don’t make a choice at all or accept a default choice that isn’t very good. Sometimes, people end up with their entire retirement savings in what amounts to a savings account, returning only a few dollars a year.
The fear that you’re going to make a huge mistake with your retirement investment choice is a sensible one. There are horror stories out there, stories of the stock market crash of 2008 where people lost half (or more) of their retirement savings all in one fell swoop. The idea of saving for years and then seeing half of it disappear all at once is intimidating, to say the least.
Here’s your gameplan. I’m going to keep it short, sweet, and simple.
First of all, every single “bust” or “bubble bursting” in investment history has been followed by a big boom unless literally the government is collapsing and taking whole industries down with it. Why? Over time, businesses constantly innovate and, at the same time, there are constantly more customers around the world (more people are being born than dying). At the same time as all of that, workers are gradually becoming more and more productive. Add all of that together and buying shares in stable companies is going to be a long term money maker.
Aha, but what about unstable companies?! What if you put your money into stocks and discover that you’ve bought into the next Enron or some other huge company that just collapses? Aren’t you just out of luck?
Not really. Almost every investment offered to you is going to be some kind of a mutual fund. A mutual fund is when a large group of people – all of the people everywhere that are in the same retirement plan as you, and probably people beyond that – pool all of their money together and invest together. That mutual fund takes that money and buys shares in lots and lots of companies, so for every collapsing Enron, it also will have money in Google and Coca-Cola and many other things. The exact companies that a mutual fund chooses varies from fund to fund, but that’s the purpose of all mutual funds. They spread out the risk a little bit so that no one loses everything.
When you actually make an investment choice, you’re not buying shares in a company. You’re buying shares in some kind of a mutual fund. Imagine that share entitles you to some small fraction of ownership of that whole mutual fund, which is invested in hundreds and hundreds of companies. Whenever one of those companies goes up in value, your mutual fund goes up a tiny amount. Whenever one of those companies goes down in value, your mutual fund goes down a tiny amount.
When times are good, most companies are rising in value and thus your mutual fund will rise in value, and that’s how things are most of the time. There are times when the overall stock market falls and, yes, your mutual fund shares will drop in value, but as I explained above, unless the whole government and tons of industries are all collapsing, they will rebound eventually. That’s the engine of capitalism at work.
The point is this: over the long term – more than 10 years or so – stocks have historically been a good investment almost everywhere in the world almost always throughout history outside of historical events where nations are collapsing. If that’s the case, you have bigger worries than your retirement fund.
Over the short term, you can get caught in a period where stocks are falling, which is why it’s a bad idea to ever put money into stocks if you’re going to be taking it out in the next few years. You might get caught in a downturn.
So, what’s the advice, then? If you’re more than 10 years away from retirement and don’t think that the United States is going to literally fail as a nation in the next several years, stocks are a reasonable place to put your retirement money.
The same philosophy is true with any investment that goes through up and down periods but largely points upwards. Real estate goes through similar cycles – mostly upwards, but with occasional dips. Bonds do as well, though their valleys aren’t as bad as stocks and real estate and their peaks aren’t as high.
Although I’ve established that most of the options in your retirement account are reasonably safe if you have a lot of years left until your retirement, it doesn’t answer the question of which one you should invest in.
I’m going to keep it extremely simple: unless you want to dive into some number crunching, your best option is to look for a “target retirement fund” and put all of your money into that. A target retirement fund is a mix of different kinds of investments that’s focused based on the year you expect to retire. In other words, when you’re far from retirement, it’s mostly full of aggressive things that have a high average annual return but sometimes have huge dips, like stocks and real estate. As the years pass and you grow closer to retirement and into retirement, it gradually moves into safer and safer things – that means lower average annual returns, but it means that the dips aren’t nearly as intense.
Basically, it’s a one-stop shop. Unless you want to spend a lot of time comparing different investment options, it’s a strong default choice.
One final thing: If your workplace offers matching funds, contribute enough to your retirement to get every dime of it. If they offer to match every dollar up to a 10% contribution from you, contribute 10%, even if it seems hard. Why? That match is essentially part of your salary and if you don’t contribute enough, you’re essentially telling your employer, “No, I don’t want part of my salary, you keep it.” It’s money that they’re pledging to contribute to your retirement provided that you contribute, too. So get every dime of it!
If your workplace doesn’t offer matching, I recommend saving 10% of your income, or even a little more if you’re over 40 and haven’t contributed anything yet.
Now, obviously, I’ve chosen to simplify a lot of things here. I’ve brushed away a ton of details in order to make the choices stark and clear, but if you’re curious and you want to start digging into the details, I highly recommend starting with The Bogleheads’ Guide to Retirement Planning, which is the best single guide I’ve read on retirement. This is a pretty heavy book – you’ll want to move through it very slowly if you read it and you’ll probably want to visit Wikipedia and Google as you do so – but if you’re wanting to dig deeper into your retirement choices, that’s the best single book you can read.
Regardless, the best single move you can make for your retirement is to start saving now, even if you’re not necessarily choosing the “best” option. Get signed up, pick the target retirement plan that’s closest to your retirement year, and start pushing money in there. Remember, if you later discover that you want to do something else with your money, you can quite easily move it to another investment with little worry, but you can’t get these opportunities for contribution back. You will never, ever again have as many years until retirement as you have now, and the more years you have, the more years that the power of compound interest can work in your favor.