Getting Started: Investing For Your Retirement
If you’ve either started to make real money, or are looking to hit the restart button to get a better grip on your financial life, the question now is: where do you start? To begin with, I recommend saving about 3 months of living expenses in your savings account for any potential bumps in the financial road. If you do need to tap the emergency savings, refill it as quickly as possible. After you have your emergency savings, pay off your credit card balances. Having credit card debt makes it really tough to improve your net worth.
Next I would prioritize retirement savings because no one else will do it for you. If you have to pick, do this before you begin saving for your child’s college education. Your kids will have a lifetime of earnings ahead of them and might qualify for loan forgiveness, while you are on your own in terms of funding your retirement!
There are some really great retirement programs (some with nice tax benefits) to help people save for retirement. The 401K and 403B (for non-profits) are employer-provided plans that allow you to deduct the contributions from your taxable income, and often include a company paid match. You can choose how to invest this money - and because retirement is long-term, I recommend investing it in a well-diversified stock mutual fund or two. Do note that you’ll pay taxes on the money when you take it out, and a penalty on any funds you withdraw before retirement age.
The other programs I like are the IRA (individual retirement account) and the Roth IRA. These can be done on your own as long as you have earned income. For an IRA, work with one of the many large mutual fund providers to set up your account. You’ll sign up online, send them money, and invest it in the mutual funds they offer. If you’re self employed, there is a similar plan called a SEP.
The two IRA’s differ in a critical way. The tax treatment of a regular IRA is just like the 401K in that you deduct the contributions from your taxable income. The Roth IRA, on the other hand, does not provide a tax break when you contribute. Instead, all the money that accumulates in the account is tax-free when you take it out! If your earnings are fairly low, this is a great way to go. You’re giving up a small tax break now in return for tax-free money when you hit retirement age. If you want to keep it simple and retirement is a ways off for you, just put your money in an S&P500 fund and check back near retirement time. The fees should be very low and you will be investing in 500 large American companies - meaning it’s well-diversified.
Once you’ve set aside some emergency cash, paid off those nasty credit cards, and started saving for retirement, you may be wondering: what’s next? I would consider making a down payment for a house. You will get a big tax break on mortgage interest, and over the long-term, housing has historically done very well. Be sure to keep in mind that transaction costs can be large, so plan to hold it for a reasonable period of time – at minimum for five years.
Now you’re well on your way to financial freedom! As you move forward in your investing career, I recommend buying productive assets like stocks or property as they have the biggest payoffs in the long-term.