How to Invest for Retirement

From a 401(k) to IRA, find out the various ways to prepare your finances for retirement.

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Saving for retirement is a top financial priority for most Americans. People generally live longer these days and need a considerable amount of money for a comfortable retirement. The trend away from defined benefit pension plans has put the responsibility of retirement savings onto individuals. Here are some ideas on how to invest for retirement.

Investing for Retirement Tips

When it comes to investing, you need to find the types of investments, timeline, and amount of money that will give you the retirement you want. Here are a few of my tips for setting up an investing strategy for retirement:

  • Come up with an asset allocation that fits your situation.
  • Use target-date funds or other managed accounts if you are not comfortable making your own investment decisions.
  • Consider all of your investment accounts when coming up with an asset allocation strategy for retirement.
  • Buy low-cost investments like index funds where possible.
  • Automate your savings, such as with a 401(k) plan, when possible.
  • Don't take too much risk, but don't shy away from stocks. Younger investors have a long time horizon until retirement. But even those in their 50s and 60s generally need growth to ensure they don't outlive their money.
  • Take advantage of catch-up contributions if you are 50 years of age or older.
  • Be flexible and adapt over time.

Let's go deeper on our guide.


Timing is Crucial. Start Early

Start EarlyThe earlier you start investing for retirement, the more money you will have when it's time to withdraw the funds. Time is one of the biggest allies you have in saving for retirement. Use the “miracle” of compound growth in your retirement savings.

The money you invest when you're 20 years old is money you ideally won't be using for another 40 years. During that time, it grows in the market. Historically the stock market has returned an average of 10% a year. That includes the ups and downs of times like the Great Recession. The earlier you can invest, the more time it has to weather the downs and to grow during the ups. Don't try to time the market; instead, opt for the time in the market.


Develop a Retirement Investment Strategy for Yourself

Before you start investing, determine how much you will need to retire comfortably and set a goal. Having a set goal in mind helps you make sure you are on track. And it enables you to determine which investments to make.

Take some time to figure out the big picture vision of retirement for yourself. You don't need to predict every detail of the future, but knowing what you want will help you devise a strategy.

Think about:

  • Where you want to live, taxes, and the cost of living
  • How often, if at all, you'll travel
  • If you will have kids and will help them with things like funding their college studies or buying a house
  • If you will bring in any money in retirement (via a part-time job)
  • Your housing: Will you downsize or upgrade? Will you split the time between states?
  • At what age you will retire and how long you think you'll be retired
These considerations will give you an idea of your annual cost of living in retirement. Multiply that number by how long you think you'll be retired, and you'll have a number for how much you may need in retirement. From there you can begin to think about the types of investments that will bring you to that number.

For example, if you are currently in the city or an area where you'll be retiring, rental real estate can be a great investment right now. You know you'll be in the area to manage the property and you can buy for the long term. If you know you'll be moving within a few years, rental real estate in your current market may not make as much sense.

To make sure you are on track to retire with the amount of money you need, consider hiring a financial planner through Facet Wealth.  This unique financial planning firm connects you with a dedicated Certified Financial Planner (CFP) who will work towards your best interests. Or use an online service like Personal Capital, which has lots of free tools to track your retirement goals and finances.


Types of Investments

There are five types of investments you can make to create a retirement investment strategy. Money invested for retirement should be thought of as long-term investments.

1. Stocks

Stock ChartThere are a lot of options in the stock market. You can buy individual stocks, mutual funds, index funds, dividend-producing funds, blue-chip stocks, and more. Which ones will be best will depend on how far you are from retirement, the fees, and where you do your investing.

Before you buy any stocks, read our investing in stocks guide. Make sure you understand what you're buying and how it plays into your long-term plan.

2. Bonds

Bonds vs Bond FundsBonds are a way of loaning money to a separate entity. Municipal bonds, for example, are loans you give to a city or township. Bonds tend to be less volatile than stocks and can have much lower rates of return. However, the rate of return is steady, since bonds come with a set interest rate you're paid throughout the term of the bond. When it comes to retirement planning, bonds are a more reliable income.

Bond interest rates fluctuate when the Federal Reserve changes interest rates, so keep an eye on that.

3. Annuities

AnnuitiesAnother option that comes in many forms is annuities. Annuities are often lumped into investments but are actually a form of insurance. With immediate annuities, for example, you pay the insurance provider a lump sum of cash and receive regular monthly payments in retirement.

With a variable annuity, your money is invested in a portfolio of your design. To get the same guaranteed return, you can add in what is called a “rider“, or a guarantee of payment. Riders come with additional fees and each has its own formula for how your payments are calculated. Annuities are often an expensive option for your retirement portfolio, and as such many people disregard them. However, many other people like them for securing monthly payouts in retirement.

4. Real Estate

Rea; EstateWe all need somewhere to live and real estate investors bank on that fact to earn them money. Collecting a rental check-in retirement is appealing to many people. Real estate investing can be very lucrative, but it also comes with generally higher upfront costs and the ongoing maintenance costs of home improvement, property taxes, and a mortgage. Rental real estate is best for people who have some handyman skills themselves or have the money to hire people to fix or manage the property.

If you want to invest in real estate without buying and managing property yourself, you can use a crowdfunding service like CrowdStreet or invest in Real Estate Investment Trusts (REITs)

5. Cash

CashKeeping some money in cash, especially as you near retirement, is advised by almost every single financial advisor out there (Find the good ones with Paladin investing). Cash is king, and when it comes to an emergency, it can't be beaten. How much cash you want to keep will depend mostly on your risk tolerance. Those who value more stability may want to keep up to a year's worth of living expenses in cash. Those who are more risk-tolerant will do fine with four months of living expenses in cash.

These are just some retirement investment options, but they represent the major ways of constructing a diversified investment portfolio.


Consider the Help of a Robo Advisor

Robo Advisor for retirementRobo advisors offer a sound and easy alternative for retirement investing. They typically offer a portfolio of low-cost ETFs or other investments based on your answers to the Robo advisor's questionnaire. And they typically offer both taxable accounts and IRA accounts.

Some services offer access to a live advisor as well. Even larger custodians like Vanguard and Schwab offer a robot advisor-like service. Costs, service levels, and the amount you must invest vary by Robo advisor. Most do not charge a commission for trades, and they have low annual fees. As these services are all different, do your homework and research prior to investing with any Robo advisor. Betterment, for example, gives retirement advice as a fiduciary and recently added human advisors who can assist you with your retirement account.


Contribute to Employer-sponsored Retirement Plans

401(k)For many people, employers' 401(k) plan is their primary retirement savings vehicle. If you have a 401(k), it typically offers a menu of investments from which to choose, such as mutual funds. Typically the plan lineup includes funds representing a number of asset classes. Funds may include both actively managed funds and index funds. Index funds track things like the S&P 500 index or the total U.S. or international stock markets' performance.

Some plans may offer managed account options such as target-date funds or risk-based accounts. These serve as a one-stop pick for those who do not want to choose their own investments.

Many plans offer both a traditional 401(k) option, where the contributions are made on a pre-tax basis and a Roth option. With a Roth, you pay tax on the income you invest but then withdraw your money on a tax-free basis.

If you have a 401(k) or another employer-sponsored retirement plan, contribute as much as possible up to the maximums allowed. If your employer offers matching funds, make sure you contribute enough to earn the full match. After all, it's essentially free money. Start with some amount, even if you can contribute only a small percentage of your salary, and increase that amount at least a bit each year. Some plans offer an automated feature that allows you to increase the percentage contributed each year.

You can contribute only up to a set amount to your 401(k) each year. For 2020 those limits are:

  • $19,500 for those under age 50
  • $26,000 for those who are age 50 or over at any point during the year

Invest in a Traditional or Roth IRA

How to invest in iraBeyond an employer-sponsored plan, you can also contribute to an IRA (an individual retirement account).

  • IRAs are available as traditional and Roth accounts. The annual contribution limit for 2020 is $6,000 in total in both accounts. Those who are age 50 or over can contribute an additional $1,000.
  • Tradition IRA contributions are made on a pre-tax basis, subject to certain income limits for those covered by a retirement plan at work. In retirement, you pay tax on all withdrawals.
  • Roth IRA contributions are made on an after-tax basis, again subject to certain income limits. And you withdraw your money tax-free in retirement.
  • IRAs generally offer a wide range of investment options, including individual stocks, bonds, exchange-traded funds (ETFs), and mutual funds.
  • IRAs are excellent retirement savings vehicles for contributions and a solid destination for retirement plan rollovers.

As with any other investment account, your asset allocation should be based on your time horizon until retirement and your risk tolerance. Also, consider the asset allocation in other accounts that you may have. An IRA generally offers more options than a 401(k) and other types of retirement accounts. This helps your retirement investing efforts.

If you are self-employed, you can also invest in a special type of IRA account called a SEP IRA. This allows an employer to contribute up to 25% of employee compensation, including for freelancers and contractors. And if you own your own business or are a spouse involved in the business or a business partner, you can set up a solo 401(k).


50 Years or Older? Take Advantage of Catchup Contributions

While we should all start investing for retirement as early as possible, the good news is that you can go beyond the normal contribution limits if you are over the age of 50. Save more for retirement as you get closer to retiring by using these catchup contributions. The contribution amounts vary by year. For 2020 the total contribution limit for those 50 years old and older is $7,000 for IRAs and $26,000 for 401(k)s.

Investing for retirement is a long-term endeavor. Revisit your retirement investing strategy overtime to make sure you are on track to meet your retirement goals.


Open a Target Date Fund

Target Date FundTarget date funds can be a very efficient way to invest for retirement. These are professionally managed all-in-one funds that are allocated for an investor who will retire on or near the target date listed on the fund. For example, a fund with a target date of 2040 is geared toward an investor who will retire in 2040 or thereabouts.

Target date funds are a staple in many 401(k) plans. They are typically offered by mutual fund companies and invest in a mix of funds from that company. Vanguard, Fidelity, and T. Rowe Price, among others, all offer target-date funds. All target-date funds have a glide path.

This formula determines the funds' best asset allocation through the years for people of a specific age. As you get closer to retirement, the allocation of stocks is decreased. You can invest in a target-date fund with a target date sooner or farther out than your planned retirement date. The longer-dated funds have a larger allocation to equities.

You can buy target-date funds by opening a brokerage account with a fund manager or an online discount broker like E*TRADE. Or you can buy them directly from fund providers, though your choices may be more limited, and you could be required to make a minimum investment in the fund. Watch out for high fees, as rates vary.


Bottom Line

The best retirement portfolio is likely a mix of the investment options above and can use these free tools to plan it. No single investment is permanently safe, so diversification will serve you well. And as you approach retirement, some types of investments may become more appropriate than others.

Start with what you envision for yourself in retirement and use that to build an investment portfolio that you feel good about.

Roger Wohlner

Roger Wohlner is an experienced financial advisor, finance blogger and freelance writer based in Arlington Heights, Ill. His expertise includes providing financial planning and investment advice to individual clients, 401(k) plan sponsors, foundations and endowments. Roger contributes to his own popular finance blog, The Chicago Financial Planner, where he writes about issues concerning financial planning, investments and retirement plans. His work has been featured on Investopedia, Go Banking Rates, US News & World Report, Yahoo! Finance, Equifax Finance Blog and other publications. You can follow Roger on: Twitter - LinkedIn

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