Saving Smart for Retirement
Creating a sound investment strategy
“The most important decision you will
probably ever make concerns the balancing of asset categories (stocks, bonds,
real estate, money market securities, etc.) at different stages of
— Professor Burton Malkiel of Princeton University, author of
"A Random Walk and former member of the council of Economic Advisors
Down Wall Street,"
Saving is about much more than money
It's about peace of mind. The kind that comes from knowing that
you'll be able to retire in comfort. And have the resources you need to weather
life's storms, provide for your family, and turn your dreams into reality.
What's the best way to go about saving for today and tomorrow?
You'll find specific answers in this easy to read guide from ShareBuilder 401k.
We hope you enjoy it and that you find it of real value. We also invite you to read
our companion guide titled Six Rules for Making
Smart Investment Choices. It was designed to help you make appropriate investment
An important word about risk: It's important to remember that investing
in stocks involves risk. Markets are unpredictable and may or may not act in the
future the way they have in the past. However, we believe that by following sound
principles and applying them consistently over time, you can get on track to meet
your goals and achieve financial peace of mind.
Reaching your financial goals may be easier than you think
This guide was designed to provide you with a simple, practical, common-sense investment
strategy. In it, we explain:
- Why it's so important to start saving early
- Why diversified, low-expense investment options can better help you build a comfortable
- Why "asset allocation" decisions are crucial (asset allocation simply refers to
how you divide your money among investment types)
- How investing "on autopilot" can help you reach your investment goals
Planning for retirement: how much will you need to save?
Decisions about how much to save depend on your retirement goals. You may want to
retain your current standard of living through your retirement years. Or perhaps
you hope to travel, or leave something to your children or grandchildren.
Many financial experts believe that you will need 75% of your current annual income
for every year of retirement, or a total of eight to ten times your current
annual income (for those in established careers). An easy way to make
a quick estimate of the total amount you'll need in retirement is to multiply your
current salary by 9.
These calculations, of course, are simply starting points. Every person's situation
and goals are different. Because health care costs are rising, Americans are living
longer, and the future of Social Security is in question, you may need more than
75% of your current income each year after you retire. This means you should set
a target of at least 75% and then make adjustments based on your personal goals.
To help get you on your way to achieving your savings goals, let's take a closer
look at the "market."
An important fact:
The U.S. stock market has outperformed other investment types over time.
That's right. Since 1926, U.S. stocks have delivered 10.4% returns, bonds 5.4%,
and cash 2.0%.1
This is why, depending on how long you have until retirement, you may want to invest
a majority of your savings in stocks. The reason stocks typically wouldn't make
up 100% of your portfolio is that they are more volatile, and there is no guarantee
that they will continue to outperform other investment types in the future.
Another related point: You may hear from a friend, or in the media, that a certain
stock or mutual fund is
"outperforming the market." So you decide to chase good
results and make an investment in that stock or fund. But after making the investment
you find that its value starts to decrease. This happens quite often to investors
who try to
"jump on the bandwagon." That's because by the time the secret is out
and everyone knows the positive information, it's too late to make a profit.
Or perhaps you've heard about an equally powerful force called the "reversion
to the mean." This statistical rule says that a fund or asset class
that outperforms the market for a period of time will underperform for another period
of time. In other words, over the long run, the market will gravitate back towards
its average (mean) results. To put it simply, today's media darlings are often tomorrow's
5 rules for creating a sound investment strategy
Rule 1 — to build wealth, start now and save for the long run
Starting young is the key to wealth accumulation and the smart way to grow your
investments over time. Why is this true? Because time can have a surprisingly powerful
effect on the size of your nest egg.
To understand how invested savings can grow over time, let's take a look at Mary
and Bill's retirement plans. Mary and Bill earn the exact same salary and share
identical investment goals. Their investment returns are 8% per year every year
after expenses. The only difference is one starts investing earlier than the other!
Mary begins setting aside $3,000 a year in her company 401(k) at age 27. She contributes
for 10 years and then stops saving completely. Bill waits until the age of 37 to
start investing $3,000 a year in his 401(k), but he continues to invest for 30 consecutive
Mary contributed $30K in total to her retirement plan, and has $510,089 at age 67.
Starting ten years later, Bill contributed $90K – three times as much! –
yet by age 67 has only saved $399,640.2
Rule 2 — take advantage of the power of compounding
The example in Rule #1 begins to illustrate the awesome power of compounding.
Perhaps an easier way to see how savings grow over time is to look at a one-time
investment of $1,000. In this chart, you can see how just $1,000 compounds and shoots
up the chart at the 10-, 20-, 30-, and 40-year marks:3
Getting a late start? You're in luck – there is help! 401(k)'s allow people
who are 50 or over to contribute more than those who are younger. In
2019, a person
age 50 or over can contribute
annually plus an additional "catch-up" contribution of
Rule 3 — don't let fund expenses drag you down
The expenses your fund charges can be the biggest drag on your ability to grow your
Consider this fact: The average active U.S. mutual stock fund has an expense
ratio of 1.52%.4 Let's assume that this year the stock market
delivers its historical average of 10.4%. For your fund to meet the market average,
your fund will need to return 11.92%.
While some may brag that their funds beat the market this year, if you deduct fund
costs, this may not be true at all. This is why it's so important to be aware of
your fund's expenses and look at the prospectus.
We offer index funds because they typically have low expense ratios. That's why
we believe strongly in index-based investments called Exchange Traded Funds (ETFs).
And for most 401(k)s, transaction fees don't apply. This helps to make ETFs very
To give you an idea of how low expense ratios are for index-based investments, an
ETF fund (such as SPDR, series 1) tracking the S&P 500 tends to carry an
expense ratio of around 0.1%. We call that a market-efficient fund!
Rule 4 — use diversification to balance risk and return
The concept of diversification is both easy to understand and extremely important.
There are three main asset classes: stocks, bonds,
and cash. Owning any single stock or bond is more risky than owning
many stocks or bonds. To diversify within an asset class, simply own many securities
– not just a few.
Then consider the different asset classes you can choose from. Stocks, as an asset
class, are the most volatile but have had the greatest returns over time. Bonds
and cash follow. Because financial markets prosper or struggle, depending on economic
circumstances, there is no guarantee of high future returns. Even wide diversification
can't fully protect you against a declining market.
But there's good news. Stocks and bonds do not always move together in lockstep
and their volatility often differs. Therefore, holding a broad-based portfolio of
different asset classes gives you wide diversification that can help to limit your
Thus, there are two key rules to follow:
- Diversify within each asset class. Don't
hold just one or two stocks. The risk is high that you will lose money versus a
small chance that you will outperform the markets. Instead, choose an index fund
or broad-based fund that covers a large swath of the market. Example: A diversified
stock portfolio might include a 80% investment in a total U.S. market index fund
and a 20% investment in a total international stock market fund.
- Diversify across asset classes. This
means you should choose to invest a percentage of your savings in each of the asset
classes – stock, bonds, and cash – based on your personal comfort level.
Example: A person who's 40, with a moderate tolerance for risk, might allocate 70%
to stocks and 30% to bonds in their 401(k), and manage cash reserves in their personal
money market account.
Rule 5 — make sure your assets are allocated correctly
Asset allocation is technically just part of the diversification strategy discussed
above. The important thing to know is that since the first asset allocation study
was conducted in 1986, industry research and financial theory have continued to
demonstrate that asset allocation has a greater influence on your portfolio's performance
than the specific funds you select.5
The important point is that you should really consider a percent to invest in each
asset class (e.g. 60% stocks, 40% bonds). Your asset allocation needs to fit your
goals, your comfort with market swings, and the time until you will use those funds.
The younger you are, the more time you have to travel through the market's ups and
downs. A younger person should consider investing more in stocks – upwards
of 90% if she is in her mid-twenties – with only 10% in bonds.
Conversely, a person who is 62 and plans on retiring in three years may be better
served by a portfolio comprised of 60% in stocks and 40% in bonds. In general, most
people want to keep more of their investments in stocks, given the asset class's
long-term history of superior performance. Even at age 65 you may not have to access
your stock funds for ten or twenty years or more, which means you may have a good
chance of riding out storms in the market.
With a good asset allocation plan, you can invest with confidence. Some providers
offer tools like auto-rebalancing at no additional charge. They will automatically
maintain the percent allocation you designate, making it easy to manage your plan.
Keys to creating a sound investment strategy
- Start investing now
- Time is your friend – compounding can be huge
- High costs are a drag on profits – avoid them
- Diversify, diversify, diversify
- Manage asset allocation carefully
By following these rules you can feel confident that you're building a solid investment
plan for the long term. Stick with your strategy, avoid the performance-chasing
mentality, and you stand a great chance of weathering the inevitable storms.
Start with our companion guide, Six Rules for
Making Smart Investment Choices. It's loaded with practical, valuable information
you can put to work immediately.
Also you may want to check out our
Want to learn even more? Then try these books:
- Bill Bernstein, The Four Pillars of Investing
- Burton Malkiel, A Random Walk Down Wall Street
- Larry Swedore, The Only Guide to a Winning Investment Strategy You'll Ever Need