In your 20s, funding your 401(k) might have sounded like a good goal … for your 30s. Now that your 30s are here, you may be nervously noticing the countless articles on the virtues of investing in your 20s.
This isn’t one of those articles. Yes, you’re probably too old now to go on “The Bachelor” — actually, let’s call it “too wise” — but you’re definitely not too old to reap the benefits of investing. Getting started now gives you plenty of reasonable paths to build a healthy $1 million by retirement.
Here are five steps to help you achieve that goal.
1. Start with your 401(k)
Your 20-something self was right about the 401(k) part: That’s the first place most people should save for retirement.
There are many reasons why, but we’ll hit just the high points:
- A 401(k) has a high annual contribution limit of $18,000.
- Contributions get swept into the account directly from your paycheck — before taxes — like magic.
- Many plans, particularly those at large companies, offer access to inexpensive R share classes of mutual funds. (The “R” stands for retirement, but it could also stand for “reduced price.”)
- Perhaps best of all, many employers will match your contributions, at least up to a cap. That’s free money you won’t find through other offerings.
The payoff: Let’s pretend you make $50,000 and begin saving at age 30. Assuming 2% annual salary increases and a 6% average annual return, saving 10% each year and collecting a 3% match will net you a little over $1 million by age 67. You can do the math for your own situation with our 401(k) calculator.
2. Supplement with a Roth IRA
Once you’re capturing that full 401(k) match, you should take a second look at your 401(k)’s investment options. Yes, they’re often inexpensive, but not always — and some plans tack on administrative fees. If your plan is too costly, you’re better off directing any additional contributions this year to the second-best place for your retirement savings: an individual retirement account, such as a Roth IRA.
As noted above, with a 401(k), your contributions go in pretax, which means they’re taxed when you withdraw them in retirement. With a Roth IRA, your contributions go in after tax, which means no tax in retirement. Your money also grows tax-free in a Roth IRA. (If you’d prefer to make pre-tax contributions, you can select a traditional IRA, which gives you a tax deduction now but requires you pay taxes on distributions in retirement.)
This kind of tax diversification is why it’s a good idea to combine a 401(k) with a Roth IRA, if you meet the income eligibility rules for a Roth. (Of note: Some companies are offering a Roth version of the 401(k) that — again, if your plan fees are low — can be the best of both worlds.)
The downside is that IRAs allow you to contribute only $5,500 in 2017. If you max that out, go back to your 401(k) until you hit its $18,000 ceiling or otherwise max out your budget for savings.
The payoff: Consistently saving $5,500 in your Roth IRA each year won’t land you $1 million if you begin at age 30 — at a 6% return, you’ll end up with about $740,000 at age 67. But remember, we called this a supplement — and that’s $740,000 you can draw on tax-free in retirement.
3. Take as much risk as you can stomach
Risk is one reason there’s such emphasis on investing when you’re young — young people have a long time horizon before retirement, which means they can worry less about short-term volatility. That allows them to accept risks that should lead to higher average returns over the long term.
But with 30 or so years before retirement, you, too, are young. And you should be taking risks, investing the vast majority of your long-term savings — 70% to 80%, at this age — in stocks and stock mutual funds. Here’s how to buy an individual stock.
The payoff: Risk doesn’t guarantee higher average returns, but it makes them more likely over the life of a long-term investment. Let’s say you played it safe in your 401(k) and earned an average annual return of 4% instead of the 6% we used in the earlier example. That would trim your $1 million down to about $740,000.
4. Seek inexpensive diversification
Investing becomes less risky if your investments are diversified, which means no, you should not dump all your available cash in the Snapchat IPO.
Here are two tricks to diversification:
- Having enough money to spread around.
- Using index and exchange-traded funds.
Being older can help a great deal with the first item, as the years between 20- and 30-something probably netted you a few salary increases. As for the second item, funds like these track an index: A Standard & Poor’s 500 fund, for example, tracks the S&P 500. That index includes 500 of the biggest companies in the U.S.; the index fund pools your money with other investors to buy shares of those stocks.
The performance of the fund, then, virtually mirrors the performance of the index — less the fees you pay for the convenience of the fund. Aim to pick funds with fees less than 0.50%. In some cases, you can get that number down to 0.10%.
The wide assortment of stocks in index funds makes you somewhat diversified. To diversify even further, you can put together several funds — for example, one that gives you exposure to international stocks, and one or two that invest in small and medium U.S. companies. Because bond prices tend to move in the opposite direction of stock prices, you can also buy bond funds to further balance the risk of those stock funds.
If all of that sounds too hard to manage, you can pay to have someone do it for you, or even some thing: A robo-advisor, which uses a computer algorithm to build and manage your portfolio for a small annual fee, is a good choice at this stage. See NerdWallet’s list of the best robo-advisors of 2017 for more on this option.
The payoff: This benefit comes in ways both monetary and not: Your overall portfolio return may or may not improve, but it should be less volatile, which means you’ll get more sleep than had you bet your retirement on one individual stock. You may gain additional peace of mind from knowing a smart computer is watching over your investments.
5. Take off the retirement blinders
Retirement is the universal long-term goal, but it’s often treated as the only goal. You can save and invest for other things, and in your 30s, those other things tend to come up more: college for your kids (if you have them), vacations (perhaps away from those kids), or a down payment for a house (if you’d like to realize the dream of unclogging your own gutters one day).
The trick is to prioritize these goals. Retirement should come first, but you can divert money into these other goals by saving more when you get a raise, stashing away windfalls and taking advantage of changing expenses. Let’s say you pay off your car or student loans. Instead of kicking your restaurant spending up a couple of notches, put those payments into a savings account or a 529 college savings plan instead.
The payoff: If you invest $200 a month at a 6% return from the time your child is born until he or she turns 18, you’ll end up with about $75,000 — and, with any luck, a kid with a college degree. (You might want to boost that savings rate if your son or daughter aspires to the Ivy League, though.)