Getting Started: Retirement Saving & Investing
In some previous posts I’ve explained how my true introduction to personal finance came through Dave Ramsey.
It’s a bit ironic really.
I already had a business degree and somehow remained clueless about how to properly save and invest for my retirement.
For three years after my graduation, I worked professionally and saved very little for retirement because I didn’t really understand the importance of compounding interest for building wealth.
And while I’m thankful that my brother let me borrow his copy of Dave Ramsey’s Total Money Makeover when we were 24 (we’re twins), I wish someone would have given me the basics a little earlier.
In that spirit, this post will cover, at a very high level, some basic saving and investing principles for those just looking to get started.
As I walk through each point, I will closely follow The Next Dollar Roadmap and link resources to more detailed posts about the topics I discuss.
We have about 185 posts on our website now and over 100 topical videos on YouTube now, so you can stroll as deep into the rabbit hole as you want.
Are You Really Ready to Save for Retirement?
Retirement saving is incredibly important. I’m fond of reminding people that there are loans available for a lot of things, but retirement isn’t one of them.
It’s up to you (and maybe Social Security) to ensure you have enough money saved to cover your living expenses after you stop working.
But, there are some other things you need to get in order first.
To begin, if you haven’t already put together a budget go do that first.
I know you probably enjoy budgeting as much as the average person enjoys a good root canal, but just like those pesky trips to the dentist, budgeting is a financial necessity. (At least starting out anyway.)
The reason you need to do a budget is relatively simple. You can’t establish a saving and investing plan if you don’t know how you are really spending your money.
If you just broadly aim to save more without taking the time to figure out where that money is going to come from you will find yourself frustrated by very slow progress.
For example, the first time I did a budget I was shocked to learn that I was spending more money eating out each month that I was on groceries from the supermarket.
When I started eating out less I suddenly found I had more cash available for saving or debt reduction.
I know this isn’t earth-shattering stuff, but the fact is most of us are unaware of the extent of our consumption and spending habits unless we write them down and add them up.
Once you have a budget you need to establish an Uh-Oh Fund.
An Uh-Oh fund is just a small emergency fund of around $1,000 that will cover unforeseen emergencies like a car breakdown, household repair, or medical need instead of taking on debt to pay for these expenses.
Having adequate cash on hand to cover these costs is like safety margin or insurance for your future cashflow. Debt places a claim on that money before you even receive it which makes saving it impossible.
Once you have your budget and Uh-Oh fund in place then you may be ready to get started with your retirement investing.
The Employer Match
Around 73% of American workers have access to some sort of retirement account through their employers.
Of that group, 85% also enjoy employer contributions to their plans at work.
If you are among those who have the option to receive some sort of contribution to your retirement accounts, then you should take advantage of it as soon as your Uh-oh fund is in place.
This is such a high financial priority because it’s like getting extra money without having to exert any extra effort to get it.
In other words, it’s free. And if you pass it up, there’s not an option to get it back.
Naturally, the value of your employer’s contribution depends on how much they’re willing to give. If they’ll match 100% of each dollar you save, then their contribution effectively doubles the impact of your own.
If they contribute 50% of each dollar you save, then they make it that much more effective.
Since average market returns are around 8.3% annually, a single boost of 50% or 100% from your employer is like replacing years of waiting for compounding interest to increase your account size allowing you to fast forwarding to larger balances right away.
Perhaps you can think of it as a tailwind or turbo booster to your retirement savings. However, you view it, just be sure you place a high value on your employer match and take advantage of it.
In case you’re wondering how much to contribute, I recommend contributing as much to your plan at work as your employer is willing to match.
For example, my employer matches 85% of each dollar I contribute to my 401(k) up to 6% of my annual income. So, I start by contributing 6% of my annual income to my 401(k) each year.
Ultimately, you want to get to where you’re saving 15% to 25% of your annual income for retirement each year, but for now, you’re just maximizing the benefit of your employer’s matching contributions.
Once you’ve exhausted your employer match, tap the brakes on saving until you’ve completed step three which is next on the list.
Eliminate Debt and Build A Real Emergency Fund
Before you continue saving for retirement, the next step is to get your current financial status in better order.
To do this, you should pay off any high-interest debt and build a fully funded emergency fund.
High-interest debt is a bit of a subjective term, but a guideline I often use is an interest rate over 6% on a depreciating asset could be considered high-interest debt.
So, credit cards, debt on appliances, car debt, or even some student loans could be considered high-interest debt.
The reason you want to focus on this is because the cost of carrying these debts is actually hurting your financial situation more than it’s helping.
Setting money in an IRA that earns 10% is great, but not if you owe 21% on a credit card balance. This is like trying to walk backward up an escalator that moves downhill faster than your legs.
You need to focus on getting rid of these debts so they don’t hinder your progress any longer than they have to.
Also, I wouldn’t lump a mortgage into this group unless you have a loan with an adjustable rate or a ridiculously high interest rate compared to the market. In that case, you may just want to refinance.
The other part of step 3 is building up a fully funded emergency fund.
While the Uh-oh fund provides some margin for small emergencies, a fully funded emergency fund will allow you to ride out longer or more expensive financial situations like a job loss or a big expense (like a new roof, air conditioning, or car).
Again, this will allow you to avoid the setback of debt because you’ll have sufficient cash to navigate these tough days.
Think of an emergency fund as an insurance policy for your financial plan. It provides room for you to absorb disruptions without a catastrophic outcome.
Save 15% to 25% of Your Income
You should already be putting as much of your income into your retirement plan at work as your employer will provide some match for.
You need to save more than this in order to fund your retirement sufficiently.
I recommend saving at least 15% of your income if you’re starting in your 20s, 20% of your income if you’re starting in your 30s, and 25% if you are starting at 40 or older.
I’m trying to keep this post somewhat brief, so I’m not going to get into how I arrived at that conclusion. If you want to dig into the details, please read this post about how much you need to save depending on how many years you have until retirement.
Earlier I shared that my employer matches 85% of my contributions to my 401(k) up to 6% of my income. That means my combined employer and employee contributions are equal to 11.1% of my salary.
Since my wife and I started in our 20s, we aim to save at least 15% of our income at a minimum.
Assuming she makes an equal level of contributions in her own plan at work, we need to make up the difference with contributions of at least 3.9% of our annual income (15% – 11.1% = 3.9%).
If you too have a gap between your contribution goal and your employer matching maximum, then there are a few options you can consider for the next dollars you save:
- Individual Retirement Accounts (IRAs)
- Your Employer-Sponsored Retirement Plan (401k, 403b, TSP, or 457)
- Solo-401k Plans
- Health Savings Accounts (not technically a pure retirement account)
- Taxable Brokerage Accounts
Again, in the interest of time I’m not going to get into a lengthy explanation of which one you should use and in what order. Instead, I’ve already done that in another post.
In summary, I would typically recommend using an IRA next because it gives you the greatest amount of flexibility to choose the account custodian you are most comfortable with and provides a range of investment options that will allow you to target your investment objectives with accuracy (i.e. – diversification, asset allocation, asset classes, expenses, etc.)
Since annual contributions to IRAs are limited to $7,000 in 2024 ($8,000 if you’re 50 or older), if you still need to save more to meet your goal I would move back to the employer-sponsored plan.
However, if you are eligible for an HAS or Solo 401(k), those are possibly even better options.
Unfortunately, the best strategy will depend on your circumstances and the options that are available to you, so I can’t make an accurate recommendation through a blog post.
Keep taking advantage of these tax-advantaged options until you run out of money to save or run out of room to save in these accounts.
After that, move on to taxable brokerage accounts which have no contribution limits.
Roth vs Traditional
As you look into enrolling in many of the plans I’ve described above, you will probably be asked at some point if you prefer to make contributions on a Roth or Traditional (Tax-Deferred) basis.
First, you should know that the words “Roth account” are a reference to the tax treatment of your contributions, not the actual account type.
IRAs, 401(k)s, 457s, 403(b)s, and Thrift Savings Plans are all different types of accounts.
Each one of these account types allows Roth or Traditional contributions.
Roth contributions are made to these accounts on an after-tax basis, meaning that you don’t receive a tax deduction for the contribution. The benefit of this arrangement, however, is tax-free earnings and withdrawals later on in life.
Traditional or Tax-Deferred contributions are made on a tax-deductible basis, meaning that you don’t owe any tax on the contribution. However, the withdrawals are completely taxable.
In summary, Roth contributions allow you to pay your taxes on the front end, forever removing that liability from your future.
Tax-deferred contributions provide you with a tax deduction today, but you will pay taxes on withdrawals in retirement.
The superiority of making contributions on a Roth or Tax-Deferred basis will come down to your tax rate when you make the contribution versus the tax rate when you make withdrawals.
If you are in a lower bracket today than you will be in when you make withdrawals, then you should contribute to the Roth so you can pay the tax now at a low rate and withdraw it later to avoid the higher rate then.
If your tax situation is the opposite then you should use tax-deferred contributions to take advantage of lower taxes later on.
For more about the decision to use Roth or Traditional contributions, check out this post and video.
Rinse & Repeat
There is certainly more to personal finance than I have covered here, but this brief explanation is enough to get you started.
If you just do these things year in and year out for most of your working life, you will find yourself with quite a bit of wealth as you get older.
I’ve been at it for 17 years myself and can confirm with confidence that this plan has worked very well for Mrs. Martin and myself.
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