Senior Investment Analyst of Vanguard's Investment Strategy Group
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I enjoy almost every aspect of cooking, from finding recipes to plating. (In fairness, does anyone really enjoy cleaning up afterward?)
I spend about 45 minutes planning, preparing, and plating a meal that takes my family of 4 about 20 minutes to eat. In other words, we devour what I make in about half the time it takes me to make it.
Our busy schedules don’t allow me to spend more time than that in the kitchen on any given night, but I make the most of my prep time. I choose an easy recipe with a few steps―and if that recipe is broken down into simple tasks … bonus! Then I ensure all of my ingredients are on hand, and I step into the kitchen with a plan.
I’m not going to liken preparing a tapenade to creating a tax-efficient portfolio, but I am going to focus on the similarities between meal prep and retirement prep.
If you work and save from age 18 to age 63, you’ll spend around 45 years preparing for a retirement that spans about half as long—just over 22 years.* Your personal circumstances will determine whether you remain in the workforce (and continue saving) longer.Either way, you have to make the most of the time you have—whether you’re meal planning or retirement planning.
Here are 4 steps, broken down into simple tasks, to help you make the most of your retirement prep time so you can savor life in retirement.
1.Save—early and often.
- Start early. Time is money. Thanks to compounding, the value of your investment can increase over time when your earnings generate interest and capital appreciation.
- Take advantage of your employer match. If your employer offers to match a percentage of your contribution to an employer-sponsored plan, such as a 401(k), contribute at least enough to get the full match. After all, the match is a 100% immediate return on your investment!
- Increase your savings each year. Increasing the percentage of your income you save by 1% a year and earmarking a certain percentage of every raise or bonus for retirement can add up to big savings over time. Work toward saving 10%–15% of your annual income (including any employer match) for retirement during your working years.
- Pay yourself first. Automate your savings through paycheck deduction or automatic contribution. Once you enroll, you won’t have to think about saving again until it’s time to increase the amount you save.
2. Use a portfolio of diversified investments to create a balanced foundation.
- Start with your asset allocation. Choose your asset allocation (the percentage of stocks, bonds, and cash you hold in your portfolio) before selecting any specific investments. Research shows that 91% of your portfolio’s long-term return can be attributed to your asset allocation.**
- Be diverse. All investing is subject to risk. But by investing in a diversified mutual fund or exchange-traded fund (ETF)—rather than an individual stock, for example—you can avoid the risk of losing everything if a specific company or sector goes under. Owning just 1 share of a mutual fund or an ETF gives you exposure to all of the fund’s underlying investments, which makes it easy to build a broadly diversified portfolio.
- Invest globally. International markets don’t always rise and fall in concert with U.S. markets, so investing in international mutual funds and ETFs is another way to diversify your portfolio and lower your risk. We recommend investing about 40% of your stock allocation in international stocks and about 30% of your bond allocation in international bonds.
3.Rebalance to stay on track.
- Stick to your target asset allocation. When your current asset mix strays from your target, you may be subjecting yourself to a level of risk (either too much or too little) that doesn’t align with your long-term goals. To stay on track, review your account once or twice a year and rebalance when your current asset allocation differs from your target by 5% or more.
- Consider following a glide path. It’s important to stick to your target asset allocation. But it’s also important to revisit that allocation and make necessary adjustments over time—especially as your goals, time frame, or risk tolerance changes. In the years leading to retirement, consider gradually making your portfolio more conservative.
- Tune out the noise. Investors can’t accurately anticipate what the markets will do next. And research shows that when they try, they’re more likely to experience lower returns.† My advice? Stick to your plan.
4.Control costs and pay attention to taxes.
- Choose low-cost investments. Investment costs can add up over time and eat into your returns. Say you make a onetime investment of $10,000 in 2 funds. Both funds have a 6% average annual return, but Fund A has a 1% expense ratio and Fund B has a 0.30% expense ratio. In 10 years, your balance in Fund A would be $16,196 and your balance in Fund B would be $17,378. That’s a difference of more than $1,000, attributable entirely to your investment expenses.††
- Take advantage of tax-advantaged accounts. Consider including traditional and/or Roth accounts in your portfolio to diversify how your retirement assets are taxed now and how they’ll be taxed in the future. If you contribute to a traditional IRA or 401(k), you won’t pay any taxes on your contributions or investment earnings until you make a withdrawal. With a Roth, you’ll pay taxes up front on the amount you contribute, but the account will grow tax-free and you won’t be subject to any taxes on withdrawals in retirement—as long as you’ve held the account for at least 5 years and you’re age 59½ or older when you withdraw the money.
- Think about asset location. The mix of assets you own is important, and so is the type of account that houses each asset. Hold tax-efficient investments, such as equity index funds, in taxable (nonretirement) accounts. Hold less tax-efficient investments, such as taxable bond funds and actively managed equity funds, in tax-advantaged accounts.
Food for thought
Eating is part of life. So isretiring. Some days I don’t have a clear plan for what I want to cook, I don’thave time to prep, or I’m distracted by other responsibilities. Thanks totakeout, there will still be food on the table even if meal planning falls bythe wayside for a night or 2. Unfortunately, there’s no substitute forretirement savings if you don’t make saving a priority throughout your workingyears. You have a finite amount of time to prep for retirement—make the most ofit.
I’d like to thank my colleague, Steve Weber, for his contributions to this blog.
*According to data from theSocial Security Administration, a man who reaches age 65 today can expect tolive, on average, until almost age 85. Under the same circumstances, a womancan expect to live until just over age 86½.
**Source: Brian J. Scott, JamesBalsamo, Kelly N. McShane, and Christos Tasopoulos, 2017. Theglobal case for strategic asset allocation and an examination of home bias.Valley Forge, Pa.: The Vanguard Group.
†From January 1, 2002, throughDecember 31, 2016, the average annual difference between investor return andfund return was –0.33 for balanced funds, –0.44 forinternational equity funds, –0.47 for U.S. equityfunds, –0.61 for diversified emerging marketsfunds, –0.62 for commodities funds, –0.62 for foreignsmall-cap/mid-cap blend funds, –1.1 for global real estatefunds, –1.12 for alternative funds, –1.15 for taxable bondfunds, –1.17 for sector equity funds, –1.43 for municipalbond funds, –2.14 for high-yield bond funds, and –2.61 foremerging-markets bond funds. Sources: Morningstar and Vanguard calculations.
††These hypothetical examples donot represent the returns from any particular investments.
- When taking withdrawals from an IRA before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against a loss.
- Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
- Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
We recommend that you consult a tax or financialadvisor about your individual situation.