Last time, we got through two of the toughest steps in our personal finance plan, eliminating our most expensive debt and building up an ample emergency fund, should the need arise. Now that you’ve ensured that your financial situation is secure, it’s time to look at some of the other goals you may want to accomplish.
Step 7: Ensure Your Retirement Saving is on Track
Reality check time: for better or worse, funding your retirement is largely up to you. As a result, you need to be sure you are providing enough funding to cover your expenses. The standard set of assumptions is that you’re going to need 70-80% of your final income during retirement, and that if you take 4% of your nest egg each year (adjusting for inflation), you should be able to make your nest egg last throughout your retirement, no matter how long it lasts. Crunching the numbers, holding 20 times your final income in your starting nest egg will allow you to withdraw the proper amount.
However, getting to 20 times your final income is quite an achievement. The earlier your start saving, the easier it will be to reach your goals. Here’s roughly how much of your gross salary you will need to save to meet your goal at age 65, starting with no invested money at each of the following ages:
Start Investing at 20: Save 12% of your income
Start Investing at 30: Save 20% of your income
Start Investing at 40: Save 37% of your income
Start Investing at 50: Save 75% of your income
As you can see, the earlier you begin, the less money you will have to save to reach your goal by the age of sixty-five. Of course, the assumptions I made when running the calculations are fairly conservative; no pension payments (pretty reasonable, nowadays), no Social Security payments (a bit more of a stretch; you should be getting at least some portion of the promised Social Security payments, if not the full, expected amounts), and an 8% growth rate (a little below what the markets have returned historically, but reasonable for our calculations). So, if you are fifty and can’t imagine saving 75% of your salary, don’t panic; chances are, you will have some help from the government. Still, the further you are from retirement, the less you should count on things like Social Security or a pension, and the more you should try to save, at or above the levels listed above, if necessary.
Here’s a short list for the priority of your retirement savings:
-In a 401(k) up to the match: We covered this already, back in step 3, but it should be your top priority. If you’re fairly young and your company gives a good match, this might be all you need to get to your desired contribution level.
-Open up an IRA: Opening an Individual Retirement Account (IRA) with a mutual fund company allows you to have much more choice and control over your retirement investments. They come in two flavors, traditional and Roth, which vary in how they are taxed. Which one to choose? My suggestion: go with the opposite of your 401(k); if you have a traditional 401(k), go with a Roth IRA, if you have a Roth 401(k), choose a traditional IRA. That way, you will come ahead, no matter what happens with tax rates by the time you retire.
-Max out your 401(k): Unless your 401(k) has truly horrible investment offerings, you’re probably best off by taking advantage of the tax deferment by investing more in your 401(k).
-Invest in a nonretirement account: If you need to invest a fairly substantial portion of your income or you have a very large income, you might need to invest more money than you can put into a 401(k) and IRA. In that case, even though you won’t get any tax advantages, putting money into a nonretirement account is pretty much the only remaining option.
Step 8: Buy a House (If You Want to Own Your Home)
An often overlooked financial goal, but one that’s especially relevant to my fellow young whippersnappers, buying a house is worthy of consideration. It’s not an easy or quick process to buy a house, but it can provide a solid base from which to continue your financial growth. Given the upheaval in the real estate market recently, there are a few things you need to keep in mind:
-You’ll need a sizable down payment: The days of zero percent down, liar’s loans are gone. Expect to pay at least 10% down on your mortgage, and better yet 20%. Save up the money, using either very safe methods like money market funds, or if you have lots of time before you intend to buy your home, a higher-yielding short-term bond fund.
-Go for a fixed rate mortgage: Again, with the current environment, this might be your only option. In any event, having a fixed rate mortgage will save you from worrying about sudden rate hikes and allow you to more easily plan for your future. Plus, over time inflation will lowered the real cost of a fixed payment, making it easier to handle.
-Buy only as much house as you can afford: If you can’t afford to make the payments on the house using a thirty-year fixed mortgage, you can’t afford it. Period. No using option-only loans or reverse amortization loans to buy a huge house.
Given the current mortgage rates, chances are getting a mortgage in the next year will let you have a mortgage that falls below our six percent threshold for our debt, so we won’t worry too much about paying down the mortgage. Instead, you can add the mortgage to your low-interest debt, and just be sure that you can make the payments on all that debt without overextending ourselves financially.
We’re almost at the end of our journey to control your finances. There’s only two steps left, and at this point, you’ve paid off all your high interest debt, built up an emergency fund, created adequate investments to fund your retirement and possibly bought a house. Congratulations to you; that’s quite the list of accomplishments. The last few items should be a piece of cake for you by now.