Making Over Ron
Aug. 20, 2001 -- Ron worries his low salary will make it hard for him to retire comfortably. But you don't need money to plan shrewdly, as Ron's proving as he plots a secure retirement.
Ron has two important things going for him — discipline and time. In combination, they give him a head start on building his retirement nest egg.
Ron shows extraordinary discipline — he's saving between 20 percent and 30 percent of his annual income. For perspective, Americans typicallly save less than 5 percent, and the overall savings rate has been negative in recent years, meaning Americans, as a whole spend more than they earn.
Since Ron is just 26, his investments have 40 years to grow before he'll tap them for living expenses.
Retirement calculators
An example best illustrates how discipline and time will help Ron reach his goals. Let's say he works until he's 65 and that he'll spent the equivalent of $21,000 a year (about what he spends now) during retirement. If his expenses grow by 3 percent a year, Ron will need to accumulate about $1.3 million by age 65 to fund his living expenses until age 90.
Saving $1.3 million on Ron's salary may seem unatttainable, but it's well within his reach. If he continues to save 20 percent of his gross income each year, and his investments earn an 8 percent average return, he'll have a $1.9 million nest egg by age 65.
Of course, he'll owe some taxes on this, but he'll still have enough left over to retire. Plus, he'll have his Social Security income and perhaps a teacher's pension.
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To demonstrate the power of time, if Ron waited five years to start saving he'd end up with $1.3 million at age 65, or $600,000 less than if he starts now.
Uncle Sam Wants to Help
The federal government provides a number of opportunities for savers like Ron to accumulate money for retirement and also pay less in taxes. The best retirement savings opportunity is the Roth IRA. It enables people to set aside as much as $2,000 a year, which grows tax-free forever. The Roth IRA contribution limit increases to $5,000 by 2005.
Since Ron works for a public school, he probably can contribute to a 403(b) plan, also called a tax-sheltered annuity, or TSA. Like better-known 401(k) plans, 403(b)s give public school employees the opportunity to make tax-deductible contributions to an account that grows tax-deferred until retirement. The contribution limit is $10,500 in 2001, growing to $15,000 within four years.
Ron should take advantage of these opportunities by establishing a Roth IRA and making the maximum contribution each year. He should accumulate any additional retirement savings through his school district's 403(b) plan.
Four Pillars of Retirement Security
Of course, Ron now needs to choose appropriate investments within his Roth IRA and 403(b) plans, which, for the vast majority of investors, means investing in mutual funds. Because of his young age, Ron should commit most, or even all, of his retirement investments to mutual funds that invest in stocks.
As Easy as ABC
It has become very easy for investors, even those with only modest amounts to invest, to develop a broadly diversified portfolio of stock mutual funds that invest in large and small companies, both in the United States and abroad. Index funds, which try to match the performance of a large segment of the stock market by investing in hundreds of stocks, are generally the most-diversified mutual funds and are also especially well suited for buy-and-hold investors.
Ron can establish a Roth IRA at the Vanguard Group, which offers a number of index funds including Total Stock Index fund (which invests in almost every public company in the United States) and the Total International Stock Index, which invests in several hundred companies overseas. By owning just these two funds, an investor can construct a highly diversified, all-weather stock portfolio.
Roth IRAs
Another option is to establish a no-fee Roth IRA account at E-Trade, a mutual fund "supermarket" that provides access to thousands of no-load stock mutual funds from a variety of companies. Ron can achieve broad diversification by investing in a "fund of funds" such as Masters Select Equity and Masters Select International. These funds hire up to 10 managers, who each provide the fund with their best investment ideas.
Ron's investment choices are more limited in his 403(b) plan, as school districts give participants a list of approved vendors to choose from. Ron should stick with a well-respected mutual fund company such as Vanguard, Fidelity, T. Rowe Price, or American funds, if they're on the approved list. Most of these companies offer index funds and free telephone advice if you have questions about which funds to choose.
Many insurance companies also offer 403(b) accounts. They usually levy sales charges, higher fees and other expenses that mutual funds don't charge, but they often also come with the assistance of an agent who can dispense advice about how to allocate the money in the account.
Guest columnist Greg Schick, CFP is a financial planner at Kochis Fitz, a wealth management firm in San Francisco.
Ron can establish a Roth IRA at the Vanguard Group, which offers a number of index funds including Total Stock Index fund (which invests in almost every public company in the United States) and the Total International Stock Index, which invests in several hundred companies overseas. By owning just these two funds, an investor can construct a highly diversified, all-weather stock portfolio.
Roth IRAs
Another option is to establish a no-fee Roth IRA account at E-Trade, a mutual fund "supermarket" that provides access to thousands of no-load stock mutual funds from a variety of companies. Ron can achieve broad diversification by investing in a "fund of funds" such as Masters Select Equity and Masters Select International. These funds hire up to 10 managers, who each provide the fund with their best investment ideas.
Ron's investment choices are more limited in his 403(b) plan, as school districts give participants a list of approved vendors to choose from. Ron should stick with a well-respected mutual fund company such as Vanguard, Fidelity, T. Rowe Price, or American funds, if they're on the approved list. Most of these companies offer index funds and free telephone advice if you have questions about which funds to choose.
Many insurance companies also offer 403(b) accounts. They usually levy sales charges, higher fees and other expenses that mutual funds don't charge, but they often also come with the assistance of an agent who can dispense advice about how to allocate the money in the account.
Guest columnist Greg Schick, CFP is a financial planner at Kochis Fitz, a wealth management firm in San Francisco.
Guest columnist Greg Schick, CFP is a financial planner at Kochis Fitz, a wealth management firm in San Francisco.