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June 23, 2020

Step by Step Retirement Investing Guide

Do you feel confused when strategizing how to invest for retirement? It’s common to feel this way, especially since the average American spends more time planning a vacation than selecting 401(k) investments. Having enough money for a successful retirement can seem like a daunting goal, but it can be achieved by breaking larger goals into smaller ones. This guide will discuss the fundamentals of retirement planning including different types of accounts, stockbrokers, and investment choices.

Table of Contents

  1. Select a stockbroker
  2. What to look for
  3. Customer Reviews
  4. Fees
  5. Account Types
  6. Technology
  7. Choose the right accounts
  8. Tax-deferred
  9. 401(k)
  10. IRAs
  11. Tax-free
  12. Roth IRAs
  13. Develop your risk tolerance
  14. Conservative
  15. Moderate
  16. Aggressive
  17. What to invest in
  18. Indexing
  19. Individual stocks
  20. Should you hire a financial advisor?
  21. Bottom Line

Select a stockbroker

One of the first actions you must take when learning how to invest for retirement is to select a stockbroker. While you might have an employer-sponsored 401(k), a stockbroker is helpful if you want to open other retirement accounts like Individual Retirement Accounts (IRAs).

Luckily, most stockbrokers have top-notch technology, offer commission-free trading for most investments, and even allow you to access financial advisors. Yet, every broker is different, and some brokers are better for different types of investors. 

For example, Robinhood can be a great choice if you want simple investment choices and minimal support. It wouldn’t be a good choice if you want to work with a financial advisor. On the other hand, Charles Schwab or Fidelity could be better options if you want more support and a wider variety of investment options.

What to look for in a broker

There are many factors you should consider when selecting a broker, including:

Customer Reviews

You can use sites like Yelp and TrustPilot to learn about your potential broker’s customer service quality. These sites will also help to indicate if that broker is ethical and competent. Some brokers, especially ones that operate solely online, may only offer email or chat support. 

Others have email, phone, and may even offer in-person services if they have retail branches. If you’re looking for extra guidance, consider working with a broker that has all of these support channels.

Fees

Trading commissions and expense ratios can add up over the long run. Check to see if your broker offers commission-free trading and learn about any fees for consulting an advisor. Luckily, most brokers don’t charge commissions for trading US stocks or ETFs. They also don’t have account minimums for most retirement accounts.

Account Types

Using a mix of retirement accounts like IRAs, Roth IRAs, and 401(k)s can be great tools that will help you achieve your financial goals. See if your broker offers these accounts and others like a SEP IRA if you’re self-employed.

Technology

Technology has greatly advanced and all trading is conducted online. Still, the best brokers have streamlined tech including Robo advisors, paperless account opening, and mobile apps. These tools will let you automate parts of retirement investing, easily open new accounts, and trade on the go, respectively.

Some brokers have a Robo advisor, which automatically rebalances your investments and conducts tax-loss harvesting. Robo advisors can make it easier to manage your portfolio for a fraction of what an investment advisor might charge. Charles Schwab’s Robo advisor is called Intelligent Portfolios and it has an account minimum of $5,000. If your balance is at least $25,000, you can pay $30 per month to have unlimited consultations with a CFP®  pro.

Choose the right accounts for your goals

One of the most important factors to consider when learning how to invest for retirement is the type of account. Some accounts are offered by employers, while others can be established via stockbrokers. 

Tax treatment is important to consider as well since you can invest on a tax-deferred, taxable, or tax-free basis.  Nobody can predict tax rates in the future, but using various tax-advantaged accounts can help you prepare for these changes. 

Generally, you’d invest with tax-deferred accounts if you think you’ll be in a lower tax bracket during retirement. If you’re concerned with higher tax rates in the future, using Roth accounts could be a good choice. Taxable brokerage accounts are a good choice for when you’ve hit your contribution limits for tax-deferred and tax-free accounts. Taxable brokerage accounts have more flexibility since you can withdraw your money without a penalty, unlike with an IRA, Roth IRA, or 401(k).

Below, you’ll learn about some of the most important retirement account options.

Tax-deferred accounts

401(k)

401(k)s are tax-deferred accounts that are offered via an employer. Tax-deferred means that you’ll receive a tax deduction on your contributions. You also won’t pay taxes on dividends, interest, and capital gains as your account grows. You’ll only pay taxes when you take distributions from your account.

In 2020, you can contribute up to $19,500 per year if you’re under 50. If you’re older than 50, you can contribute an additional $6,500 per year. One of the main advantages of a 401(k) is the employer match. Many employers have terms like matching 50% of the first 6% of your contribution. This means your employer will match 3% of your salary if you contribute 6% to the 401(k). Be sure to contribute enough to obtain your employer’s match as this can significantly grow your balance over time.

Most 401(k) plans are tax-deferred, but some employers let you invest on a Roth basis. This means that you’ll pay taxes on your contribution in exchange for tax-free growth and distributions.

IRAs

Like most 401(k) plans, IRAs are tax-deferred retirement accounts. However, they don’t have employer matches and the contribution limits are much lower. In 2020, you can contribute up to $6,000 to an IRA if you’re under age 50. You can invest an additional $1,000 per year if you’re older than 50. Also, you can’t invest $6,000 into multiple IRAs each year, as this is the aggregate annual contribution limit for all IRAs combined.

Some advantages of IRAs include lower fees and more investment options. Most IRAs have lower fees and cheaper investment options than some employer-sponsored 401(k)s. You can also invest in a wider variety of investments like bonds, individual stocks, and even options.

Tax-free accounts

Roth IRAs

Roth IRAs have the same contribution limits as IRAs. However, you can invest money that has already been taxed and not pay taxes on future gains. This type of investment account also has more flexibility than a 401(k) or IRA. For example, all ages can contribute to it and you can access your contributions. While it’s best to keep your contributions invested, you’ll have peace of mind knowing you can access them in case of an emergency.

You also won’t need to take Required Minimum Distributions or RMDs. RMDs force you to withdraw certain amounts from your 401(k) or IRA when you turn 72. It’s simply the government’s way of collecting taxes on your tax-deferred investment accounts.

Know your risk tolerance

Risk tolerance refers to how well you can handle market volatility. The three main types of risk tolerance are conservative, moderate, and aggressive. 

Conservative

Conservative investors are usually older and don’t want their investments to fluctuate much. A sample conservative portfolio might be 70% bonds, 20% cash, 10% stocks. 

Moderate

Moderate investors can handle some volatility, but also want a buffer for security. A high-level moderate portfolio could be invested in 60% stocks and 40% bonds.

Aggressive

Aggressive investors are typically younger and have time on their side. They can manage large drops in their portfolios as they could easily recover from these over time. Some aggressive investors might have a portfolio with 70% small-cap stocks, 20% large-cap stocks, and 10% cash.

Knowing your risk tolerance is crucial when learning how to invest for retirement. While risk tolerances can vary, usually older investors are more conservative since they have less time to recover from market volatility. If you’re younger and just starting to invest, it’s likely that you’d be a more aggressive investor. 

You may choose to work with a financial advisor or stockbroker to help you accurately determine your risk tolerance.

What to invest in

Risk tolerance and investment time horizon go hand and hand. You need to know how long you’d need to invest for in order to achieve certain goals. For example, saving for a luxury vacation could be a one or even two-year goal. Another goal like saving for a down payment on a home might be a five-year goal. Retirement is unique as it can be a decades-long goal for some, and a five-year goal or less for others.

Once you know your risk tolerance and investment time horizon, then you can start selecting investments. One option could be a target date fund within your employer’s 401(k) plan. A sample target date fund is the Vanguard 2050 fund or VFIFX. 

This target date fund is meant for those wanting to retire in or around 2050. These funds have an asset allocation that starts with a high allocation towards higher risk, higher reward choices like US stock funds. As you age, they adjust or rebalance to conservative investments like bonds or fixed income.

Another similar and popular option to target-date funds are Exchange-Traded Funds or ETFs. ETFs invest in numerous companies and this minimizes risk. You can find ETFs that invest in various sectors and asset classes like small-cap stocks, large-cap value stocks, consumer staples, and even sustainability. 

Indexing

Other ETFs track common stock indexes like the S&P 500. This is referred to as passive investing or indexing. Many people use this simple strategy when learning how to invest for retirement as it can be inexpensive and prevent mistakes like market timing or selling at a loss. 

Legendary investor Warren Buffet made a bet with hedge fund managers that his investment in an index fund would outperform the hedge funds. Warren Buffet won the bet since the index fund’s five-year return was 126% compared to the hedge funds’ five-year return of 36%.

This shows that long term investing with simple, low-cost tools like index funds can be very effective. It demonstrates that excessive fees can erode portfolios by hundreds of thousands of dollars long term. Fees are one of the most important factors to consider with any advisor, investment, or account. 

Individual stocks

You might have considered investing in individual stocks when learning how to invest for retirement. However, stocks have more risk and can be more expensive than ETFs. For example, ETFs allow you to invest in hundreds of companies, which minimizes risk. You also won’t have to buy hundreds of different stocks and this prevents you from possibly racking up high transaction costs. 

While stocks can double, triple, or 10x in value, they can also go to zero. Companies can go bankrupt and even those that seem solid might have some skeletons in their closet. For instance, WorldCom was a telecommunications company that seemed legitimate, until it went bankrupt due to accounting fraud. Its stock went to zero and investors lost thousands of dollars.

Should you hire a financial advisor?

You might think that a financial advisor could help you learn how to invest for retirement. Well, yes and no. You can ask your broker if they provide access to their financial advisors. He or she could answer some questions and point you in the right direction.

However, be sure that your advisor is a fiduciary and won’t make money by selling you  investment or insurance products. Steer clear if your advisor doesn’t have transparent terms, offers investment “guarantees” or uses hard selling techniques to sell you products or convince you to invest money with them for a management fee.

It’s best to work with advisors that have good reviews, are good listeners, have at least three years of experience, and have advanced certifications. Many high-quality advisors have a CFP, CFA, and/or a CPA.

Hiring an advisor makes more sense if you have a more complicated situation. Advisors can be useful if you have millions of dollars, a complicated tax strategy, different types of stock options, and/or a family.  

Many advisors also have account minimums that start at around $200,000 and charge roughly 1% of assets under management. Advisors are less likely to work with those that have limited funds, since they need to have standards in order to stay profitable.

Bottom Line

It can be challenging to know how to invest for retirement since there are many variables and it can be decades before your retirement date. However, you can successfully plan for this goal by learning the fundamentals and setting small milestones along the way. Taking these actions could help you be better off than 48% of Americans who have less than $10,000 saved for retirement.

Knowing about different account types, your risk tolerance, investment time horizon, basic investment choices, and more can let you grow sizable retirement accounts over the long term.


Disclaimer: This guide isn’t investment advice, but education. Please consult a financial professional for advice.

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