The first step to starting your retirement fund is to find a “box” where you can protect your assets from taxation over time. The next step is to fill that box. But with what?
Investing can be an extremely complex topic, and for the purpose of keeping this in a single blog post, we’ll keep in simple and start with the bread and butter of investments — stocks and bonds. A stock is a share of ownership in a company. Its value may go up over time, and ownership may entitle you to a portion of the profits called dividends. A bond is ownership of debt, where you’re the bank lending money to a business or a government and receive interest in exchange. In general, bonds are considered more conservative investments than stocks, which can rise can fall rapidly (as you can see in the stock market on any given day). Stocks, however, have a history of building greater value over time, so the key is to invest more heavily in stocks while you’re young and gradually move into bonds as you approach retirement. Some suggest using your age as a measure of what percentage of your portfolio should be in bonds — at age 30 your should be 30% bonds and 70% stocks, and if you’re 60 you should be at 60% bonds and 40% stocks.
But how do you start buying stocks and bonds to put into your retirement “box?” The easiest way is to buy a bunch all at once through a mutual fund. In a mutual fund, investors pool their money and buy many different stocks, bonds, or a blend of the two. This is great because you can diversify your portfolio, which means spreading your money out over a wide variety of companies, reducing risk. My favorite kind of mutual fund is called an index fund. You may have heard of the Dow Jones Industrial Average or the S&P (Standard and Poors) 500. These are examples of financial indeces, which simply track large companies and use their performance each day as a measurement of the market as a whole. Instead of trying to pick a handful of stocks that you think will be good investments, you are statistically better off just buying as many as you can and spreading the risk over several areas. The S&P 500 measures 500 of the biggest companies in America, and you could have a piece of all of them for as little as $100 buy investing in the Charles Schwab Total Stock Market index fund. This is just one example — there are funds that also follow smaller companies, international compaies, real-estate investments (in the form of Real Estate Investment Trusts — REITs) and also bonds.
To learn more about how to invest using index funds, check out the website bogleheads.org. The site (and the group) are named after Jack Bogle, who came up with the idea of the index fund back in the 1970s. You’ll find several examples of financial portfolios you can build, including a couple “lazy portfolios” if you want to keep things simple. The simplest portfolio of all, however, is one with a single fund inside — a “target retirement” fund. More investment companies are offering these, and they’re dead simple to follow. You simply buy one fund based on the year closest to when you plan to retire (I’m aiming for the year 2045). All you have to do is buy shares in that fund and let it sit. Your investment company will rebalance your fund to make it more conservative as you get closer to retirement.
One last point we haven’t discussed is fees and commissions. The underlying goal of the investment strategy outlined above is to make investing as inexpensive as possible. Many mutual funds — particularly actively-managed funds — come with fees in the form of loads (a fee paid when you buy or sell a fund) expense ratios (fees built into the fund as an annual cost) and commissions, which you can get charged to purchase a fund. If you want to buy into an index fund managed by Vanguard, you’ll have to have your “box” with them to avoid paying a commission. I have a Roth IRA with Schwab and I’m limited to a handful of Schwab funds that I can buy commission-free, and my wife has one with Vanguard. There are other brokers with their own collections of funds, such as T. Rowe Price, Fidelity, and TD Ameritrade. Check their websites and see what they have to offer.
We’re only scratched the surface, but hopefully this information will be enough to get started. Post your questions below, if you have any!