Whether retirement is right around the corner or decades away, it’s never too early or late to start saving. The question is: What’s the best way to start saving? The answer, of course, will depend on your age and your financial situation. But there are some general rules of thumb that most people follow to successfully save for their retirement.
401(k), IRAs and Investment Accounts
There are three main options when saving for retirement: 401(k)s, IRAs and investment accounts.
Most employers offer a 401(k) retirement account, or a 403(b) plan. Both plans are great options because they allow your money to grow tax-free until you withdraw it in retirement. You also avoid having to pay taxes either on the money you invest, or the money you withdraw from the account, depending on whether you choose a Roth or traditional option.
If your employer doesn’t offer retirement options or you’re self-employed, you can put your money into a tax-advantaged retirement account of your own. IRAs are the most common. They offer similar tax advantages to a 401(k), but eligibility rules differ.
You can also put your money into a regular investment account that doesn’t offer tax advantages.
Accounts with tax advantages are preferred, but there are limits to how much money you can invest each year. If you’ve maximized these options but want to save more for retirement, you can put that money into a regular investment account.
A Mix of Investments
There are three main types of investments: stocks, bonds and cash. Ideally, your retirement accounts should contain a mix of stocks and bonds. You may have some cash, too.
Stocks can be purchased either individually, or through a mutual fund. A mutual fund is, essentially, a collection of stocks, bonds, or cash equivalents. In some cases, they are a mix of all three.
You can also invest in ETFs, which are different from mutual funds. The primary difference between the two is that net asset value is not calculated at the end of the like with a mutual fund. ETFs allow you to track broad market indexes, like the S&P 500, which allows you to enjoy instant diversification. Fees are low, and you won’t be hit with a major tax bill until you sell (in most cases).
Adjust for Risk Tolerance
As you age, your investments should also change. Your tolerance for risk will decrease as you as you get older.
Stocks offer long-term growth, but they’re also volatile. You can lose a lot of money in the short-term. When you’re young, the long-term growth outweighs the risks of investing in stocks. But as you age, that will change. Ideally, you should scale back the percentage of stocks in your investment portfolio over time.
Bonds are interest-bearing loans that you provide to the government or a company. They’re less volatile, but they offer weaker long-term returns. Because they’re less risky, you may want to increase your percentage of bonds as you age.
Cash, or cash equivalents, are the least risky, but they also have the lowest returns. You may not need to add cash to your retirement account until you’re in or approaching retirement.