Retirement Planning Guide – 5 Steps for the Young Professional

You spent your college years waiting tables or working part-time retail jobs in order to pick up extra cash for tuition, books and beer. Now, you’re working a nine-to-five job, but your dreams of cashing in on a killer apartment, new car, and dream vacation still aren’t a reality. On top of that, you’re juggling credit card bills, student loan debt, rent, car payments, and other living expenses. Learning retirement planning strategies and saving a nest egg for a time that’s forty years away may be the last thing on your mind. However, you should invest in your retirement as soon as possible to take advantage of the power of compound interest. With compound interest, you earn interest on your invested amount as well as on the interest you’ve already accumulated. This really adds up in the long run. 

Imagine that you have nothing saved yet, but you can afford to begin saving $100 a month and continue saving that amount each month until you retire at age 65. The following table illustrates the nest egg values you’d accumulate based on your age when you start investing. Assume that the interest rate is adjusted for inflation.

It’s true! Waiting just ten years to start saving can cost you hundreds of thousands of dollars. To keep that from happening to you, check out the five retirement planning strategies below:

• Evaluate your current financial situation
• Establish a personal investment strategy
• Start investment planning
• Consider hiring an investment manager
• Monitor and change your investment plan

1. Evaluate your current financial situation

It’s important to evaluate your current liabilities before you decide on a retirement planning strategy. Chart out how much of your income is spent on debt repayments, rent, household bills, and entertainment. Figure out how much interest you’re currently paying on credit cards, student loans, or other debts. It’s generally best to pay off high interest debt before investing in your retirement. For example, a $500 credit card balance with a high interest rate of 15 percent will cost you $75 in interest each year while a $500 investment earns only $40 a year, assuming an eight percent interest rate.  In this case, pay off your credit card balance before you start investing. Debt payments that have low interest rates – such as student loans – shouldn’t keep you from investing now. Continue to pay your student loans on time, but invest other money in a retirement account where you’ll typically earn higher interest rates than what you pay in student loan interest.   

You may need to reduce your monthly spending in order to fund your personal investment strategy. Brainstorm ways to slash expenses or increase your current income level. Make use of last night’s leftovers and bring your lunch from home a few days a week. Look for restaurants that are running specials or that allow you to bring your own bottle of wine when you go to dinner with friends. Try to carpool with someone else from your office a few days a week if you drive to work. The little stuff really adds up!

2. Establish a personal investment strategy

Establish a retirement investment strategy that’s tailored to your specific, long-term financial goals. Consider how soon you want to retire and how comfortably you want to live during your retirement years. Americans spend an average of twenty years in retirement according to the US Department of Labor, and a 2007 Consumer Expenditure Survey reports that people over 65 spend an average of $36,000 per year. Assuming three percent inflation, that figure will be over $100,000 a year by the time you retire! This means you'll literally need your money to grow to millions of dollars in order to retire at age 65.

It’s important to plan for your specific situation though. Use an online calculator to identify how much you’ll need to save for retirement based on your income, current investments, years until retirement, and other factors. Yahoo, MSN, and Bloomberg offer free retirement calculators – it might be a good idea to check out more than one as they have slightly different outputs. Here are some tips when using these tools:

• Assume inflation is three percent per year
• 65 is the average retirement age
• Assume a salary increase of three percent per year
• You’ll need 70 to 90 percent of your pre-retirement income to retire comfortably
• Assume a ten percent return on your investment before retirement and a five percent return during your retirement years
• Don’t include social security benefits in this exercise

3. Start investment planning

Here are some of the ways you can invest for your retirement:

• 401k plans – You should start your investment planning process by evaluating any 401k plans that your employer offers. A 401k is a retirement plan that allows employees to save money that’s not taxed until it’s withdrawn during retirement. You can contribute up to $16,500 in 2010 unless your employer’s plan has set a lower limit. Many employers match 401k contributions up to a certain dollar amount. Always take advantage of an employer’s match – you’re adding free money to your 401k!
• IRAs –Open an individual retirement account (IRA) if you don’t have access to a 401k plan, or consider opening an IRA as a supplement to your 401k. Traditional IRAs and Roth IRAs are the most common IRA types. You contribute tax-free dollars to a traditional IRA, but you’ll pay taxes on your withdrawals based on the tax rate at the time of withdrawal. Contributions to Roth IRAs are taxed now, but your investment and any interest you earn won’t be taxed when it’s withdrawn. You can contribute up to $5,000 a year in a traditional or Roth IRA; however, you must make less than $120,000 per year to participate in the Roth plan. A few other types of IRAs exist – such as Simple and SEP – that have higher contribution limits and cater to individuals that use IRAs in lieu of a 401k.
• Low-risk investments – Savings or money market accounts and certificates of deposits are safer investments. These options are usually low-risk, but they also yield a lower rate of return. Low-risk investments are the optimal way for young professionals to save an emergency fund for near-term unforeseen expenses, but you should consider more aggressive, high-risk investments when you build your retirement planning portfolio.
• Real estate – Real estate can be a solid long-term investment, particularly if you’re planning to stay in one place for a long period of time. Owning real estate creates tax savings throughout your life, allowing you to save more money for retirement. You can also sell your real estate assets during retirement to supplement cash flow from other investments.

 
Your 401k and IRAs will likely consist of higher yield investments, such as stocks, bonds, and mutual funds. It’s important to diversify your overall retirement portfolio regardless of the types of investments you select. Make sure you select a good mix of aggressive and moderately aggressive funds in your IRA or 401k, and consider investing in several of the vehicles listed above to reduce your overall risk.   

4. Consider hiring an investment manager

Wading through the endless investment options available in the marketplace can be a time-consuming and frustrating process, particularly for new investors. You should hire an investment advisor if you’re intimidated by the amount of knowledge and research required to start investing. Although hiring an investment manager may initially cost you money, it can prove invaluable in helping you set up a successful retirement plan. Investment advisors can help you with your financial investment strategies, budgeting, and diversifying your portfolio. They can assist you with mutual fund and stock picks as well as answer any questions related to your retirement planning strategy. 

Your friends, family and co-workers are some of the best sources for finding a qualified investment advisor. Interview investment managers before hiring one, even if they come highly recommended by a family member or friend. You should interview at least three planners before making a final selection. Ask for the planners’ credentials. Qualified planners should have accelerated credentials, such as a Certified Financial Planner designation. Make sure you work with a planner that specializes in individual wealth management, particularly among young professionals just starting to save. Find out exactly how the planner is compensated and what fees you’ll pay up front and over time. Ask the planner for references, and follow-up with those references to find out how satisfied they are with the advisor’s services. You should also consider the types of questions the investment managers ask you. Don’t work with investment managers that neglect to ask you good questions about your finances, goals, and risk preferences.

5. Monitor and adjust your investment plan

You should monitor the performance of all of your investments at least annually. If an investment is not performing well, consult a financial advisor if you're considering moving your money to another type of investment. Remember that you shouldn’t always react to sudden changes in an investment’s value, particularly if it’s a long-term investment.

Your age will determine when you should adjust your overall investment strategy. As a young professional, you should invest the majority of your portfolio in aggressive funds or growth stocks and a smaller percentage in conservative fixed assets – such as bonds. Your current age is the approximate percentage you should invest conservatively. For example, a 30 year old’s portfolio should be 30 percent conservative and 70 percent aggressive.

Keep an eye on money that you’ve invested for a specific time period such as a certificate of deposit. When the investment matures, you’ll need to cash it in and reinvest the money elsewhere. Revisit your investment plans whenever you experience a major life change – receiving a raise, getting married, having children, or losing a job. Remember that monitoring and changing investments can be tricky. Talk with your financial advisor if you’re uncertain about when to revise your investments.

These five steps can help put you on the path to smart financial investing, but the bottom line is that you must take action now. You can become financially secure if you begin planning for your retirement today.

By: Charity Delich

8-09-2009

Charity Delich is a professional writer and a practicing attorney. She lives in New York City, where she's working on a master's degree in publishing at New York University.

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