How do you become retirement-ready without breaking the bank or making unrealistic goals? Retirement-readiness refers to an individual's ability to accumulate enough savings to properly sustain and provide an income stream that will last throughout your retirement years, which is now estimated to be 20 years or longer by the Employee Benefit Research Institute. Retirement-readiness is the single most important metric to track as individuals accumulate savings throughout their working years. It makes sense, right? Let's face it. It's not very important for a 39-year-old that the Standard & Poor's 500 returned a staggering 32 percent return last year.
In fact, during the accumulation phase, it may be more beneficial to accumulate savings in a flat to slightly down market. However, in my career as a 401(k) consultant, I've spoken to thousands of participants and realize that many of the shortfalls of the 401(k) system could easily be overcome by simple actions that can be taken today by the participant. I won't delve into a discussion about the shortfall of the current retirement plan system in the U.S., but focus on actions people can take today. For now, it is far easier for you to take these simple steps to properly accumulate savings and move toward retirement-readiness.
1. Have a savings rate of 15 percent of your household income. The single most important factor of future success in retirement is the total amount that you put away for that goal. However, I realize that for many, 15 percent is a difficult savings rate and it may be better to work toward that amount over a period of several years. Many of the major 401(k) providers, such as Fidelity, Vanguard and T. Rowe Price, have automatic savings increase features that allow an individual to increase their savings rate by 1 percent, 2 percent or 3 percent per year until you reach 15 percent. If this feature is not available in your plan, why not make a habit of increasing your savings rate by 1 percent to 2 percent per year, manually, on your birthday, until you are putting away 15 percent of your household income?
If you are ready to jump in today and make the commitment to a 15 percent contribution, you may want to see how your paycheck will be affected on an after-tax basis and reference the Charles Schwab's take-home pay calculator. Using the calculator, you can see that an individual who makes $60,000, contributes 15 percent and has a 25 percent tax rate, would contribute $375 to their 401(k) plan on a semi-monthly basis, but only realize a $281 reduction in their take home pay. Of course, any matching contributions that are provided by your employer would decrease the burden on you to provide the full 15 percent amount.
2. Consider the length of time that you contribute to your retirement account. During the course of an individual's working career, you will likely experience multiple bull markets and recessions, so it is vitally important that you can save your money in tax-advantaged accounts, such as 401(k)s and IRAs, over a long period of time. There is no better time to start than right now. My recommendation is that your savings horizon needs to be at least 20 to 25 years to be properly retirement-ready. Although it is best to start savings in your early to mid 20s, an individual that starts at age 50 can still save for two decades of savings and be retirement-ready by age 70. As John Bogle, founder of The Vanguard Group, says about investing, "Time is your friend; impulse is your enemy."
3. Make sure that you are properly diversified within your 401(k) and other retirement savings accounts. My colleagues and I are big advocates of target-date funds from the major, low-cost investment firms such as T. Rowe Price, Fidelity, Vanguard and the index-based target-date funds from BlackRock. These specialized mutual funds, which now have collective assets of over $500 billion, take the burden of being a professional portfolio manager off of the backs of the average individual investor, and use age as the objective measure to determine the appropriate portfolio mix for individuals that have a target-retirement age, most likely between 65 to 72 years of age.
According to Morningstar's 2013 "Target-Date Series Research Paper," an analysis of the average industry glide path (which refers to the shift in the allocation between stocks, bonds and cash) for target-date funds, found target-date funds will meet most retirees' spending needs throughout retirement. In addition, the same Morningstar report indicates that fees continue to fall for all target-date series. Vanguard offers a passive, index-based lineup of target-date funds that range from 0.19 percent to 0.23 percent in expense ratio, while T. Rowe Price offers an actively managed suite of target-date funds that range from 0.57 percent to 0.78 percent.
So, let's recap the three action items that can be taken today to help you on your path to retirement-readiness: Get to a 15 percent of household income savings rate, maintain that rate for a period of 20 to 25 years, and properly diversify your account according to your years until retirement. The beauty of these steps is that they can all be taken today if you pause and take the time to set up a plan.
Henry Yoshida is a Principal of The Maresh Yoshida 401k Group, a nationally recognized retirement plan consulting firm in Austin, Texas. Henry is a regular speaker and contributor at several leading financial services industry conferences. You can find him on Twitter at @henryyoshida.
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