Employer-sponsored plans, such as 401(k) and profit sharing plans, are convenient, easy-to-use retirement savings vehicles. You select the deferral or contribution amount and it is deposited straight into the plan by your employer. Out of sight, out of mind! Contributing from your payroll also lets you pay less taxes. The amount you defer is not subject to federal income taxes—giving you more money to invest. With the 2018 maximum deferral limit of $18,500 (plus $6,000 for employees aged 50 and over) per year, 401(k) plans allow you to save much more than is permitted in an Individual Retirement Account (IRA).
Another advantage is a potential employer contribution. If your employer offers a matching contribution, you receive free company contributions into your 401(k) just by contributing your own dollars. Typical matching contributions are 25 or 50 percent of deferrals—where else are you guaranteed a 25 or 50 percent rate of return? Group retirement plans also have investment buying power—allowing the use of lower cost or institutional mutual funds. You may also have access to an advisor for education and guidance.
With the numerous retirement plan benefits, it is surprising so many employees fall short of their goals. One reason is lack of participation. The 2016 PLANSPONSOR Defined Contribution Survey found only 78.5 percent of eligible employees participate in their employer-sponsored plan—and many wait several years to join the plan. Delaying can significantly reduce your retirement income. For example, Joe starts a retirement plan at 25 and contributes $100/month until retirement at 65. He contributed a total of $48,000, and with an annual rate of return of 8 percent, has an ending account value of almost $350,000. Jane waits to save until 35. She contributes $100/month until retirement at 65 for total contributions of $36,000. With the same assumed annual rate of return of 8 percent, the ending value is only $150,000. That is a decrease of $200,000 of retirement income from missing 10 years—or $12,000—of contributions!
Another reason participants fall short of retirement goals is by not maintaining a long-term focus on investing. By letting emotions drive investment decisions, investors can be their own worst enemy. A recent study by DALBAR, a financial research firm, found on average, most stock and bond investors underperform the general market by a significant margin over time. One of the main reasons for the underperformance is investors tend to invest when they feel most comfortable—and sell when they feel most fearful. Emotional investing is costly. According to DALBAR’s study, over the 20-year period from 1996 to 2016, the average stock investor produced an average annual return of 4.79 percent, while the annual return on the S&P 500 over that same time period was 7.68 percent. If the average investor stayed fully invested, the results would likely be more in line with the S&P 500. A hypothetical $100,000 investment in the S&P 500 would have generated $184,323 more money than compared to the average investor’s return over that 20-year time period. By developing a long-term financial plan of saving, investing—and sticking to it—you can see through the daily market noise, stay focused and reach your retirement goals.
Lastly, although investing can be intimidating, it has never been easier to get started or to find a strategy that is right for you. Many retirement plans offer target-date funds based on your targeted retirement date. For many investors, the ultimate appeal is the ease with which you can make appropriate investment decisions. Simply choose the fund named for the year that most closely coincides with your expected retirement date. From there, the investment decisions are handled for you, such as selecting the asset allocation and rebalancing the portfolio so the risk is in-line with your retirement date.
The sooner you begin saving for retirement, the better. Even modest savings can add up over time. If you already contribute, consider increasing your contributions by 1 percent or even $20 per pay. It can add up to significant savings over time. And finally, maintain a long-term focus when investing for retirement. Studies show the detrimental effect short-term trading and pulling in and out of the market can have on your return. Remember, your retirement savings need to last 10, 20 or even 30 years, so maintain a long-term outlook.
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