Last week, John shared a great post on saving for retirement. Reader Diana took the post to heart, and she left us with a heartfelt comment about getting started saving for retirement in your 40s.
I’m in a similar scenario as Sheena and was about to ask the same question. Though – ours is more serious because we are more than 10 and 18 years older. We have been putting it off for years for numerous reasons, much of it the above belief of not having enough, but this is the year we have to start socking away as much as we possibly can. The problem is, I have no idea where to start and who to trust. Years ago I lost a fairly substantial amount in my first and only attempt at working with a broker who invested too much in tech stocks. After that I got scared, and I don’t think we have a huge risk tolerance now. On the one hand we need to accumulate as much as possible because of our age and lost time to make up for, but for the same reasons we can’t afford the losses that go along with those higher risk/potentially higher gain stocks. We also want to invest in ethical, socially responsible companies not just the ones that will give the biggest return. We’re self-employed, so no 401(k). What do you suggest for people like us? I feel like you need a degree in stock picking and investing unless you are lucky enough to choose the right adviser.
That is a big gauntlet of questions, but I have answers to all of them. I’ll go through them one by one below.
Starting Saving For Retirement in Your 40s
You are not alone in this one Diana. One of the top financial regrets for most people is that they didn’t start saving early enough, and that they didn’t save enough when they started. But all hope is not lost, you just need to act today to get the ball rolling.
First, because you are only about 20 years from retirement, you have to contribute more to retirement plans to “catch up” than if you start when you are 22. But 20 years is a long time to save and build up a solid retirement fund.
First, you have to decide how much you need at retirement and work backwards. AARP has a great retirement calculator that takes you through the steps to figure out what you need and what you need to save. Bloomberg has a simple retirement calculator if you’ve already figured that part out.
Also, remember to take into account all of your current assets. You may not receive as much as current retirees, but I would say you can safely assume you will get something from social security. Because you are self-employed, you will likely be able to sell your business or keep working part-time in retirement to keep income flowing in past 65.
For me, I don’t ever want to quit working completely, I just want to save for financial freedom, where my own business can support my family and will not take full-time dedication later in life. You are already closer to my own goal than I am!
Make Saving a Priority
First, take whatever you think you can save and start today. Whether it is $10 per month or $5,000 per month, anything is better than zero. Don’t berate yourself for what you didn’t do in the past, take proactive steps to make a positive influence in your future.
Because you are self-employed, you can’t simply pick a percentage of your pay to go into a 401(k) account (we’ll get to accounts in just a minute). Instead, you should pick a fixed amount to deposit on a regular schedule, ideally aligned with when you are paid by your business.
The best strategy to start is optimistic but conservative. Try to come up with a number you can comfortably save every month to start. A higher number is always better, but don’t be discouraged if your number is as low as $10, $50, or $100.
Once you get used to contributing that much each month, raise it a little bit. Just last month I increased my own contributions by about $30 per month. Over 20 years at 5% interest, that $30 each month is worth almost $12,400.
Overcoming Past Losses
Sometimes, investment ideas don’t pay off. Taking the advice of an investment advisor during the high flying dot com boom was very common, and a lot of people lost a lot of money. It’s sad to hear about your experience, but it shouldn’t scare you away from investing forever.
In the long run, the market as a whole tends to rise. From 1970-2012, the S&P 500 index had a compound annual growth rate of nearly 10%. That’s a big gain that you can be a part of. I have had single stock picks go up or down, but over time my wider investments have always gone up.
Low Risk Tolerance
Investing with a low risk tolerance is common and understandable. Higher risk can lead to higher returns, but it can also lead to bigger swings and losses. Finding the right place for your goals (retirement), time horizon (about 20-25 years), and risk tolerance (low) will help you choose the right investments.
The best way to avoid risk is to diversify your investments. A combination of many stocks and fixed income (bond) investments will lead to the best outcome for you. It is all about avoiding keeping all of your eggs in one basket. If you only invest in one company, or one sector (like tech companies), you are at a much higher risk for losses than if you invest across many companies and many sectors.
To learn more about how the stock market really works, I suggest taking a few minutes to read my ultimate guide to the stock market.
Socially Responsible Investments
This one can be a bit trickier. Socially responsible companies often do great things for their customers, employees, and the environment. Many companies call this the triple bottom line – people, profit, and planet.
Just because a company makes a lot of money does not mean it is bad. That said, many companies with overly large focuses on the environment may not earn you as big of a return. There is always a sweet spot in the middle.
When you invest in funds across industries, you often don’t have much control over the specific companies. Bigger companies often get bigger investments. Widely held companies today include companies like Exxon and Apple. But other funds may hold companies like Whole Foods or Starbucks with well-known environmental policies.
To start, take a look at this list of the top sustainable publicly traded companies (according to the study author). There are also mutual funds focused only on sustainable companies, but the fees they charge can take a big chunk out of your profit.
For me, I trust that most companies are move more and more toward sustainability and better environmental practices. I would rather focus on the best investments for my long term success than limit myself.
Retirement Options for the Self-Employed
While setting up 401(k) accounts for your company might not be feasible, there are lots of great options to save for retirement in a tax advantaged account when you are self-employed.
I recently wrote an in-depth article on retirement plans for self-employed entrepreneurs, but will only highlight the most relevant for your situation here.
First, you can open an IRA or Roth IRA online in just a few minutes. A traditional IRA is funded with pre-tax dollars. That means at the end of the year you get a tax deduction based on the amount you contributed, but you pay taxes on money you take out at the end. A Roth IRA is funded with after-tax dollars, but you don’t pay any taxes when you withdraw during retirement. The 2013 maximum to contribute to an IRA is $5,500.
You can also look at an SEP, or Simplified Employee Pension to fund your retirement, up to 25% of your take-home pay per year, from your business funds rather than your own.
If you have maxed out these options, don’t stop. You can put the rest in a regular old investment account and don’t have to worry about waiting until retirement to withdraw without penalties.
Do You Really Need to Pay an “Expert”
No. You don’t have to pay someone to tell you what to do with your money.
The markets can be scary, but it is easy to pick a conservative strategy and administer it yourself. Those guys usually take a good chunk of your money as a fee and don’t offer much that you can’t do yourself with a little research.
What to Do Today
First and foremost, open an IRA account. For people in their 20s-30s, I always suggest a Roth IRA or Gold IRA. For people in their 50s+, I always suggest a traditional IRA. For you in the gray area in the middle, it really depends on what your likely investment returns will be compared to taxes and inflation over the next 20 years.
In your situation in particular, I think a traditional IRA would be best because you get the tax benefit this year, which you can re-invest each year moving forward. That will help compound your investments as you move forward.
Next, setup an automatic investment plan. Most finance bloggers call it “paying yourself first.” You can setup recurring, automatic investments from any brokerage account. Just set the amount you want to save each week, every other week, or month and it will take care of the transfers for you so you don’t forget.
To make life easy on yourself, I would probably pick Vanguard as a brokerage in your scenario. They offer tons of very low fee mutual funds. To get started, I would pick a target date fund, which is automatically invested by a skilled team to become more and more conservative as you get closer to retirement. You can take a look at this page for which funds might be most appropriate.
In the long run, you can always diversify out of one account. To avoid annual account fees (about $20), many Vanguard funds have a requirement of $10,000 saved. That doesn’t happen overnight, so I would just put everything into one target date account until you have at least $20,000 or more to spread among other investments, such as dividend stock funds, bond funds, and other options.
What Did I Miss?
Do you have any questions based on this post? Any suggestions for Diana that I missed? Please share your thoughts in the comments.
Image by andrefaria / flickr