Young investors have a valuable asset, yet many neglect to take advantage. “People start to focus on retirement after age 40,” says Chris Long, a financial planner in Chicago. “In their 30s, people may be more interested in spending their money.”
What asset are those 30-somethings overlooking? Their youth. The more years you invest prior to retirement, the more time you have to profit from the earnings on your investments. “If you assume a 9% annual return,” says Long, “saving $10,000 at age 32 is the same as saving $20,000 at age 40.”
Ed Fulbright, a financial consultant in Durham, North Carolina, says that your 30s are “a great time to implement a ’10/10/30′ strategy. If you save at least 10% of your income and earn 10% on your investments, you will be financially independent in 30 years or less.”
Of course, no one can be sure of earning 10% annualized returns over 30 years. If you want to be in that neighborhood, you should do most of your investing in stocks and stock funds while you’re in your 30s. Historically, long-term returns in stocks have been slightly over 10%.
Long says that people in their 30s generally should have at least 80% of their retirement investments in equities. “In stocks, you have the short-term risk of seeing your holdings fall 20%, 25%, or more,” he says. “However, if you invest too little in stocks you have the long-term risk of not accumulating enough money.”
Deborah Jordan, a financial planner with Ameriprise Financial in Williamsville, New York, says that a moderately aggressive investor might hold around 70% in equities. “People in their 30s with strong risk tolerance might have 70% to 80% in stocks,” says Fulbright. “However, most of them prefer to have closer to 60% in stocks, which will provide lower volatility.”
According to Long, a young investor with 80% to 85% in stocks is likely to accumulate twice as much money as someone with only 50% in stocks. As we’ve seen, however, stock markets can provide some nail-biting days, weeks, and even years.
The key to a successful long-term retirement plan is to keep investing in stocks or stock funds, good times or bad. This process, known as dollar cost averaging, allows you to buy when stocks are low as well as when they’re high, boosting your eventual return. Contributing to a 401(k) plan via paycheck withholding is an easy way to become a disciplined investor.
Even if you can’t maximize contributions to a 401(k) plan (in 2008, the ceiling for people in their 30s is $15,500), you should contribute at least enough to get any employer match. A 50% matching contribution, for example, enables you to earn 50% on your investment, risk-free.
What’s more, contributing just enough to get an employer match can provide an ample nest egg. “Take someone who is 30 years old with $10,000 in her 401(k),” Jordan says. “Say she contributes $250 a month-$3,000 a year-and gets a 50% employer match, for another $1,500. Say she earns 8% a year inside her 401(k). By the time she’s 65, she’ll have over $1 million in the account.”
Jordan recommends diversifying your holdings as a way to reduce short-term volatility. “If you invest though funds, about half of your stock market allocation might be in funds holding large domestic companies,” she says. “For the other half, you might spread your investments among mutual funds and exchange-traded funds (ETFs) that hold international stocks, small companies, medium-sized companies, and specialty funds such as those investing in real estate.”
To Long, low-cost broad index funds make the most sense. His picks include Vanguard Total Stock Market Index Fund (VTSMX), Vanguard Total International Stock Index Fund (VGTSX), and Vanguard REIT Index Fund (VGSIX), which invests in real estate investment trusts (REITs). As an example of their low costs, VTSMX charges only 0.15% per year. If your 401(k) does not have these funds on the menu, look for what’s available in terms of low-cost funds with many holdings.
If 60% to 80% of your portfolio is in stocks, while you’re in your 30s, then 20% to 40% will be in fixed-income investments, which provide current yield and lower risk of loss. “We like laddered CDs,” Fulbright says. That is, you might put some money into a one-year bank certificate of deposit, some into a two-year CD, etc., out to five years. As each CD matures, you’d buy a new five-year CD. Fulbright also suggests Treasury Inflation-Protected Securities (TIPS) and regular bonds with maturities no longer than seven years.
While you’re diversifying your portfolio, avoid the temptation to load up on shares of your employer’s stock, no matter how wonderful the company’s prospects seem to be. “It’s too risky to have your retirement depend on just one company,” Jordan says. From Enron to Bear Stearns, recent years have produced all too many stories of employees who regretted excess exposure to company stock.