What is the best way to save for the future outside of a work retirement plan?
I am 27 years old and have finally worked myself into a well-paying job. I want to make the most of it by setting myself up for success down the road. I am currently investing into my thrift savings plan (TSP) once a month with the drill paycheck I receive for being in the National Guard and I also will be joining my company's retirement plan.
Other than these two methods of saving that I am currently contributing to, what is the best way for me to save for the future? I don't want to put all of my money into a standard savings account which will not grow much over time. Should I consider online savings accounts with higher interest rates? I am also intrigued by dollar-cost averaging. Should I consider index funds?
Thank you for your question and congratulations on being so forward looking. At age 27 you have about three decades of saving and investing before retirement. Your future is in your hands in more ways than you may know. For example, by the time you retire the Social Security Trust Fund may well be exhausted and your benefits may be a lot lower than current retirees.
You should put as much as you can into your TSP and participate in your company’s retirement plans, which probably includes either a regular 401(k) or a Roth 401(k) plan. At your age I would consider contributing to a Roth plan. A Roth plan does not give you an immediate tax benefit, but when you retire you can get your money out tax free, and meanwhile your money grows tax free.
You should try to save about 15% of your income for retirement. You should first create an emergency fund that can be used for unexpected expenses. You may be surprised to learn that four in ten people in this country can’t afford a $400 emergency without borrowing. An emergency fund equal to 6 months of your net income should be adequate.
After funding your TSP and 401(k) plans you should open an investment account with a discount broker. Fund it with extra savings beyond what put in your tax-free accounts. Keep in mind that tax free accounts like IRAs, TSPs and 401(k) plans are not readily accessible without taxes or penalties. Over the next few decades you will need money for things such as a home purchase, weddings, children, vacations, etc. That's why taxable accounts come in handy, as well as providing liquidity when you first retire.
Based on your question I am assuming that you are not an experienced investor; few people your age are. In fact, most people of any age are poor investors. I suggest you shop around for a good fee-only financial advisor who is willing to spend time teaching you the basics of investment management. He will charge you a fee, but it will be well worth it because learning by making mistakes is a lot more expensive.
Good luck and give me a call if you need more advice.-
Congratulations, you are on your way already for financial independence. I always recommend you build your savings account at your bank up to an amount equal to 3 months worth of living expenses. After that, you may consider getting with a Registered Investment Adviser and getting a financial plan and start a wealth management account.
I would encourage you seek out a “Fee only” independent Registered Investment Adviser (RIA). RIA’s are fiduciaries and will have your best interest at heart. Find one who is a Certified Financial Planner professional ™ (CFP®). You can find advisers at the following websites:
National Association of Personal Financial Advisors - https://www.napfa.org/financial-planning/how-to-find-an-advisor
Financial Planners Association - http://www.plannersearch.org/
XY Planning Network - https://www.xyplanningnetwork.com/
Great questions. If you're already contributing a solid amount to retirement accounts you may consider just opening a taxable/brokerage account. Unlike a retirement account, which is tax-advantage in the sense it grows either tax-free or tax-deferred, brokerage accounts have to pay taxes when you realize gains. The downside is it inevitably results in a lower balance when compared to the same investment strategy as a retirement account. However, you can access the funds sooner (before 59 1/2) without paying a 10% penalty. This is advantageous because it means you can invest in other goals outside of retirement.
A high yield savings account is useful for hosting your "emergency fund", a buffer for any unexpected expenses. Typically we recommend 3-6 months worth of living expenses in an emergency fund. However, as a long term investment, savings accounts shouldn't be used.
Dollar-cost averaging is a great way to invest. Setting up automatic contributions once per month to your retirement accounts, or brokerage accounts are all examples of dollar cost averaging. It forces you to buy less shares when prices are high and more shares when prices are low. Which can be hard to do when you input human emotion into the equation. Anything to take the emotional side out of investing is a plus. Index funds or ETF's are great for this strategy because they're low cost, which has proven to over long periods of time to outperform their active counterparts simply due to the fees they charge.
At age 27 you should not be investing to earn interest. You should be investing for growth. The first thing you should do is set up regular 401K contributions. These are pretax dollars and are often matched with contributions from your company. You can deposit $18,000 per year and while that might be a lot for you now, do the most you can and get into the habit.
If your well-paying job allows you to put away more than that, by all means do so -- into a regular (taxable) investment account. Keep in mind that 401Ks are designed for retirement only, so they can be difficult and costly to tap in an emergency. You should have other savings -- just please don't keep it in cash.
Put your nest egg into good-quality equity funds. Equities will fluctuate in value and everyone gets scared of that, but don't let volatility scare you away. Keep in mind that you are saving money for a time 40 years in the future. If the market declines you will be able to buy more shares with the same money. That will pay off, eventually. You can't earn a good return on an interest-bearing account (even online) so don't hold any more cash than you absolutely have to (2-3 months' expenses at most).
That's a good question and it's great that you're taking your retirement seriously now. As you know the thrift savings plan works very similar to a 401(k) which it sounds like you will also have access to at your company. A couple of thoughts here for you.
1) You are certainly allowed to contribute to both the thrift savings plan and the 401(k), but you're limited to $18,500 in your personal contributions. That includes both accounts combined. If your company offers a match then certainly contribute enough to get the full match, but after that consider where to put the remaining contribution. If you work for a large company of more than 100 employees then the cost is probably fairly reasonable. If it's a small company then check out your fund expenses and compare them to the expenses in your thrift savings plan. If it's a small company and the employer isn't picking up the tab then there may be high fees and you'd be better off contributing more to the thrift savings plan.
2) By contributing to these plans then you are already taking advantage of dollar cost averaging, and I would certainly consider index funds given your age. Right now risk is your friend, and if the market drops it's to your advantage. A market drop would allow you to buy more shares at a cheaper price and that's all good news for you.
I utilize an online savings account for my 6 - 9 month emergency account. I keep a small amount at a regular bank savings account so it's accessible, but the rest is online getting around 1.5% annually. That's a great idea and I'd encourage you to do that.
If you want to invest excess cash, but don't want to lock it up until you're 59 1/2 then consider opening a Roth IRA. Someone previously mentioned a taxable account, but that should be the last bucket you fill. Contributions can be withdrawn in a Roth IRA at any time so it's important you track them. If you withdraw earnings then you get hit with a 10% early distribution, but you can always access your own contributions. Again I'd consider index funds or ETFs. If you're going to dollar cost average in then make sure the ETFs don't have transaction fees. Many custodians offer a wide list of transaction free ETFs.
Good luck to you and please let me know if I can be of help,
Matt Ahrens, CIMA®