You hear it all the time. Save for retirement!
Many financial experts -- including my favorite, Suze Orman -- tell you to contribute to a Roth IRA or traditional IRA outside of your 401(k) plan. But once people hear this advice, many draw a blank on what contributing to an IRA or Roth IRA really means.
I've spoken to dozens of people about this topic, and many seem to view a traditional or Roth IRA as a savings account that you simply deposit cash into.
But that's not the case. IRAs and Roth IRAs aren't simple deposit accounts, but rather tax-sheltered accounts designed to hold investments -- investments that you'll need to choose wisely if you want to grow your nest egg in a meaningful way.
If you open a Roth or traditional IRA account with a bank that posts a set annual return rate with the retirement account, the money is generally invested in CDs or money market accounts within the bank (which offer 1% to 2% interest yields). This works fine for older people who already have most of their retirement funds saved up and don't want to risk losing their hard-earned money.
However, if retirement is more than five years down the road and you want inflation-beating returns, you'll need to open your retirement account with a brokerage firm. Once your IRA is open, you can stocks, and REITs.it up with more aggressive instruments including
Using this guide, you could potentially start a fully diversified retirement portfolio in 20 minutes using just an online broker and $100.
Open a Retirement Account with an Online Brokerage Firm
Pick an inexpensive, online brokerage firm to open your Roth IRA or Traditional IRA. Each online broker is different, so be sure to consider all maintenance fees, trade commissions, minimum balance requirements and other fees before making your selection.
If you're starting with less than $500 to invest, consider opening a Roth IRA or Traditional IRA using an online service such as Stockpile or M1 Finance, where you can buy partial (or fractional) shares of investments. That way you can efficiently diversify your portfolio through dollar cost averaging, where you can regularly invest a small amount of money (e.g. $100 a month) at a time, instead of having to buy entire shares of an investment a time (more on that below).
If you have $500 to $1,000 to start investing, you can also look to open a retirement account at other low-cost brokers like Charles Schwab, Fidelity, Scottrade, or E*Trade which have low (or no) minimum balance requirement for retirement plans and charge commissions of less than $5 per trade (or sometimes no commission at all!).
How to Invest Money to Get Good Returns: Find the Right Portfolio Allocation
Before you start trading in your newly opened retirement account, you'll need to decide which investment mix is best for you to maximize returns and minimize risk. But remember, one portfolio allocation model does not fit all.
For some guidance, financial experts Daniel C. Goldie (CFA, CFP) and Gordon S. Murray laid out three portfolio allocation models in their book, The Investment Answer (no relation).
|Source: The Investment Answer (Book)
As you can see, the S&P 500 delivered a respectable 9.5% annualized return over the 37 year period. However, you can also see the benefits of investing outside just the S&P 500: Even the most conservative portfolio beat the S&P 500 performance over the long run.
And much to my own surprise, the most aggressive portfolio model, with all its small-cap stocks and international stocks, had a significantly lower standard deviation (had less severe ups and downs over the years) than the tried-and-true S&P 500.
If you originally invested $10,000 in one of these portfolios in 1973, it would have grown to a balance between $369,000 (Conservative Model) and $788,000 (Aggressive Model) by the end of 2009.
The authors explain this simple, yet important tenet of diversified investing: 'Focus on the performance as a whole, rather than the returns of its individual components.'
Because every investor is a different age and has a different stomach for risk tolerance, these models won't suit everyone. To develop your ideal portfolio, you should consider further reading on investment allocation or consult with a professional before you start trading.
Use These 4 ETFs to Create your Own Diversified Portfolio
The five major asset classes in Goldie and Murray's model portfolios are: U.S. stocks, foreign stocks, real estate, bonds and cash.
By investing in index-tracking ETFs that follow the first four major asset classes (your broker will hold your un-invested money as cash), you can easily create your own retirement portfolio that mimics one of the allocation models shown above, without having to buy dozens of stocks, individual , or any physical land.
Here are four inexpensive, index-tracking ETFs that cover these major asset classes:
|The Lazy Man's Retirement Portfolio of ETFs
|Source: Fund Prospectus
By using one of the allocation models shown in the last section as a rough guide (or use a financial advisor to guide you), you can invest monthly in these ETFs to build your own Lazy Man's Retirement Portfolio over time.
How to Invest in a Lazy Man's Retirement Portfolio Through Dollar Cost Averaging
So now that you have the blueprint to make your own retirement portfolio, you may be wondering how to set up your initial deposit in your new retirement plan and then regularly make deposits in your investments to keep your portfolio growing.
Here's how you'd start. Let's say you have $1,000 to invest and you're following the moderate portfolio model above. You'd invest $360 into VTI (US stocks), $300 into AGG (bonds), $180 into VXUS (international stocks), and $60 into IYR (US real estate). The remaining $100 would just sit as cash in your brokerage account.
From there, you could set up an automatic deposit through your broker to keep investing $100 (or whatever you can afford to invest) each month in those proportions so you can dollar cost average into these major asset classes while staying diversified (Again, a broker that lets you buy partial / fractional shares of stock or ETFs will make this much easier to keep your allocation percentages steady as you invest each month).
Voila, you're officially an investor! Combined to make up your simple retirement portfolio, these index-tracking ETFs offer diversification that will carry you through periods of inflation and market downturn without sacrificing performance over the long-term. Keep investing your money regularly, and it won't be long until you hit your first million.