“Money is like gasoline during a road trip. You don’t want to run out of gas on your trip, but you’re not doing a tour of gas stations. You have to pay attention to money, but it shouldn’t be about the money.” –Tim O’Reilly
So you just got a new job, or maybe your first job ever, and one of the benefits is a 401(k) retirement plan. You’ve been trying to come up to speed, but now you’re being asked to make a bunch of complicated investment decisions that will have an impact at the end of your career—before it’s even begun. Here are 4 simple steps to get you started:
Ten years ago I embarked on my retirement savings journey by opening a Roth IRA. The research I did at the time gave me the conviction to make post-tax contributions in the present—to avoid paying taxes on the projected earnings 35-40 years in the future (while also hedging against the risk of higher taxes). It seemed like a no-brainer. Later, when I had access to a Roth 401(k) at work, I followed suit and contributed even more, rolling that balance over to my Roth IRA between jobs.
But it turns out that I fundamentally misunderstood how our progressive tax system works. In short I’ve been paying the full marginal tax rate on my contributions (25-28% Federal + 9.3% CA), but if I had put that money in a Traditional 401(k) instead, I could have avoided paying those taxes, and I would very likely have paid little to no effective tax on any future distributions (depending on my cost of living in retirement).
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I didn’t think I had anything to add beyond Scott Adams’ 9-point financial plan (which got me started on this path 10 years ago), but I did wonder whether others might benefit from keeping a yearly log of their financial decisions and plans, as I do on my blog. So I distilled Adams’ list down to what I thought were the 4 most important pieces of advice, and then added my own. Here it is:
I always expect, after recounting my financial chores from the past year, that the next will be simple and uninteresting. That all I will have to write in 12 months is, “I worked a lot and saved a little.” Instead, it seems, each year I confront new challenges, learn the details of increasingly complex financial acronyms, and continue to fine-tune my savings strategy. This, my tenth such dispatch, is no different. (You can read my first here.)
Just before my birthday I got an email that contained a retirement factoid I’d never heard before:
Fidelity suggests that by age 35, you should have at least one times (1X) your yearly income saved to meet your basic needs in retirement.
Nothing like a little extra retirement anxiety on my birthday. Thanks Fidelity!
Update: Don’t put too much stock in rules-of-thumb. A year later, Fidelity sent me an email that said:
Fidelity suggests that by age 35, you should have at least two times (2X) your yearly income saved to meet your basic needs in retirement.
It looks like they’re sticking with “2X by age 35”. Fidelity just produced a video with the following benchmarks:
Update: I’ve since learned that a far better indicator of retirement-readiness is aiming to reach a point where “your assets now equal 25-times your annual spending”. With Fidelity’s rule-of-thumb, age and salary are largely out of your control—and as your salary increases, counter-intuitively that pushes back the goalpost on retirement (because it assumes a proportional level of lifestyle inflation). Using savings and spending as the indicators puts financial independence squarely in your control. Want to retire before age 67? Reduce your spending and/or increase your saving.
But it did succeed in getting me thinking about how I measure up. If I combine both my Roth IRA and my 401(k), I’m a hair over 50% (or 0.5X) of my salary. If I also include my brokerage account (which isn’t strictly earmarked for retirement—it’s more medium-term savings), it bumps up to just over 60%. So by that yardstick, I’m coming up short. Their email obviously had the intended effect, because I increased my 401(k) contribution from 6% to 75% just in time for my final paycheck of 2014.