Q: I’m 35, saving for retirement. Am I on the right path?

Question:

Over the last year I went from not caring at all about my retirement funds to a point of near obsession. When our union set us up in our retirement account, we were defaulted into the Vanguard Balanced Index. I just changed it to 20% Vanguard total bond market index, 40% vanguard growth index, 20% vanguard mid cap growth index, and 20% vanguard small cap value. Does this seem alright for the options we have? I’m 35 and there’s only $20K in the account currently. I plan to max out a Roth IRA starting next year and put all extra money into this work sponsored 401(k). Does this sound like a reasonable plan? (Steve Meyers from Steubenville, OH)

Answer:

Hi Steve,

Firstly, congratulations on having money in your retirement account and being obsessed by it! Further, congratulations on having money saved up for your retirement. Yes, there are people who have saved more, but there are a great many people who have saving much less as well. Shockingly, approximately 62% of Americans have saved $1,000 or less, so having a portfolio with $20,000 in it by the time your 35 is far better than more than half the population. Further, if you can put aside that much money every year, you can easily become a millionaire by the time you retire; more on that later. For now, let’s look at your portfolio makeup.

There are a great MANY varying opinions regarding what to invest in and how to allocate your investments. I am impressed and happy to see that your union offers index funds in your retirement plan. Given that the plan is administered by Vanguard, one of the leaders in index fund investing, it’s not surprising that there are very low cost index funds in your plan. These low cost passively managed index funds allow you to pay far less in fees than you would pay with managed funds. While there is a growing acceptance of index funds in 401(k) plans, it’s still not the primary option in most retirement plans. John Bogle, the 87*year old founder of Vanguard, indicated that index based products now comprise 30% of mutual funds and exchange-traded assets.

Index Funds

Just because a retirement plan offers index funds, doesn’t necessarily mean that those funds are inexpensive. There has been a bidding war for your assets by many brokers. The fees charged for S&P 500 index funds — the largest and most popular of such funds — by many brokers are minuscule. For example, brokers like Schwab, Vanguard, and Fidelity all charge less than 10 basis points; that’s 0.10% or one dollar for every $1,000 under management. While many index funds charge low fees, there are those that appear to be gouging employees. Several employers and the fund managers have come under greater scrutiny of late. New York Life Insurance and Anthem Insurance have both faced the possibility of class action lawsuits for pricing issues on such funds. Essentially, jut because your plan offers index funds, doesn’t mean you are getting a good deal. In the New York Life suit, the cost to participants of the higher fees isn’t huge in the grand scheme of things, but it’s still $3 million paid out over five years that could have plumped up retirement funds, the lawsuit estimated. Check the expenses on your plan’s fund lineup. If the fees are high, especially on the index funds, you might want to bring this to your employer’s attention.

Target Funds

Index funds aren’t the only option for investors. Many 401(k) plan participants opt for target funds. These are funds which combine various investment vehicles into one package and adjust the allocation based on the participants age. For instance, a 35 year old today might expect to retire in about 30 years. As such, those 35 year old participants might opt to invest in a target date fund based around the year 2045 — about 30 years from now. The allocation of assets among stocks and bonds shifts from a stock-heavy portfolio when you are younger to a bond-heavy portfolio as you get older.

target-funds

These types of funds are growing in popularity. As you can see from the upper chart, nearly all 401(k) plans — defined contribution plans — offer target funds as part of their fund lineup. The lower chart shows the increasing acceptance of such funds by plan participants. Today, almost 25% of participants’ balances are in target date funds. These funds are for those people who have no interest in monitoring their portfolios at all. The funds take care of everything for you, but this hands-off approach comes at a cost. These funds charge fees for the management and some of the individual fund choices might be suspect.

Managing your funds

If you are willing to make a few minor adjustments to your portfolio, I think managing the assets by yourself are a better option. I am not going to get into the specifics of your fund lineup. As I mentioned above, there are many different approaches to asset allcoation. Some people might suggest putting all your money in three funds — an S&P 500 fund or a total (USA) market fund, an international stock fund, and a bond fund. Others might suggest adding several other funds as well (i.e. real estate, small cap). Whatever lineup you select for yourself is probably reasonable provided that a large portion of your stocks allocation is in either a total stock fund or an S&P 500 fund. What next is how to allocate your money.

Asset Allocation

For people who aren’t going to closely monitor their portfolios, but are willing to do an occasional (i.e. once a year) adjustment, I might suggest the “110 – your age in stocks” approach. You subtract your age from 110 to determine how much of your portfolio would be in stocks. Since you are 35, you would have 75% of your money in stocks and 25% in bonds. (that’s 110 – 35 = 75)

This allocation allows you to have money in stocks well into your retirement years. When you turn 65, you would still have 45% of your money in stocks. Why is that important? Most people think that you should have far less than that in stocks when you retire. Many of these target funds have very small, if any, allocation to stocks after 65. To me, that’s poor planning. People are living longer. Many 65 year old still have another 25+ years to live. The Social Security Administration suggests that a 65-year old today will likely live another 19 to 22 years. (My dad made it to 94. My mom is still alive and will turn 97 this month.) So being 65 and having 45% of your money in stocks will allow a reasonable portion of your money to continue to grow. that’s important as you may need the money to last a long while, perhaps another couple of decades.

Maxing out could make you a millionaire

You mentioned that you are planning to max out your IRA and try to invest whatever you can into your 401(k) plan as well. Great planning. The earlier you start saving for retirement, and investing steadily every year, the better off you’ll be in the long run. Starting to save for your retirement at 35 might not be considered early, but it’s not late either. In fact, a 35 year old, like yourself, could fairly easily reach millionaire status by the time you are ready to retire, provided that you continue to invest as you suggested that you would.

Today, you have $20,000 in your investment account. If we assume that you can set aside another $20,00 each year, you will very likely become a millionaire. Yes, $20,000 is a big number. For many people that’s about one-third of their wages, but you might be tempted to live below your means when you see how much that $20,000 each year can grow to.

A $20,000 a year investment each year will be worth $1 million is your average annual return on your money is just 3%. If you were able to earn about 6% annually, assuming that you invest that $20,000 each year, you would have about $1.6 million when you turn 65. An 8% annual return would mean you would have $2.6 million when you retire. This is certainly something to strive for.

You asked if you were on the right path. If you continue investing $20,000 each year, that’s a total of $600,000 in invested cash over the next 30 years, you will almost certainly be a millionaire, maybe even a multi-millionaire. Yes, I’d say you are on the right path. Stay obsessed. Stay vigilant. Invest as much as you can. Your future self will thank you.

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