Financial Planning For Retirement

In this set of principles in the  Investment Advice: Retirement Planning series we'll be covering dollar cost averaging versus lump sum investing,  how to use tax-deferred growth In building your retirement as well as how to set financial goals that have real chance to work!

Principle #7: Dollar Cost Averaging Versus Lump Sum Investing   

This is the seventh principle in the Investment Advice: Retirement Planning For Everyone series.

Dollar-cost averaging is a fancy term for investing small amounts of money on a consistent monthly basis, as opposed to in a large lump sum once a year or so. For instance, let’s say you invest $100 in a mutual fund that is currently selling at $10 per share. You would have bought 10 shares ($100 divided by $10 per share). Next month, the price of the fund drops to $5 per share and you invest $100 again, this time buying 20 shares. In the third month, the fund price increases from $5 per share to $7.50. You invest another $100, this time buying 13.3 shares. 

If you total your shares for the three months, you would find that you have 43.3 shares. If you then multiply the 43.3 shares by the latest fund price of $7.50, you would find that your account is now worth about $324.75. That’s $24.75 more than you invested — even though the share price is still below the original starting price of $10.   Another great benefit of dollar-cost averaging is that many mutual fund companies will waive their required minimums for investors who set up automatic contribution plans.

Keep in mind that dollar-cost averaging does not protect against losses in declining markets. If all the market does is go down, it really doesn’t matter how often or when you invest, you’re going to lose money.

There’s another school of thought regarding how to invest: lump sum investing. As the name implies, you put the entire amount in at one time. If you had $10,000 to invest, instead of dollar-cost averaging it into the market every month over a year or two, you would invest the entire $10,000 at once. The reasoning is, if you think the market will be higher over time, why not put all of your money to work for you immediately? If the reason we’re all investing in the first place is to make money and if we expect the market to be higher over the years, (even taking into account all of the ups and downs), then this approach certainly makes some sense, too.

There are a few reasons, however, why I believe most people would be better off dollar-cost averaging their investment monies. First, many people don’t have a lump sum to invest. (That’s a big roadblock to lump sum investing.) What they do have is a certain amount of money from their paycheck to invest monthly. Second, if you put a lump sum into the market right before the market has a big correction (a correction is when the market drops to better align stock prices with their earnings) and see 20-30 percent or more of your investment erode almost immediately, you might be psychologically unable to deal with it. You might want to take out all your money, which is almost always a bad move. That would just cause you to lock in whatever losses you just suffered.

Third, if you were dollar-cost averaging a lump sum and the market did correct, you would have the option of putting a lump sum in at that time and buying at a much lower — and therefore better — price. Both lump sum investing and dollar-cost averaging have merits, so you need to decide which is best for you.

Principle #8: Using Tax-Deferred Growth In Planning Your Retirement   

This is the eighth principle in the Investment Advice: Retirement Planning For Everyone series.

Usually, investing the maximum amount of your earned income allowed into a retirement account, such as an IRA (Individual Retirement Account), 401(k) or any other tax-deferred plan is an excellent move. This should be money, however, that won’t be needed in the near future and can be invested for a long time. This is because most of these programs penalize you for money you withdraw before age 59½.

Keep in mind that an IRA can take the form of many different types of investment vehicles, such as a savings account, CDs and, of course, mutual funds. There is no difference between investing in a regular mutual fund account or in a mutual fund as an IRA, except how the government views it for tax purposes.

Just so we’re clear, tax-deferred means that, you don’t have to pay tax on any of the capital gains and/or dividends you earn during the years your investment is growing. The taxes are paid when you begin withdrawing the money.

As an example, let’s say you were going to invest $2,000 per year for 40 years and you were able to average 10 percent annual interest during that time. (I used $2,000 in these examples, but you can contribute more if you choose, subject to IRA contribution limits.) If you were in the 28 percent tax bracket, your investment in a taxable account (one in which you had to pay taxes annually on your gains) would total approximately $450,000.

That same exact investment in a tax-deferred account would total approximately 973,000 — more than double! Now let’s say you could do a little better on your investment, this time earning 12 percent. You would still invest $2,000 over 40 years. Now your taxable account would total almost $667,000 and your tax-deferred account would be over $1,700,000. That’s an extra million dollars!

Another option is the Roth IRA, named after Senator William Roth who invented it. It’s the retirement vehicle of choice for many people who don’t have employee-sponsored plans. In a Roth IRA, you invest with after-tax dollars, as opposed to a traditional IRA, in which you usually invest with pre-tax contributions (meaning you get to deduct them from your income that year).

Since your contributions in a Roth IRA are made with after-tax dollars, (meaning you did not get a tax-deduction for them) the government allows your money to grow tax-free! (Assuming all the guidelines have been met) This obviously means a lot more money for you.

Be sure to check with your financial advisor and your accountant when deciding which type of retirement account is right for you. Once you find out which program is best for you, let the government begin helping you to build your nest egg through reduced taxes.

Principle #9: Setting Your Financial Goals   

This is the ninth principle in the Investment Advice: Retirement Planning For Everyone series.

All goals, including financial goals, must be envisioned. You must know exactly what you want, because if you don’t, how will you ever attain it?

Have a passionate desire to achieve your goals. If your attitude towards building financial independence for you and your family is, “It would be nice,” you should probably forget it. You must have desire as well as discipline, because it will take that to become knowledgeable and follow through in the many areas discussed in these posts

Now, make sure your goals are well defined and measurable. As an example, you shouldn’t have, “become wealthy” as a goal because it’s not measurable. If you say you want a million dollars in 35 years when you retire, however, that’s measurable.

Short and intermediate financial goals will be required to get you where you want to go. If you want a million dollars in 35 years, start by breaking down what you think you will need 15 years from now and 5 years from now to be on that pace. Then, decide what you need to invest today to reach those goals and track your progress.

Next, for goals to have a chance to work in your life, you have got to write them down.

And, if you don’t have a winning attitude, develop one! I believe you have to believe. Many people I speak with can’t really see themselves becoming financially successful, so they aren’t. You must believe you will become wealthy. Having a positive attitude toward wealth building is one of your most important allies.

Life is meant to be a self-fulfilling prophecy, meaning it will turn out pretty much the way you see it turning out. This is why I believe life will give you what you will accept. So, accept nothing less than the best. Resolve to be in charge of your own future. Don’t let procrastination, lack of direction or the opinions of others prevent you from achieving financial success.

I can’t promise that reaching your goal of acquiring financial wealth will be easy,  just that it will be worth it. Don’t wait for the right time to start, or you never will. It’s been said that knowledge is power. I believe knowledge is power only if you do something with it. The road to financial wealth is paved with uncertainty and has many turns and pitfalls. If you have read all the posts and you now have a road map that you can use to begin making your plan and getting the additional knowledge you need to succeed. 

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Disclaimer:

In an attempt to provide the reader with accurate information, material has been obtained from sources believed to be reliable; however, the accuracy and completeness, and the opinions based thereon, are not, cannot and will not be guaranteed.

All examples in this text are hypothetical. Any negative statements or criticisms of individuals or organizations is unintentional. The information contained in this text represents the opinion of the author and is to be accepted as opinion only. It is not intended to provide legal, accounting or financial advice for individual readers.

Each individual's financial needs are different. This text is not meant to be utilized as a substitute for a sound financial plan. An individual financial plan should be developed only after consultation with a qualified professional.

In this set of principles in the Investment Advice: Retirement Planning series we'll be covering dollar cost averaging versus lump sum investing, how to use tax-deferred growth In building your retirement as well as how to set financial goals that have real chance to work!