Guest Author Blog: "Investment Advice You’re Not Getting: How to Boost Your Inadequate 401(k) Savings by Jane White, author of "AMERICA WELCOME TO THE POORHOUSE What You Must Do to Protect Your Financial Future and the Reform We Need."
2011 is the year that the first wave of Baby Boomers turn 65, the age when they expect to retire but the vast majority of them can’t afford to. Why? The shortfall is NOT due to the stock market but the measly employer contribution rate to your account—typically equal to no more than 3% of your pay.
Here’s the formula for how much you need to have saved by the time you reach retirement: 10 times your “final pay” or salary at retirement. So if you’re earning $65,000 when you’re 65—the median salary for that age group—your total savings should be $650,000.
Unfortunately, fewer than one-tenth of Americans have account balances greater than $200,000. The result: most of the 38 million Boomers who are scheduled to retire between 2011 and 2020 will need to stay on the job another eight to 10 years to save enough.
In contrast, Australians between the ages of 30-34 are projected to have more than $540,000 in their version of our 401(k) accounts; those age 20-24 will have nearly $700,000. The reason: virtually all Australian companies are required to contribute the equivalent of 9% of pay to employee accounts.
What’s the solution?
1. Both spouses should work and save at least 10 % of your salaries
If you’re part of a married couple, both of you will have to work and one spouse will probably have to save most of his or her paycheck. Needless to say, both of you should contribute the maximum to your 401(k) accounts along with saving outside of the plan.
As I testified before the Department of Labor in 2007, even the tiny minority of participants who start contributing to their accounts at age 25 must save 10% of their salary to build an adequate nest egg by age 65. The longer the participant postpones starting to contribute, the greater the required contribution. For example, waiting until age 35 increases the contribution rate to more than 17% and waiting until age 40 increases it to more than 23% of pay.
2. For the most part, most of your 401(k) investments should be in stocks, especially if you are 20-30 years from retirement.
For some strange reason, people who are not “risk tolerant” are advised to stay out of stocks. What’s more, economics professor Larry Kotlikoff has created software advising people to avoid stocks, telling the New York Timesthat “investing in the market (is) like going to the casino with…money you are prepared to lose.” This is irresponsible nonsense. For most of your life, most of your money should be in stocks; on average, you will double your money every seven or eight years. On the other hand, bonds and money market funds perform poorly because the issuer of the investments “controls the coupon” and inflation can devour these returns. For example, if your money market fund pays 2% in interest and the inflation rate is 3%, you’re losing money.
3: Reduce costs and improve returns by investing in index funds versus managed funds.
You know how prescription drugs often cost an arm and a leg but the generic version is much cheaper? I would describe the S&P 500, which encompasses the 500 American companies with the greatest market value, as the “generic equivalent” of a mutual fund investing in large companies.
4: Choose a target-date fund that invests in index funds.
Target date funds are set up to shift your asset allocation away from stocks and toward fixed-income investments as you get closer to retirement when it’s a good idea to reduce your stock holdings to reduce the risk of loss. Needless to say, if your employer offers an S&P 500 target date index fund, that’s your best choice.
5: If your employer offers a target date index fund that invests in international stocks, go for it.
Although many Americans wear jeans sewn in China, drink coffee whose beans hail from Brazil and drive Japanese cars, only one-third of 401(k) participants invest in international funds. Not only are two-thirds of the largest publicly held companies based overseas but going global will improve your investment returns. For example, while Vanguard’s S&P 500 fund’s10 year return was a measly 1.4% in 2010, its global equity fundreturned a healthy 7.19% over the same period.
6. Get Congress to hold hearings on improving 401(k) plans.
Go to my web site and cut and paste the URL to the link on the top of the page, “Stop the 401(k) Nightmare,” and send it to your Congressperson.
This Guest Author Blog was written by: Jane White, author of "AMERICA WELCOME TO THE POORHOUSE What You Must Do to Protect Your Financial Future and the Reform We Need."