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How to Start Retirement Savings in Your 40s

Last week, John shared a great post on saving for retirement. Reader Diana took the post to heart, and she left us with a heartfelt comment about getting started saving for retirement in your 40s.

I’m in a similar scenario as Sheena and was about to ask the same question. Though – ours is more serious because we are more than 10 and 18 years older. We have been putting it off for years for numerous reasons, much of it the above belief of not having enough, but this is the year we have to start socking away as much as we possibly can. The problem is, I have no idea where to start and who to trust. Years ago I lost a fairly substantial amount in my first and only attempt at working with a broker who invested too much in tech stocks. After that I got scared, and I don’t think we have a huge risk tolerance now. On the one hand we need to accumulate as much as possible because of our age and lost time to make up for, but for the same reasons we can’t afford the losses that go along with those higher risk/potentially higher gain stocks. We also want to invest in ethical, socially responsible companies not just the ones that will give the biggest return. We’re self-employed, so no 401(k). What do you suggest for people like us? I feel like you need a degree in stock picking and investing unless you are lucky enough to choose the right adviser.

That is a big gauntlet of questions, but I have answers to all of them. I’ll go through them one by one below.

Starting Saving For Retirement in Your 40s

You are not alone in this one Diana. One of the top financial regrets for most people is that they didn’t start saving early enough, and that they didn’t save enough when they started. But all hope is not lost, you just need to act today to get the ball rolling.

First, because you are only about 20 years from retirement, you have to contribute more to retirement plans to “catch up” than if you start when you are 22. But 20 years is a long time to save and build up a solid retirement fund.

First, you have to decide how much you need at retirement and work backwards. AARP has a great retirement calculator that takes you through the steps to figure out what you need and what you need to save. Bloomberg has a simple retirement calculator if you’ve already figured that part out.

Also, remember to take into account all of your current assets. You may not receive as much as current retirees, but I would say you can safely assume you will get something from social security. Because you are self-employed, you will likely be able to sell your business or keep working part-time in retirement to keep income flowing in past 65.

For me, I don’t ever want to quit working completely, I just want to save for financial freedom, where my own business can support my family and will not take full-time dedication later in life. You are already closer to my own goal than I am!

Make Saving a Priority

First, take whatever you think you can save and start today. Whether it is $10 per month or $5,000 per month, anything is better than zero. Don’t berate yourself for what you didn’t do in the past, take proactive steps to make a positive influence in your future.

Because you are self-employed, you can’t simply pick a percentage of your pay to go into a 401(k) account (we’ll get to accounts in just a minute). Instead, you should pick a fixed amount to deposit on a regular schedule, ideally aligned with when you are paid by your business.

The best strategy to start is optimistic but conservative. Try to come up with a number you can comfortably save every month to start. A higher number is always better, but don’t be discouraged if your number is as low as $10, $50, or $100.

Once you get used to contributing that much each month, raise it a little bit. Just last month I increased my own contributions by about $30 per month. Over 20 years at 5% interest, that $30 each month is worth almost $12,400.

Overcoming Past Losses

Sometimes, investment ideas don’t pay off. Taking the advice of an investment advisor during the high flying dot com boom was very common, and a lot of people lost a lot of money. It’s sad to hear about your experience, but it shouldn’t scare you away from investing forever.

In the long run, the market as a whole tends to rise. From 1970-2012, the S&P 500 index had a compound annual growth rate of nearly 10%. That’s a big gain that you can be a part of. I have had single stock picks go up or down, but over time my wider investments have always gone up.

Low Risk Tolerance

Investing with a low risk tolerance is common and understandable. Higher risk can lead to higher returns, but it can also lead to bigger swings and losses. Finding the right place for your goals (retirement), time horizon (about 20-25 years), and risk tolerance (low) will help you choose the right investments.

The best way to avoid risk is to diversify your investments. A combination of many stocks and fixed income (bond) investments will lead to the best outcome for you. It is all about avoiding keeping all of your eggs in one basket. If you only invest in one company, or one sector (like tech companies), you are at a much higher risk for losses than if you invest across many companies and many sectors.

To learn more about how the stock market really works, I suggest taking a few minutes to read my ultimate guide to the stock market.

Socially Responsible Investments

This one can be a bit trickier. Socially responsible companies often do great things for their customers, employees, and the environment. Many companies call this the triple bottom line – people, profit, and planet.

Just because a company makes a lot of money does not mean it is bad. That said, many companies with overly large focuses on the environment may not earn you as big of a return. There is always a sweet spot in the middle.

When you invest in funds across industries, you often don’t have much control over the specific companies. Bigger companies often get bigger investments. Widely held companies today include companies like Exxon and Apple. But other funds may hold companies like Whole Foods or Starbucks with well-known environmental policies.

To start, take a look at this list of the top sustainable publicly traded companies (according to the study author). There are also mutual funds focused only on sustainable companies, but the fees they charge can take a big chunk out of your profit.

For me, I trust that most companies are move more and more toward sustainability and better environmental practices. I would rather focus on the best investments for my long term success than limit myself.

Retirement Options for the Self-Employed

While setting up 401(k) accounts for your company might not be feasible, there are lots of great options to save for retirement in a tax advantaged account when you are self-employed.

I recently wrote an in-depth article on retirement plans for self-employed entrepreneurs, but will only highlight the most relevant for your situation here.

First, you can open an IRA or Roth IRA online in just a few minutes. A traditional IRA is funded with pre-tax dollars. That means at the end of the year you get a tax deduction based on the amount you contributed, but you pay taxes on money you take out at the end. A Roth IRA is funded with after-tax dollars, but you don’t pay any taxes when you withdraw during retirement. The 2013 maximum to contribute to an IRA is $5,500.

You can also look at an SEP, or Simplified Employee Pension to fund your retirement, up to 25% of your take-home pay per year, from your business funds rather than your own.

If you have maxed out these options, don’t stop. You can put the rest in a regular old investment account and don’t have to worry about waiting until retirement to withdraw without penalties.

Do You Really Need to Pay an “Expert”

No. You don’t have to pay someone to tell you what to do with your money.

The markets can be scary, but it is easy to pick a conservative strategy and administer it yourself. Those guys usually take a good chunk of your money as a fee and don’t offer much that you can’t do yourself with a little research.

What to Do Today

First and foremost, open an IRA account. For people in their 20s-30s, I always suggest a Roth IRA or Gold IRA. For people in their 50s+, I always suggest a traditional IRA. For you in the gray area in the middle, it really depends on what your likely investment returns will be compared to taxes and inflation over the next 20 years.

In your situation in particular, I think a traditional IRA would be best because you get the tax benefit this year, which you can re-invest each year moving forward. That will help compound your investments as you move forward.

Next, setup an automatic investment plan. Most finance bloggers call it “paying yourself first.” You can setup recurring, automatic investments from any brokerage account. Just set the amount you want to save each week, every other week, or month and it will take care of the transfers for you so you don’t forget.

To make life easy on yourself, I would probably pick Vanguard as a brokerage in your scenario. They offer tons of very low fee mutual funds. To get started, I would pick a target date fund, which is automatically invested by a skilled team to become more and more conservative as you get closer to retirement. You can take a look at this page for which funds might be most appropriate.

In the long run, you can always diversify out of one account. To avoid annual account fees (about $20), many Vanguard funds have a requirement of $10,000 saved. That doesn’t happen overnight, so I would just put everything into one target date account until you have at least $20,000 or more to spread among other investments, such as dividend stock funds, bond funds, and other options.

What Did I Miss?

Do you have any questions based on this post? Any suggestions for Diana that I missed? Please share your thoughts in the comments.

Image by andrefaria / flickr

Comments

    • Eric says

      It is much harder to get there when you start later, but you can still certainly possible. It just takes focus and dedication.

  1. says

    it has to be top priority indeed. I like index funds if you don’t want to pay an adviser, and since you have 15 or so productive years ahead you should try to find ways to make extra money, and put all that extra towards retirement. A second job, rent a room if your kids are off to college, etc.

  2. says

    Great tips. The biggest key is to just start saving. By making it a habit, regardless of the amount at first, you will not have to think about saving each month, it will just be habit. Then you can start increasing the amount to save more and more.

    • Eric says

      Great advice. Making saving a habit makes it so much easier to put money away for anything. Long term goals can feel daunting, but doing a little bit at a time it become possible.

  3. Thomas | Your Daily Finance says

    Great job at answering all of her questions! I use to get his alot when I worked in investments. Couples with 50-100k in there 60s and they want to know whats the best thing to do with there retirement savings. Its hard because they want the great returns but little risk. Those two just dont really go together. Starting at 40 is better then not starting at all and you have to learn from the past not hold on to it. That investor lost you money though its hard you have to move on.

    • Eric says

      Only $100k in your 60s is a much tougher spot. Starting in your 40s you still have about 20 years of savings ahead. In your 60s you are pretty much stuck.

  4. Diana says

    Thanks for this, and for notifying me of the article by e-mail, it’s much appreciated. It’s still very overwhelming, but I’m going ask around among our friends what they are doing, as well. I’m the one in my mid-40’s, my husband is 9 years older, so we really are up a creek, here. When we were making more money about 8-10 years ago at the time we bought our home, we were dumping literally all of our extra cash into our house trying to pay it off as soon as possible, planning to aggressively save the same amount plus our mortgage payment after that, thinking it was smart to get out from under all that interest, and that it would be a good investment since real estate had such a strong track record. Of course, it’s all gone, and we’re pretty significantly underwater on the mortgage. This is where I start doubting the advice about the stock market tending to generally rise, because we all thought that about housing, and I feel like we got burned again by buying into the conventional wisdom. Then there were a lot of people that accumulated a nice retirement through the stock market and sustained significant losses during the crash when they needed it most, well into their golden years. Without time on their side, their retirements probably look very different, now. So you see why this makes me pretty nervous, it’s like it’s been nothing but bad timing and the wrong decisions when we thought we were finally doing something right.

    I’ll check out all your links, I know we can be disciplined about saving (we are scared enough to do so), but we have been putting off the learning curve on how to do self-directed investments because we both find it so over our heads and are already squeezed for time. I can’t possibly work longer hours than I already am, I’ve been killing myself for years in that department and I’m actually cutting back some to try to preserve my health, but we’ve been living lean for awhile now and still looking for ways to save, so I’m also looking for ways to increase my income without adding a ton of extra hours and labor. I’m reasonably resourceful and have the entrepreneurial spirit, we have several little independent businesses going that are totally unrelated to each other, so I think we’ll ultimately be OK. I feel like that flexibility gives me more options in a down economy.

    Do you think it would be at all wise to hire a financial adviser? One that we would pay a flat rate vs. someone who earns a percentage or has a vested interest in what investments we choose?

    Thank you again for your help. I wish I knew someone like you in my 20s that could have set me straight. ;)

    • AJ says

      Diane, I’m no expert – just starting out, actually. But I have noticed that your concerns are the same concerns that I have, as (I think) do all investors. The great news for you is that you have your business and side businesses that can carry you through into retirement (with any luck and what is clearly a very strong entrepreneurial skill.) You also have your husband to share the saving and investing responsibilities and believe it or not, quite a bit of time to see growth in what you do manage sock away in the next few years. I can imagine that having been burned in the past you might be reluctant, but you’ve learned from the past and know what to look for now, go with your gut and keep at it. It sounds like you’re doing all the right things now.

    • Eric says

      Conventional wisdom can often bite us. The difference between the S&P 500 and real estate is clear in the numbers though. Over the last 50 years, the S&P 500 had a compound annual growth rate around 10%. That gives me the confidence to invest in a diverse portfolio without too much worry.

      Even in your 50s, investing in a target date fund is probably the best bet. Those types of funds slowly move you away from stocks and into less volatile investments like fixed income securities (bonds). Even if someone in their retirement lost a lot of value in the 2008 downturn, it has now come back plus more.

      I personally wouldn’t recommend a paid advisor. I get one for free, though much less involved in my day-to-day investments, from Schwab just by having an account there. With Vanguard, you get a lot of great value for free too, and I think that is the best place for you to get started.

      The most important part is to start today. No more waiting!

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