Twenty years ago, I believe few people knew or cared what the “core” was, including fitness fanatics. Today when I go to the gym, or even the office, I see everyone balancing precariously on stability balls. As we’ve learned over the past two decades, core fitness is actually one of the key determinants of physical well-being.
When it comes to investing, your retirement plan could be considered the core of your financial well-being. To get this financial core strong and stable, you need to begin working on it much younger than you may think.
Saving for the day when work becomes optional should ideally begin the day you start work. While that may not be practical for many young adults struggling to pay off student loans, by your early 30s, you should have a regular saving and investment plan in place. This will set you up early and well to fund a multi-decade retirement.
With that in mind, just in time for New Year’s Resolution season, here are four financial fitness tips for 30-somethings.
Max Out Your 401(k) Contributions
In other words, put as much as you can into your 401(k). To put a fine point on it with some actual numbers, imagine a typical 35-year-old. As a starting point, assume this individual has $50,000 in a 401(k) plan, $5,000 a year in 401(k) contributions and a planned retirement at age 65. Over a 30-year horizon, assuming a relatively modest return of 5 percent, the difference between a $4,000 and $5,000 annual contribution represents an expected difference in terminal value at retirement of $70,000: $283,000 for a $4,000 contribution vs $353,000 for $5,000.
Avoid Holding Excess Cash in Your Retirement Account
Keep enough of an eyeball on your retirement accounts to ensure you don’t consciously, or unconsciously, end up holding too much cash. Everyone needs a cash cushion, but not in your retirement savings. Yes, stocks are volatile and maybe even expensive after a multi-year bull market. However, over a three-decade horizon, the difference in returns between a cash-dominated portfolio versus a balanced portfolio of stocks and bonds can be extremely large.
Given where rates are today, a very conservative, cash-heavy portfolio would struggle to generate annualized returns in excess of 2 percent. Take the illustrative example mentioned above. For that individual, over a 30-year period, a cash-heavy portfolio would lead to an expected terminal value at retirement of $212,000. Compare that to a more aggressive portfolio, mostly allocated to stocks. Even if the return on that portfolio was 5 percent, the expected terminal value after 30 years would be $353,000, more than 65 percent higher than the cash-heavy portfolio. In short, cash is great for emergencies and a cushion, but be sure to keep the cash stash out of your long-term retirement accounts.
Scrutinize Your Investment Funds for Unnecessary Fees
Active managers can add to market returns through security selection and market timing. However, if you have active managers that are doing little more than mimicking a popular index, such as the S&P 500, the higher fees associated with their funds are an unnecessary drain on performance. Going back to the previous example, assume that individual is paying an extra 0.5 percent in unnecessary fees compared to a set of cheaper index funds. By reducing the annual return 0.5 percent to 4.5 percent, a seemingly insignificant reduction, you reduce the expected terminal value of the retirement portfolio by roughly $30,000. The lesson: Watch fees and always look to minimize them.
Plan for a Longer Career
Nothing improves your retirement funding status more than extending your working life. Working longer accomplishes three things: increases your savings, adds years to compound those savings and reduces the years you’ll spend drawing down those savings.
In our theoretical example with a 5 percent return, working until 70 rather than 65 increases the expected terminal value of the individual’s portfolio from $353,000 to $480,000. If this individual extended retirement by another two years, the size of the retirement portfolio increases by another $50,000, to nearly $540,000. As we’re all living longer, it’s reasonable to assume those in their 30s today will comfortably work to 70 and even beyond. So if you’re in your 30s and already dreaming of an early retirement, reconsider. The longer you work, the better your retirement is likely to be.
While increasing your annual 401(k) contribution by $1,000, having a bit more stocks in your portfolio, cutting fees by 0.5 percent and working an extra couple of years don’t seem like major changes, their long-term impact can be huge. A bit more return compounded over a few more years will likely lead to a much stronger retirement plan. The bottom line: While none of these tips will have a large, or even visible, impact over the short term, over a 30-year horizon, their cumulative impact for today’s 30-somethings can be enormous.
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.