I entered the workforce right after college and there was the initial learning curve that I had to overcome.
Everyone goes through this at some point in their life. The first week of a new job is always the hardest. You find yourself asking, “Is this really for me?” Eventually, that first week becomes a distant memory and everything you had difficulty with soon becomes second nature. One of the most difficult tasks starting out in any field of work is trying to understand your retirement plan. There are so many plans and funds to choose from that it can be overwhelming, especially if you were like me coming out of college with an English degree.
As I started my profession, I was so caught up in mastering my day-to-day routine that my retirement plan took a back seat. The first time and last time I looked at my retirement plan was the day I was hired; I elected what plan I wanted, my elections, and my contributions. It was not until recently, my one-year anniversary, that I began to take another look at my plan. This was primarily brought on by a fellow employee showing me an episode of PBS Frontline “The Retirement Gamble.” This special examined why 401(k)s were established and the hidden fees that you might not be aware of. Most of the people on the episode were discussing how poorly their retirement plan was doing due to fees, and how some were not actively managing their plan. After watching the episode, I quickly logged onto my account. I wanted to know my rate of return, which I was happy to learn YTD was 11.78%. This is not exceptional, but it is also not underperforming the average.
However, what I was more concerned with were the fees of the funds I was in. Contrary to the overwhelming feeling of the Frontline special on 401(k)s, I noticed my fees were not exceptionally high. That being said, I still felt I could do better. I decided to discipline myself by listing out a plan of goals, which could then help me in the future when I look at how my plan is performing.
Step one is crucial in understanding what you are really paying for fees. Lay out all your fund options on a spreadsheet with the rates of return and the fees (usually a percentage). Now take the most recent year (2012) rate of return and reduce it by the fees which you would pay. This is your net rate of return. This is what the fund is really yielding after you pay the fees. Sometimes this can be eye-opening, to learn the fund you thought was returning 16% is really only returning 14%. You will only have to adjust your spreadsheet once a year for the previous year rate of return and if the fee went up or down.
Now, what do you want to pay per fund? For me, I wanted to pay under .1% which is $1.00 for every $1,000.00 invested in the fund. Now that you have your price point, you can choose what you want your rate of return to be. I know what you are going to say, and that is you want the highest rate of return you can possibly achieve. My response would be to keep two things in mind. One, higher rates sometimes come with higher costs. Are you willing to pay more? Two, you must realize your risk tolerance. Yes, a higher rate of return is preferable, but if you find that the fund you are invested in is 100% equities that are all in a foreign emerging market that is going through heavy volatility, you might want to reconsider.
Lastly, your contribution and how you allocate your funds comes down to your living expenses and your fund choices. I have always been told that you should be investing 10% of your annual salary. However, in this day and age, this can sometimes be easier said than done. The simple answer to this is to assess your monthly expenses. Can you afford to part with $30.00 or $50.00? If so, this is what you should contribute. If you can do more, do more. Keep in mind that your employer might be contributing to your retirement plan and if they are you can deduct this percentage off that original 10%. How you should allocate monies into your retirement funds again depends on your risk level.
I can only speak from experience, but what I am doing and what I will continue to do is pick funds that meet my requirements that were previously discussed; then my allocations will be equally distributed into each fund, so if I have two funds I will put 50% into each fund. I will then check my rate of return quarterly. If I find one fund has a lower rate of return than the other I will adjust my allocations and add more to the fund that has a higher rate of return. Again, this is all dependent on where you are in your life. Right now I’m young and willing to take on a lot of risk due to the fact that I have at least 40 years before I retire. I strongly encourage you to take the time in figuring out your allocations based on where you are in life. If you are rounding the corner in your profession and near retirement, do not put 100% on red (equities) and hope to win it big.
Retirement plans are only complicated if no one takes the time in showing you how they work. Just as reading this article would be complicated if no one showed you how to read as a child. The advice and strategies I outlined are mine alone and are simply meant as advice and strategies. They are in no way a sure thing, but then again, what is?