Ten Steps to a More Secure Financial Future

Start saving now

The most important “takeaway” in investor education is: START SAVING NOW. It's never too late to start, but the earlier you start, the harder your money can work to help you reach your financial goals. For many investors, getting started is the tough part. But the sooner you start to save, the less you need to save to reach your goals—thanks to the power of compounding.

Reinvestment is the key to compounding’s magic. Many investments offer the option of taking your earnings in cash instead of reinvesting them. But by "cashing out" your earnings, you don't allow compounding to work for you. Over long periods of time, compounding can produce significant growth in the value of an investment (see example at right). No wonder Albert Einstein called it “the most powerful force in the universe.”

For more info:
The Importance of Starting Early

Make it a habit

Make it as easy as possible to save. On the theory that you won’t miss what you don’t see, arrange for automatic withdrawals from your checking account or automatic deductions from your paycheck and redirect those dollars into savings. Commit to designating a portion of each overtime payment, bonus, or annual raise for long-term investments.

Think of it as paying yourself first. If you wait to see what’s “left over” each month, you’ll likely never reach your financial goals. Research indicates that those who make a habit of saving and investing will be better prepared for retirement than those who invest haphazardly.

There is an additional reward for faithful saving. By investing a set amount at regular intervals, you’ll be investing more when the price is low and investing less when the price is high, reducing your costs over the long run. This simple, long-term strategy is known as dollar-cost averaging.

For more info:
The Benefits of Dollar-Cost Averaging

Take advantage of what’s available

The government has created tax incentives to encourage you to save for future health, education, and retirement needs. Because all of these plans offer tax-advantaged investing, your money grows faster. By comparison, in a taxable account, you pay tax on earnings in the year you receive them, leaving less money available for compounding (see graph at right).

For example, if you are eligible to participate in a retirement plan at work, use it. Set up an Individual Retirement Account. Consider a Health Savings Account. Check out your state’s 529 plan for funding your child’s college education.

No single plan can address all your future financial needs, so be sure to explore every option. You will likely find that, even if you contribute the maximum amounts allowed to these plans, you will still need to build personal savings to meet your goals.

For more info:
Investing for Your Future
Investing for Your Health
Understanding 529 Plans

Know what you’ll need

College tuition, including room and board, at a four-year school is currently averaging more than $19,000 annually. But costs can vary widely. What kind of higher education do you foresee for your children? In state or out of state? Private or public? Living off campus or on? Will your child be contributing part-time or summer income? Will financial aid be available? Plenty of questions need answers in order to plan for your education expenses.

The same holds true for your own retirement. The average Social Security payout is currently $10,000 per year, and the average retirement plan payout is $13,000 per year. Have you estimated what you’ll be getting? How far that will go will depend on the type of retirement you envision. Where will you live? Will you “age in place”? Downsize? Move to a retirement community or closer to your grandchildren? How will you spend your time? Traveling? Volunteering? Back in school?

Many retirees seriously underestimate what they will spend on health care. On average, spending to meet medical needs more than doubles after age 65; the average retiree spends about 17 percent of annual income, after taxes, on health care costs. Meanwhile, more and more employers are dropping or cutting back on retiree health coverage. Yet research indicates that fewer than half of all workers age 40 and older think much—if at all—about health insurance when planning for retirement. What are your long-term health prospects? Life expectancy? What type of insurance coverage will be available to you when you retire?

In order to plan for your future financial needs, you need to get at least a rough idea of what to expect.

For more info:
College MatchMaker
College Savings Calculator
Life Expectancy Calculator
Retirement Health Care Calculator
Social Security Benefits Calculator
Retirement Planning Interactive Worksheet

Be realistic

Once you’ve got some estimates of your future financial needs, be realistic in planning how to get there. Two factors come into play here: the level of risk you’re prepared to take to reach your goals and the long-term rate of return you can expect to see. The two are intertwined: the more risk you take, the greater your return is likely to be. But don’t kid yourself. Some investors can calmly accept the possibility that the value of their investments will move sharply higher or lower over short periods of time. Others can’t sleep at night for fear of losing their money. They might bail out of the market at what could be the worst possible time. Before you invest, it’s wise to measure your tolerance for risk.

Regardless of your risk tolerance, all investors should expect setbacks from time to time. Stock and bond markets can be volatile. But if you maintain a long-term outlook, short-term swings become less significant. Historically, gains have offset losses – on average, the stock market has returned about 10 percent per year since 1926 (see graph at right). Of course, there have also been periods of unusually high or low returns. Don’t base your expectations on these aberrations. For instance, if you are counting on those 1990s returns in order to send your children to college, they may never see graduation day!

For more info:
Assessing Your Risk Tolerance Interactive Worksheet
Developing Realistic Expectations
Understanding the Risk and Reward Relationship
The Importance of a Long-Term Perspective

Don’t put all your eggs in one basket

How many times have you heard this one? But when it comes to investing, it’s advice well taken. A diversified portfolio can help you manage risk by reducing the impact of one or two poor performers on your overall return. Even if your risk tolerance is low, you can still diversify into riskier investments as long as you keep the overall risk of your portfolio within your comfort zone.

How you divide your savings among various types of investments is called asset allocation. After you’ve identified your financial goals, ask yourself how much time you have to meet those goals, how much you can afford to invest regularly, how much your assets will need to grow, and how much risk you feel comfortable assuming. Answers to these questions will guide you toward different types of investments. Financial professionals can also help you with this process.

For more info:
The Benefits of Diversification
Understanding Mutual Funds
Investment Calculator: How Much, At What Rate, When?

Keep your hands off the nest egg

Some retirement plans allow you to borrow against your account or take withdrawals for specific purposes. When you change jobs or retire, you may receive your retirement savings as a lump sum. And if you’ve set up personal savings earmarked for long-term goals, you can make withdrawals at any time. But don’t let vacations, home or car repairs, credit card bills, or other short-term spending needs sabotage your future. Avoid the temptation to invade your long-term savings. Find other ways to meet your expenses. Roll over a lump sum into your new employer’s plan or into a Rollover IRA. If you spend it, not only will you have compromised your retirement savings, but you will likely trigger significant tax penalties as well.

For more info:
66 Ways to Save Money

Make changes based on reason, not emotion

This may seem obvious, but it’s not as easy as it sounds. In fact, neuropsychologists have found that we are hardwired to seek instant gratification. Decisions with immediate consequences involve our emotional brain (limbic system); decisions with future consequences involve our analytic brain (frontal cortex). That’s why we’re tempted to spend every last dime of our paycheck (enjoy the rewards) and to dump losing investments (end the pain), even when those actions are not in our best long-term interests. The emotional brain discounts the future; the analytic brain treats present and future the same (see quiz at right). That’s also why savings arrangements that overcome both the impulse for immediate rewards and the inertia that avoids long-term planning—such as automatic 401(k) enrollment—work so well. Dollar-cost averaging (see step two, above) is another technique you can use to take the emotion out of investing. If you stick to your plan, it helps you to develop mental toughness during down markets and to avoid overbuying during up markets.

For more info:
Why Johnny Can’t Save for Retirement

Monitor your progress

Different investments grow at different rates, so your original allocation of savings among stocks, bonds, and mutual funds will change over time. Sooner or later, you will need to redistribute some of your savings to bring your investment mix back into line with your original plan. It’s a good idea to check your progress every year.

In addition to the annual review, whenever you make a major life change, it's time to reassess your overall financial situation. Switching careers, retiring, getting married or divorced, having a child, starting your own business, taking care of an elderly parent, and returning to school or paying tuition for a child are the most common examples. These events are likely to affect your ability to invest, your goals, and your time horizon. You don't want to enter a new phase of your life with a financial plan that was designed for different circumstances.

For more info:
Action Plan Interactive Worksheet

Get help when you need it

Some investors enjoy the challenge of doing their own financial planning. Others want advice during a financial crisis or because of a specific situation. Still others want routine consultations with financial professionals to review their progress, make recommendations, or validate their decisions. Whichever course you choose, ask questions about anything you don't understand. Don't be intimidated by jargon—after all, it's your money and your future. If you're buying an investment directly, ask a professional at that organization; if you're buying through a financial professional, ask that person.

For more info:
The Importance of Being an Informed Investor
Ask Questions
Questions You Should Ask Before You Invest in a Mutual Fund
Your Investment Team (choosing a broker)
Ten Questions to Ask When Choosing a Financial Planner
Glossary for Informed Investors