By Jamie Bosse
The average person is liable to spend up to one-third (i.e. 30+ years) of their life in retirement. The sooner you start planning for it, the better off you will be! Many companies offer full-time employees the opportunity to save for their retirement in a 401(k) plan and most offer some sort of matching program. The pre-tax contributions you make to your 401(k) today actually lower your taxable income, resulting in a smaller tax bill (or larger refund) for the year.
How Much Should I Contribute?
For 2013, you can contribute the lesser of $17,500 or 100% of compensation. If you are age 50 or older, you may contribute an extra $5,500, for a total of $23,000 for the year. While it may be difficult to put away a large sum of money right now, investing small amounts steadily over time will greatly increase your chances for reaching your retirement goals. Even a modest increase in contributions can make a big difference in the long run.
Take a look at the potential growth of these 2% contribution increases in the hypothetical account of an employee who earns $40,000 per year, assuming an average annual rate of return of 7% compounded monthly.
What if the Market Crashes?
Even if the value of your holdings fluctuate, regularly adding to an account that is designed for a long-term goal may cushion the emotional impact of market swings. If losses are offset even in part by new savings, the bottom-line number on your statement might not be quite so discouraging.
This type of savings is called “Dollar-Cost Averaging,” which is defined as investing a specific amount regularly, regardless of the fluctuating price levels. You may be getting a bargain by continuing to buy (contribute) when prices are down. However, you will need to consider your financial and psychological ability to continue purchases (contributions) through periods of low price levels or economic distress. Dollar-cost averaging loses much of its benefit if you stop contributing when prices are reduced.
Can’t bring yourself to invest during a period of uncertainty? Try not to let your emotions derail your savings program completely. You could continue to contribute to the plan, but direct new savings into cash equivalent investments until your comfort level rises. Though you might not be buying at a discount, you would at least be creating a pool of funds that you could invest when you are ready. The key is not to let short-term anxiety interfere with your long-term plans.
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