The action item identified in July’s column urged readers to gather financial statements and to separate the investment balances into three distinct asset allocations: short-term, stocks and bonds. With this information in hand, readers can make good decisions that will enhance their ability to reach financial security.
Determining an appropriate asset allocation involves assessing several factors with “age” being a very important one. Each reader should consider specific time horizons, financial goals and risk tolerances before determining how to invest the various pools of money.
Because advice can differ significantly based upon age, this month’s column provides advice for those just starting on their career path and is directed to those in their 20’s and 30’s.
The first financial goal for those in this age group should be allocating money to reach a goal of establishing a savings amount equal to three to six months of expenses.
These monies should be invested safely in “short-term” investments, such as a savings account or money market fund that earns interest, but does not have the risk of dropping in value. If this savings bucket is held at a bank, make sure they are paying a competitive interest rate.
Money market funds are now paying an annualized rate of almost 5 percent. If the bank account is paying a lower amount, consider moving the balances to a brokerage account and using its money market fund option. To achieve this savings goal, automatically deposit some amount per paycheck until the balance reaches the goal.
Once the savings balance is achieved, and if you have credit card debt, pay down this debt as quickly as possible. Interest rates are generally very high. Try not to add to this balance once it reaches zero.
While saving for retirement is probably not an immediate concern at this age, there are many reasons to consider allocating monies now to this longer-term goal. Key reasons include:
- Younger workers have the advantage of “time” and this allows them to take advantage of compounding. Compounding interest is the interest one earns on interest. If you have $100 and it earns five percent interest each year, you’ll have $105 at the end of the first year. At the end of the second year, you’ll have $110.25. Not only did you earn $5 on the initial $100 deposit, you also earned $0.25 on the $5 in interest. Start saving as early as you can and enjoy watching these balances grow.
- Focus on contributing to investment vehicles that grow tax-free. Many companies offer retirement plans such as 401(k)s and 403(b)s. Contributions to these plans are deducted automatically from your paycheck and the amounts are often matched by the company. If you do not contribute at least enough to receive the match, you are missing out on “free money.” If your company does not offer a retirement plan, traditional IRAs and Roth IRAs provide similar benefits and are offered by most brokerage firms.
- The balance in these retirement accounts can be invested very aggressively, as the goal is to use this money in retirement. Knowing this long-term goal should prevent younger workers from worrying about the volatility of the stock market day by day. Because the “risk tolerance” for this money is very high, consider selecting a target date mutual fund offered by most retirement plans that corresponds to the year you expect to retire. As an example, if you are 35 in 2023 and expect to retire 32 years from now when you are 67, select a mutual fund with “2055” in its name (2023 + 32). Because the time horizon is so long, this type of fund will be aggressively invested with almost all the monies allocated to stocks. As a general rule, there is no need at this stage to have an allocation to bonds.
A final suggestion for those in their 20’s and 30’s is to use this stage of your life to invest in you. Search for opportunities to obtain additional education or skills to improve your earning power over your lifetime. Many employers offer additional training programs and many also offer assistance with educational programs not sponsored by the company.
Next month: Asset allocation recommendations for 30-40 year olds.
Beth Stegner Peabody is CEO of Stegner Investment Associates and a graduate of Sacred Heart Academy and St. Agnes School.
