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Building a pension fund – which we will define to save enough money to pay their bills when they are no longer working – can be a daunting challenge. A practical approach that focuses on what you can do today will help you address the challenge one step at a time.
Theory vs. Reality
Regardless of your current age or income, the recipe for a successful retirement fund has a simple formula: set a goal, commit, repeat. A common approach encourages would-be investors to participate in their employer-sponsored retirement savings plan. Another suggests entering personal information into a retirement planning calculator to project how much money will be needed to fund retirement. (for more information, see 5 apps & calculators for retirement planning .
While both ideas are great in theory, the reality can quickly break down. Consider, for example, that only about half of all workers in the u.S. Have access to an employer-sponsored savings plan, according to a report by schwartz's center for economic policy at the new school for social research in new york city. In addition, nearly 70% of the working-age population (ages 25-64) in the U.S. Did not participate in an employer-sponsored retirement plan because their employer did not offer one, they did not choose to participate, or they were not working. Takes the report titled "are U.S. Workers ready for retirement? "
Also, the huge dollar amounts most people see when they use a retirement planning calculator can be daunting. A savings goal of a million dollars or more may seem out of reach to young workers with low incomes, high debt and nothing in the bank.
"Thinking in terms of the total amount you will need in retirement is daunting. But I think if you break it down into small steps, it's a lot easier to swallow," says financial planner shane P. Larson, CFP®, owner of S.P. Larson financial planning, LLC, in seattle, washington.
Given these realities, let's start with a difficult scenario – one most of us find ourselves in early in our careers – and lay out a practical plan for building a retirement fund. In this scenario, we assume you don't have an employer-sponsored savings plan and you don't have a high-paying job. We will also work on the premise that you have a high debt load from college loans, a car payment and rent or a mortgage, in addition to living expenses.
Set a goal, commit, repeat
There are several goals that can be set in this scenario. The first is saving. Even if it's just a few dollars a week, open a bank account and deposit the money.For more information on the types of accounts you can open, see demystifying bank accounts .
A bank account may not be the best investment vehicle in the world, but it's a great way to make saving a habit. Remember, building a retirement fund is a long-term journey – and as the saying goes, even a journey of a thousand miles begins with a single step.
Once they sit down and commit to the goal of saving, the next goals are clear: increase their income and reduce their debt. Achieving the first goal will help you achieve the second goal. To increase your income, you can either take a second job or get a better paying job than the one you currently have. Although it may take time and effort to grow your income, keeping in mind that this is a long-term effort will help you stick to your plan. So set a goal of getting a better job (or a second job), and then take the time to do a dedicated job search.
Once they reach their goal, they can reduce their debt with their newfound income. Then you can put more money into your retirement fund. Putting together a budget can help you with this process. It's a great way to make sure your money is being used wisely. To get started, take a look at the beauty of budgeting . Remember, the sooner you start, the more time you have to increase your savings through what experts call "the magic of compound interest. "
" The power of interest is the eighth wonder of the world. A long-term mindset with compound interest as your ally will allow you to turn a small consistent savings rate into a comfortable retirement, " says mark hebner, founder and president, index fund advisors, inc., irvine, california, and author of "index funds: the 12-step recovery program for active investors. " (see also understanding compound interest .)
Don't skimp, invest
Once you have increased your income and savings, you should save enough money to put in your bank account for an individual retirement account (IRA). At this stage, they switch from saving money to investing money.
If you don't know much about investing, think about how you can put your money to work making more money. For more information on this topic, see basic investment goals . From a practical standpoint, you can start by putting your money in a mutual fund, as this is one of the easiest investing methods for beginners. Our mutual fund basics tutorial will help you learn more about these investment vehicles.
Just choose an index fund that replicates a major U.S. Stock market index like the S & P 500, or an actively managed fund that invests in blue-chip stocks. (see also passively managed vs. Actively managed mutual funds: which is better??) focus on one goal, learn more about investing and work toward that goal. Watch one or more of these tutorials to get started. Pick one and start reading.Let topics that catch your attention help you find the next topic you want to learn more about. This is also a long-term endeavor. Don't try to absorb everything at once. Just start reading, commit to doing it regularly and stick with it. As you learn more, take time to learn about mutual fund fees and make sure you are not reducing your returns by paying more interest (see stop paying high mutual fund fees and mutual funds with the lowest expense ratios ).
Get a 401 (k)
Once you master the art of budgeting and investing, you will likely want more money to increase both your standard of living and the amount you invest. Another job search can help you reach these goals. This time, look for a job that offers a 401(k) plan with an employer that matches your contributions. Invest enough to get the full company match. Over time, as they get pay raises and promotions, they increase their contribution rate to the maximum amount allowed. To learn more, read the basics of a 401 (K) retirement plan .
"Working for a company with a 401 (k) is one thing. Working for a company that offers matching contributions is another. In 401 (k) matching, you can really see your money grow. And do it quickly, " says david N. Waldrop, CFP®, president of bridgeview capital advisors, inc., in el dorado hills, california.