Question: I listen to your show on WVXU at 11 on Saturday, but am always driving during that half hour.
I've recently started a new job out of college, and was given the opportunity to join the 401k. I decided to see the employer match and add a bit more, but after seeing my relative's 401k tank, and with the general slow growth in the stock market, I didn't want to put all my eggs in one basket.
I'm looking to invest more for retirement, especially while I'm young and don't need to pay for mortgages, children, school savings, etc. Bonds are low as well with the interest rates, and real estate is also barely moving. What other viable options would I have to invest in the long term? Jacob, Cincinnati, OH
Answer: Congratulations on taking savings for retirement so seriously when you're young. Time is on your side.
I'm really glad that you don't want to put all your eggs in one retirement basket. Diversification is one of the most powerful ways to protect your finances from catastrophe, although diversification isn't much protection during the height of a major market crash. But it pays off over time. I would diversify both within the 401(k) and by accumulating money elsewhere.
The basic idea is simple. As Miguel De Cervantes put it in Don Quixote some 400 years ago, "Do not venture all your eggs in one basket holds." Shakespeare illustrated the concept of diversification around the same time in The Merchant of Venice, when Antonio told his friends he wasn't spending sleepless nights worrying over his commodity investment:
<em> Believe me, no. I thank my fortune for it, My ventures are not in one bottom trusted, Nor to one place; nor is my whole estate Upon the fortune of this present year. Therefore my merchandise makes me not sad. </em>
It's an axiom of modern finance that the only way to create the opportunity to earn a higher return is to take greater risks -- and vice versa. The trick is to mix and match the major financial market assets to create a well-diversified portfolio. When some assets, such as stocks, zig, other assets, like bonds, might zag.
As for what to invest in outside of the 401(k), I have two suggestions. One is to simply build up your safe savings. Put the money into creditworthy but low-yielding investments, everything from a savings account to CDs to Treasury bills. This money isn't just for emergencies. It's to pay for risk-taking with your career and jobs, the freedom to try something new, the ability to invest in an opportunity that comes your way, perhaps a duplex or a fourplex or a venture with low-pay and lots of stock options. It could also pay for graduate school if you decide to go that route.
But once you have a nice safety net/opportunity fund built up I would expand the list of investment. In this perspective, your retirement savings outside the 401(k) is simply part of an automatic savings program you've established over the years in taxable accounts. Some of the money will continue to go into safe savings. But I would also consider regularly investing money in a broad-based stock index fund, such as the Wilshire 5000, the Russell 3,000, or the Standard & Poor's 500. You could load up on tax-deferred inflation-protected I-bonds for the fixed income portion of your portfolio. The mix of secure and riskier savings accumulates over time. It's a simple strategy that gives you a lot of flexibility.
One last thing: I would also look into setting up a Roth-IRA. It's by far the best retirement savings plan available to individuals. You fund the Roth with after-tax dollars but when you withdraw the money in retirement the gains are free of Uncle Sam's clutches.
That's probably enough to think about for now.
Any other suggestions for someone just out of college and starting their retirement savings plan?