If you’re like me, you’ve probably sat through a 20-minute session or two on setting up your 401(k) account. And if you’re like me, you walked out nodding like you heard some really great advice, but it sounded more like a foreign language. You might have checked the boxes for the “most recommended” allocations for your age group and called that “good enough.” You may not even know how much is going toward your 401(k) each paycheck, or what the balance is currently, or if that’s “good” or “bad” … or…. OK, how much does it matter? HALP!
While it’s sometimes difficult to imagine retirement or know how to plan for it so early, I couldn’t help but wonder about my own future.
For most of us, our employer offers us a 401(k) account – but we’re in charge of contributing. So, let’s consider how those contributions actually impact the outcome (account balance) and, more importantly, the value on the day we are ready to cash out.
A 401(k) account is a tool employers offer as an incentive for their employees to save and plan for their retirement. It’s a type of savings/investment account that allows your money to grow tax deferred.
Part of the incentive could be your employer’s match. Not all employers provide a match. (*cough, cough* This is something you should look into if you don’t know.) Anyway, for every “X amount” you contribute, your employer will also contribute or match “Y amount.” As a rule of thumb, you’ll want to take advantage of this match, so you’re not walking away from the money they’re willing to offer you. (It’s basically free money, people!) Beyond that, you can save as much as you’d like each year, up to the contribution limit, which is determined by the government annually. (P.S. The pretax contribution limit for 2019 is $19,000. You’re welcome).
One major difference between a 401(k) and a traditional savings account is that you really shouldn’t withdraw your 401(k) money until you reach retirement age (which the government has decided is 59 ½ years old). If you do withdraw funds before then, you will pay a hefty 10% penalty. Yikes. While that 10% penalty may seem unfair, think of this as part of a sweet deal that you and the government have shaken hands on. You need to save money as quickly as possible for retirement, right? And you’d rather not pay taxes on that money now, so it will reap the full advantage of compound interest (aka grow faster). The government says, “OK, I won’t take taxes on that money now, because I would like you to have money to retire eventually. BUT, the one condition is that you can’t use that money to buy a new Ferrari prior to 59 ½ (unless you wanna pay a 10% penalty).” Remember, the government wasn’t born yesterday.
OK, so you’re putting this money in regularly – what happens to it after it hits your account? Remember that “most recommended” option you checked after you glanced over the pie chart? That allocation option determines a mixture of stock and bond mutual funds where your money goes to grow. The company holding your account (such as Fidelity, MassMutual,etc.), will keep track of all this for you (*takes deep sigh of relief*).
While there may be predetermined blends of “conservative” or “aggressive” allocations, you can customize your selections — if you so choose — and those selections can be changed at any time. For some people, taking advantage of aggressive models might seem scary – to diversify, and put large amounts of valuable (vulnerable) money out there. But it’s good to keep in mind that time is on our side here.
So, if you start to watch your account, you might see the balance fluctuate day to day; but just because the market may take a dip or seem “low” does not necessarily mean that you’ve lost a lot. It could actually be a good time to buy in, as the more time you have ahead, the more time the market has to correct itself and grow – to your benefit.
And lastly, a little disclaimer (because we like those). I am not a financial advisor, so please make sure to consult with one of those amazing, qualified professionals to determine your own unique retirement plan.
Stay tuned for Part 2 of this article coming Thursday!
Article Contributed By: Heidi Lengacher
Contact Us: firstname.lastname@example.org
Episode 1: Hi Friends! Nicole Ellsworth and Kaitlyn Duchien here. We are two motivated millennials facing the fear of our financial futures. Join us on the journey, as we dive into topics such as investing, retirement planning, life insurance, budgeting, and so much more!
Welcome to Face the Fear!
We are Nicole Ellsworth and Kaitlyn Duchien, two motivated millennials on a journey to face the fear of our financial future.
We created this safe space where we will dive into topics like retirement, budgeting, student loans, investing, insurance, financial terms, etc. We are passionate about educating ourselves and others in the process. Join us as we change the conversation around finances and approach our future with confidence.
If you like us, follow us here, Facebook, Twitter, Instagram and subscribe to our podcast: Face the Fear. (Social media links are on the top right of this page.)
*Disclaimer: We are not here to give legal financial advice. We highly encourage you to bring the topics we discuss to a financial professional, who is qualified to address your specific financial goals.*
It’s time for some real talk, and we are so excited that you are here to join us!
Until next time – Face the Fear!
–Nicole and Kaitlyn
Hi Friends! Nicole Ellsworth and Kaitlyn Duchien here. We are two motivated millennials facing the fear of our financial futures. Join us on the journey, as we dive into topics such as investing, retirement planning, life insurance, budgeting, and so much more.
Podcast: Face the Fear (on iTunes, Spotify, and Stitcher)
Stocks and Bonds, James Bonds
When you think of the word “stock,” what comes to mind? You may think of the New York Stock Exchange. Or, maybe (if you’re like me), you think about how much you need to stock up on Peppermint Ice Cream before it goes out of stock again after the holiday season (just me?…okay).
What about bonds? Do you picture a strapping Daniel Craig wearing a pristine black tuxedo, casually armed with a Walther P99 pistol, in hot pursuit of a criminal? Because I sure do.
No matter what comes to mind, we’re going to dive in to the definitions of stocks and bonds (the financial kind, sorry Daniel Craig), discuss what they are, and why they are important to us.
Let’s start with stocks. By definition, a stock is a type of financial security that allows the stockholder the right to ownership in a company. When someone purchases a company’s stock, they are buying a piece of that company, including the right to claim a portion of the company’s earnings (if they have any — aka if the company makes any money, which you sure hope they do if you invested in them).
Think of stock like a piece of pizza. Say you and three other friends are hanging out on a Saturday night and suddenly the midnight munchies strike.
All four of you decide to put in 2 bucks per person to buy a medium pizza for $8. When the pizza arrives, each person owns the right to ¼ of the pizza (or 2 pieces each), since you each contributed $2 for an $8 pizza with 8 slices total. #Math
Now, obviously a pizza can’t magically grow in size. But for this example, let’s say that it can. Imagine the pizza miraculously doubles in size. Now, you own the right to 4 slices of pizza! Well, since you’re on a diet and you really shouldn’t eat more than two slices of pizza, you decide to sell those two extra slices to a new friend who (conveniently) stopped by after you all ordered the pizza.
In theory, this is how buying a stock works. You own a portion of the company. When the company grows and earns profits, you are entitled to a percentage of those profits. You can then sell your portion of ownership in the company to someone else for more than you originally paid for it. By the way, that’s the ONLY way to make money with a stock — the company must grow so that you can sell your portion for more than you bought it for.
What happens if the company loses money and the stock price goes down? Well, that’s the risk of investing — which is especially risky if you invest in just ONE company or sector of the market. If the one company you invested in (Target, for example) or sector of the market (all retail stores), suddenly goes out of business (don’t panic…this is just a hypothetical example), then you would lose all of your money very quickly. Thankfully, investors have alternative options, such as mutual funds, that allows you to invest in many different companies across many different market sectors at one time — thus limiting your overall risk.
Okay, so now that we know what a stock is and how it can earn us money, let’s talk about bonds. Sorry, we’re still not talking about you, Daniel Craig.
Unlike stocks, bonds do not represent ownership in a corporation. Instead, bonds are a type of loan that an investor can make to a company or to the government, which in turn, promises to return a fixed interest rate to the investor over a specific period of time. Ideally, at the end of the bond’s lifetime, the investor will be repaid her entire initial payment, plus a fixed rate of interest. This is why bonds are often called “fixed-income securities” — because they provide a fixed amount of income (in the form of interest payments) to the investor. Shocking, I know.
Because bonds promise to pay back your initial investment plus a fixed interest rate, they are said to be less risky than stocks, which do not have a fixed rate of return and do not promise to return the money invested. However, bonds are not completely risk-free. The amount of risk you take with a bond depends largely on who is borrowing your money. In real world terms, you know that it’s a lot less risky to loan your mom a dollar than that one friend who is a notorious mooch and never pays anyone back. (I’m talking to you, Karen).
Applying that same concept to investing, a bond issued by a young, relatively unstable company is much more risky than a Treasury bond, which is issued by the federal government and is essentially risk-free. Why is a Treasury bond risk-free, you ask? Well, the federal government has this amazing authoritative power called TAXATION, which means it can always raise taxes in order to pay back the interest on its Treasury bonds. As much as a normal company would simply LOVE to force its customers to buy their products (or else!), unfortunately, they can’t do that. This means that corporate bonds may not always be able to keep their promises of paying the investor a fixed interest rate, thus creating risk. Usually, the more risky the bond, the higher the interest rate will be. On the flip side, Treasury bonds usually have the lowest interest rates on the market. Low risk, low returns. High risk, high returns. You get it.
Believe it or not, we’ve just barely scratched the surface of stocks and bonds. Tragic, I know. I don’t want to bore you to tears, so we’ll leave it at that for now.
But, before you go, one last question. Why do stocks and bonds matter? Even if you don’t plan on being the next Warren Buffett, you should feel confident in understanding stocks and bonds, and identifying where they fit into your investment portfolio (Note: If you’ve got a 401(k) or retirement savings plan, chances are you’re already investing in several stocks and bonds, whether you realize it or not. Congratulations!)
(QUICK DISCLAIMER: I am NOT a financial professional, so please consult one of those fantastic, educated, and far-more-qualified individuals BEFORE you dive into investing or making changes to your retirement plan). As a very general rule of thumb (not specific to every individual’s situation), the younger you are, the more your money may be invested in stocks and less in bonds. As you age and grow closer to retirement, the percentage of your money invested may gradually shift from stock-heavy to bond-heavy. The reason for this is, when you’re young, you have the advantage of time on your side to ride the up-and-down roller coaster of the stock market. Even when there is a market correction and you lose a portion of your portfolio, you still have decades before retirement to earn that money back. However, the closer you get to retirement, the less time your portfolio has to bounce back after a market correction. Thus, safer investment options like bonds will help prevent you from losing your entire life savings to a market drop right before you were planning on retiring and moving to Hawaii. AloNAH, you don’t want that to happen.
Alright, now you know what stocks and bonds are and why they matter! Woot woot! Next step, consult with your financial professional to collaborate on an investing plan that is specifically designed to meet your lifestyle goals.
And, don’t forget to check back here for new, exciting content to be released very soon!
Written By: Kaitlyn Duchien (@ktaylor1395)
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