 Habit 7: Save adequately for retirement, while spreading out your risk.
Every week I'm blessed with the opportunity to work with people seeking to improve their lives and financial situations. For many, especially those in their 50s and 60s, the main question on their mind is "how should I allocate my investments to get the best return with the least risk?" While asset allocation (how you split your contributions among mutual funds, stocks, bonds and cash) and making the "right" investment choices (say, picking a good mutual fund) are certainly key, the most important decision by far is actually how much you can save. In fact, a recent study by Putnam Investments verified my hypothesis. The study made the following assumptions: an individual invested 2% of their $40,000 salary into a matching 401k (50% match for up to 6% of salary) from 1/1/90 to 12/31/05, while getting 3% annual raises. With a conservative, diversified portfolio of 25% U.S. stock funds, 5% international funds, 60% bond funds and 10% cash, the investor would have a balance of $39,731 if they only picked funds in the bottom 25% in their category. If they had picked only funds in the top 25%, their balance would have been $41,869. In other words, perfect foresight would have only added about $2,000 to their account. A more aggressive growth allocation of 65% stock funds, 20% international funds and 15% bond funds would have resulted in a $48,200 balance. So, after 15 years of compound growth in one of the best equity markets in history, the growth portfolio added only a few thousand dollars to the ending balance. Big woo, huh? Let me suggest a much better strategy: save more. A 4% contribution would have left you with $79,500, even with a conservative allocation and bottom 25 percentile funds. Contributing 6%: $119,200; 8%: $145,700. Conclusion: the study said "The performance of the underlying funds becomes a virtually meaningless statistic" compared to the impact of a higher contribution rate. I couldn't agree more. Save more now, live better later.
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