This is my 3rd part follow up to “Why Conventional Saving Will Never Lead To Financial Independence and Early Retirement”. In this article, I will go over in great detail what a retirement fund is and some common misconceptions.
Before I go over saving allocations for your retirement, you must focus on:
Before we focus on how to set up our 401k or ROTH IRA, we need to understand what it is.
401k, ROTH IRA, Traditional IRA
These retirement accounts are some of the most common types that people are aware of. People typically debate about the benefits of tax avoidance depending on their specific view of future tax rates. Whatever your view, the rule to follow is simple:
Put your money in ‘all of the above’.
There are numerous pros and cons to each of these, but all of these pros and cons revolve around how these funds are taxed when you withdraw money. Tax avoidance for these funds are a whole different topic than the actual explanation of what they are.
For now, the most important thing to do is to take advantage of any employer IRA match your company may have and maximize the match percentage.
For the purposes of this article, I will explain the common misconceptions of retirement funds and how to set up your own retirement fund based on your personal risk preferences.
Explained simply, a retirement fund is a collection of any number of asset classes that receive automatic contributions at a scheduled rate.
Retirement funds can be made of stocks, bonds, municipal bonds, mutual funds, ETFs, REITS, and/or any other products available to you (depending on which brokerage you go through).
I personally use Vanguard (since my firm requires this), and will be using available Vanguard funds as examples.
So, let’s get to it!
Definition: A stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. Stocks are the foundation of nearly every portfolio.
Risk Level: High
My opinion on stocks: This is definitely my favorite asset class as it provides the most growth potential depending on your stock investing strategy.
Definition: Bonds are essentially I.O.U. notes written out to the buyer from a corporation. When you buy a bond, you are essentially loaning out money to a company for interest payments and eventual payback on your principal payment.
Risk Level: Low
My opinion on bonds: I once heard a quote from Warren Buffet, “bonds aren’t money makers, they are parking spots for money”. Personally, I don’t have a surplus of money that needs to be “parked”. I need all my money speeding down the highway, which is why I only allocate %10 of my retirement fund into bonds.
Definition: Investment fund that is a pool of funds collected from many investors for the purpose of being able to invest small amounts of money into diversified assets. Mutual funds are typically an assortment of stocks, bonds, money market instruments and/or any financial asset.
Risk Level: Medium
My opinion on Mutual Funds: These are absolutely the most common way people invest today. Most people (including myself) have the majority of their retirement fund in mutual funds. The problem is that there are so many mutual funds in the market. There is no way to know which mutual fund is going to outperform the market. I strictly use mutual funds in my retirement fund only (not my personal investment fund) because I would like to obtain average market results over the next few decades. I hope to get an average of %10 growth a year in my mutual fund investments.
Exchange Traded Funds (ETFs)
Definition: ETFs are marketable securities that track an index, a commodity, bonds, or a basket of assets. Unlike mutual funds, exchange traded funds trade like a common stock on the stock exchange.
Risk Level: Medium-High
My opinion on ETFs: I have not currently invested in an ETF, but have played around with the idea of creating my own ‘ETF’ with a faux-folio (paper money trading). For example, there is one ETF I am interested in, HMMJ, is a Marijuana ETF only traded on the Toronto Stock Exchange. However, 8 of the 11 stocks in that ETF are available in the NYSE or NASDAQ. So essentially, I plan to invest a sum of money evenly across all 8 stocks and create my own Marijuana ETF.
Real Estate Investment Trusts (REITs)
Definition: A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges like a stock. REITs provide investors with an extremely liquid stake in real estate.
Risk Level: Medium
My opinion on REITs: REITs simply do not provide enough transparency or enough information to make me feel comfortable investing in this asset class. I would be interested in creating a personal basket of REITs, where I split up a sum of money equally across the top 10 biggest REITs in the US. That is one way I could find myself investing in REITs.
Vanguard Fund Broken Down
Okay! Now that we are experts (ha!) on asset classes, let’s try to understand how these asset classes are a part of our retirement funds. Below, I will be diving into Vanguard specific funds and how to select funds that suit your personality and risk profile.
Below are the steps you will need to take for every option available under your brokerage account.
Below is a breakdown of “Vanguard U.S. Growth Fund Admiral Share”
In this image, there are some key facts to consider about this fund.
Key Details about ‘Vanguard U.S. Growth Fund Admiral Shares’
- This fund holds STOCKS in the U.S.
- These companies have been identified as a growth stock
- There are 156 stocks in this fund
- This fund is ‘highly risky’ as it is a basket of high valued stocks (w. No low risk assets)
- There is a %0.33 fee
- This fund is heavily weighted in Tech and Discretionary Consumer
This fund actually represents %35 of my real-life retirement fund and contributions. This type of fund perfectly matches the kind of returns I am looking for. I am looking for relatively safe companies, but high growth stocks. The major companies in this fund are some of the biggest companies today. This fund contains FAANG (Facebook, Apple, Amazon, Netflix, Google), along with other major stocks that I fully believe in, such as VISA, PayPal, and Starbucks.
The fund above may not be the perfect fit for everybody, since this is a ‘risky’ fund that contains no bonds, REITs, or index funds.
The point of this article is to start breaking down what a 401k is or a ROTH IRA (or traditional IRA) is. These retirement accounts are different for everyone depending on their complete asset allocation strategy. If you are a millionaire that wants to keep all of his or her wealth, then you might want to invest %100 in bonds as you are fearful that a recession will wipe you out.
I am on the other side of the fence. I do not have a lot of money. So, I want the money I do invest to fly off to the moon like a rocket ship. That is why I invest in stocks in my personal portfolio and even invest a large percentage of my retirement fund in stocks.
To make a long article short, if you don’t have a retirement fund, get one. It doesn’t matter whether you put your money in traditional IRA, ROTH IRA, or 401k. The most important thing is to start saving and putting money into your retirement fund. If you do have a retirement fund, then I suggest taking a look at your current asset allocation and see if it is inline with your personal risk profile and goals in life. There is not a single right answer to asset allocation that works for every person. The key is to find what assets fit your personality and life goals.
*DISCLAIMER: Do not invest in any asset solely based on the information above*