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How To Start Building Your Nest Egg

Posted: Jan. 27th, 2011  |  By Forbes

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Visions of retirement vary from one generation to the next. For your grandparents, perhaps it was a fat pension and a Florida condo. For your parents, it might have been cashing out a 401(k) to buy an apartment in a trendy urban center.

For you, it may seem there's no choice but to work until age 85. But even though the Great Recession has devastated defined benefit pension plans and slashed the value of savings in self-directed retirement funds, you still stand a good chance of enjoying a retirement that's even more prosperous than those of your forefathers. Step One: Don't be deterred by their mistakes and misfortunes.

"Don't worry about what happened to your parents' retirement fund," says Mary Malgoire, president of The Family Firm, a financial advisory in Bethesda, Md. "You should get out there and put your money into growth."

See Also: Florida Retirement Homes On Sale

Your initial step in planning for retirement should be to take advantage of all the available opportunities to receive free money. There are more than you might think. If you open a retirement account through your job, for example, your employer may match some or all of your contributions. A good target is to put away 15% of your gross income. Most employers cap the amounts they will match, so at minimum, try to contribute enough to receive the full employer match.

"Would I rather be in something that earns 20% a year or 5% a year? Obviously 20%," says Malgoire. "And that's what you get with employer match. It's free money."

With that free money, a young investor should build a portfolio heavy on mutual funds, index funds and stocks, but light on bonds. How light? Vanguard founder John Bogle suggests a simple rule: The percentage of your portfolio made up by bonds should correspond roughly to your age. So a 33-year-old would keep one-third of his or her savings in bonds and the rest in equities. Many retirement planners like this guideline, but warn against relying on it too heavily.

"It's a good starting point or rule of thumb," says Dan Maul of Retirement Planning Associates in Kirkland, Wash. "But people need to know they can fine-tune those rules at any point. If you want to be aggressive, you could allocate [a percentage equal to] your age minus 20 to bonds."

Make low-cost index mutual funds or exchange-traded funds the core of your investments. For domestic exposure consider something like the Fidelity's Spartan 500 Index ; for international growth check out a passively managed fund like Vanguard's Emerging Markets ETF (nyse: VWO - news - people ). Those two funds sport expense ratios of 0.10% and 0.27%, respectively. That compares with 1.12% and 1.75% for similar actively managed funds, according to Lipper. Assuming you had an average balance of $10,000 in your account and achieved an average annual return of 8% on each, the index funds would save you $2,085 and $2,920, respectively, over 10 years.

Whether you're young or old, taxes matter too. Young investors should consider putting retirement funds into a Roth IRA. With a traditional IRA or 401(k) you invest money pretax but must pay ordinary income taxes on gains when you withdraw the money. With a Roth IRA and similar Roth 401(k) holders pay taxes the year they put the money in, and can withdraw it tax-free in retirement.

"I'd recommend 50% traditional, 50% Roth," says Maul. "There's a million reasons besides retiring that people take money out of a 401(k)—buying a house, losing a job, having a kid. If you have both sources available, you can maximize your flexibility."

By following these steps and sticking to your savings goals, you can have the retirement that you--and your parents and grandparents--envisioned.

See Also: 2011 Investment Guide




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