University of Minnesota Student News

Investing Advice Everyone Should Know

February 17, 2022

Investing+Advice+Everyone+Should+Know

If you are looking for investing advice that will help you retire early, perhaps even a multi-millionaire, and teach you the proper portfolio balances to hold at different ages, read on. To new investors, investing can be intimidating and seem as though it is almost gambling at times, but in reality it is not nearly as risky or scary as it may sometimes seem. 

Surprisingly, many people are unaware of Roth IRAs and most people that know about them know very little about what they really are. Everyone should have a Roth IRA because annual contributions to a Roth IRA can make you a multi-millionaire by the time you retire.  

So what is a Roth IRA? The Oxford Dictionary defines a Roth IRA as “an individual retirement account allowing a person to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after age 59½ are tax-free”. In other words, earnings you make through investments through a Roth IRA are tax-free when you retire. 

Currently, the IRS allows annual contributions to your Roth IRA of up to $6,000 per year for those under age 50, and it allows annual contributions of up to $7,000 for those age 50 and older. Using BankRate’s online calculator, we can see just how much money we are retiring with depending on our annual contributions. For an example, we will see how much the average person can make setting aside a reasonable amount of money towards their Roth IRA.

First, we will assume the Roth IRA returns the historical average annual stock market return of 10 percent. We will also assume the median net compensation, as provided by ssa.gov, is $34,612.04 (the median net compensation for 2020). Furthermore, we will assume that this person puts 15 percent of this income towards their retirement. This comes out to be approximately $5,191.81 per year that this person would be putting towards their Roth IRA.

Using the online calculator under these parameters and assuming the person starts investing these annual contributions at age 21 and retires at age 60, the Roth IRA will have grown to $2,292,749 in value. The total taxable savings assuming a 25 percent marginal tax rate is $1,174,724. Yes, you read that correctly. The average person has the means to become a multi-millionaire by the time they retire. With a Roth IRA, savings on tax will amount to over one million dollars.

How important is it to begin investing into a Roth IRA at a young age? Very! Assuming the hypothetical average person were to begin these annual contributions at age 26 instead of age 21, and still plans on retiring at age 60, the Roth IRA will be worth $1,401,967 with taxable savings of only $795,682. As you can see, waiting just five years to begin investing in your Roth IRA costs you dearly. An entire $890,782 is the difference between beginning to invest at age 21 versus age 26. 

How should I shift my investment portfolio as I grow older? One commonly followed rule is to have your holdings reflect one hundred minus your age in stocks to bonds for the composition of your portfolio. Say, for example, that you are thirty years old, then you would subtract your age from one hundred to get seventy. The portfolio holdings you would want would be to have 70 percent of your portfolio invested in stocks and 30 percent invested in bonds. However, this rule varies based on how risk averse the investor is. 

For instance, an investor who is very risk averse would hold a higher percentage of bonds and a lower percentage of stocks. An investor who is less risk averse would hold a higher percentage of stocks and a lower percentage of bonds.

Why is this the case? It is simply because stocks are riskier than bonds. Stocks will have higher average returns than bonds in general, but this is because they are more volatile, and riskier. Bonds are typically very secure investments and have very consistent returns, but they do not have very high returns relative to stocks. According to CNN Money, from 1926, stocks averaged a return of 10 percent per year, while bonds averaged a return of about 5 percent or 6 percent per year. 

Investing may seem intimidating, but with research and knowledge it is very methodical and can set you up for a very nice retirement.

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