How To Work Your Way Around Pensions Schemes And Alternative Investments
If there’s one thing people ask Darren and I the most often it’s “How do I retire early?”
I can’t blame them.
Working 9 to 5 in an unfulfilling job waiting to get old so that you can retire when all your youth and energy is behind you? That’s no fun at all.
It’s why Darren and I work for ourselves. It’s why we paid off our debts. It’s why we built a life that allows us to travel and enjoy the world while both we and our children are young enough to enjoy it.
The only reason we haven’t retired is that we’re having too much fun to do so. Yet, the day we want to stop – we can. We’ve made sure that our pension is ready and waiting to go.
You see, it’s your pension which is at the heart of stopping work. You can quit any time. You just can’t afford to feed or clothe yourself or put a roof over your head without an income.
A pension is your guaranteed retirement income. It’s the money that comes in every month come hell or high water and that is what sets you free.
So here’s what you need to know about pension schemes and alternative investments.
If You Qualify For An Employer’s 401K You’d Be Mad Not To Take It
If you have a paid job, you almost certainly qualify for your employer’s 401K retirement plan. This is the single best investment in your future that you can make.
- Free money from your employer! Every employer agrees to match a certain amount of money paid into the 401K during the course of a year. So, if they match $10,000 and you put in $10,000 to your 401K, they put in another $10,000! That is 100% interest on matched contributions and it’s paid today.
- Free money from the government. The government also hands out a pretty awesome set of tax breaks on the first $x invested in your 401K each year. It depends on your income tax bracket as to how much you save but if you’re paying income tax it’s likely to be at least another $1,000 for free and possibly a bit more.
- Even more free money! That money from your employer and from the government is put to work for you immediately. That means it goes on to make more money for you as the years pass. So, not only did you get free money when you put your investment in, that free money will make further returns for you.
There is no legitimate form of investing that can offer guaranteed returns like that. The employer’s match plus the tax breaks are worth in excess of 100% interest in the first year! Throw in the investment returns and over the next 20 years, it’s going to come out at 500% or more.
In fact, your employer’s 401K is such a powerful investment that it’s worth prioritizing even over paying off most debts. 30% interest on a credit card is still less than that 100% interest in your 401K. You’ll never hear me encourage people to put paying debt off second, except in this one case.
I cannot stress the benefits of putting money into your 401K enough. Until you max out the contributions from your employer and from the government, it is the best investment of your life.
Sure, in the short-term cryptocurrencies or property or the next investment fad might show a better return, but these returns are not guaranteed. Your 401K’s bonus cash is guaranteed. It’s a no-brainer.
Individual Retirement Accounts (IRAs)
If you don’t qualify for a 401K or you’ve maxed out your 401K contributions and want to add an extra level of investment to provide for your future – the next port of call is the Individual Retirement Account (IRA).
The IRA is a much more flexible investment vehicle than your typical 401K. This can be very important depending on the kind of investor you are:
- I like to make all my own investment decisions. This kind of investor is well catered for in the IRA market. They can open an IRA at an online broker (see our table below) and then they can develop a diversified investment portfolio. You’d typically expect to see an IRA produce a bit more of a return than a 401K mainly because institutional investors, such as those managing a 401K, are 100% risk-averse.
- I prefer to have somebody else manage my investment decisions – I don’t know enough about this stuff to feel confident doing it myself. This is fine too, IRAs can be managed by what they call a Robo-advisor. A robo-advisor manages the portfolio on your behalf and typically makes a much lower commission that a human advisor would. You can open one of these accounts online too (see the other table below) and the big names in the industry manage billions.
It’s worth noting that online brokers are going to save you a bundle of money over a traditional financial advisory. I am also going to share with you a tip from the world’s biggest and most successful investor that will make it easy to get great returns with minimal risk over time.
Finally, there is a maximum amount you can put into an IRA each year if you want to keep the tax benefits of using one. At the moment that’s around $5,500 annually and it is subject to change.
Manage Your Own Portfolio IRA Brokers
We like Merrill Edge because they pay a nice cash bonus when you open an account with them (from $100-$600 and free money is always welcome, right?). There is no minimum balance required to be kept with them and they have a low fee structure of just $6.95 a trade.
The downside is that there are no commission-free trades and if you want to get involved in day-trading, you’re going to have to commit to a minimum balance at all times.
I love E-trade. They too offer up to $600 in cash bonuses when you open your account. They have no minimum balance and fees can be very low. In fact, they have 4,400 mutual funds which offer no transaction fees and a further 156 commission free products.
The downsides? If you don’t want to trade in the no-transaction-fee funds, it’s $19.95 a trade and they charge higher transaction fees if you don’t trade on a regular basis.
The cheapest, at least on the surface, of this style of IRA provider, is Ally Invest. They charge really low commissions of $4.95 a trade, have no annual fees, and while there’s no cash bonus – they do give you 90 days of free trading with a qualifying deposit.
Sadly, they also charge you to close the IRA and transfer out any cash. These fees are quite substantial at $25 and $50 respectively and can wipe away savings made when compared to other platforms.
Robo-investor platforms operate under a different set of general conditions compared to self-direct IRAs and it’s difficult to fairly compare the two. That’s because they are designed for a different kind of investor.
Possibly the largest robo-investor of them all is Wealthfront. It is a low-cost platform, particularly for those with smaller funds. They manage the first $5,000 invested for free and then charge 0.25% annually of the total portfolio value for amounts over $5,000.
What don’t I like about Wealthfront? I think it’s the lack of human advisor availability. It would be nice to have an option to pay a fee and talk to a real person about your investments, particularly as your IRA starts to grow.
Also, if you run a lot of money with Wealthfront, they offer no volume discount which seems a bit mean.
Putting that to one side, there’s a reason Wealthfront is so popular and it’s because it has a solid track record as a robo-investor.
Betterment is in the same cost bracket as Wealthfront really. It also has some highlights that its competitor lacks.
They offer really cool planning tools which help you offer some high-level direction in terms of how your portfolio is balanced and they allow you to sync other brokers accounts with your Betterment plan to get a clearer picture of all your investments.
They are very good with automated tax-loss harvesting to maximize your discounts with the IRS too. I also thought the fact that they have no account minimum was good.
There is a $0 minimum balance and better still, while the management fee is 0.25%, you can get a free year’s management before you have to pay them at all.
My only moan with Betterment is that they really don’t offer as many investment options as some of the other platforms.
Another Reason To Use An IRA
If you’re still not sure about using an IRA, let me give you a big reason to use one. While your money remains in an IRA investment vehicle – you pay no taxes on the investment income. That’s much better than with a traditional brokerage account where you’re going to pay tax on every gain.
If you are sure you won’t want to touch your IRA income until you retire, you might consider a Roth IRA which provides a guarantee of no tax on all investment income even when you draw on it, as long as you don’t take any money out before you retire.
Be aware that there are penalties for withdrawing from an IRA before you retire and you should talk to your broker about those before you commit to anything.
The Best Investment Tip Ever From Warren Buffet
Warren Buffer it one of the world’s richest men. In fact, he has regularly been THE richest man in the world and it’s only when somebody’s stock goes soaring high that he gets overtaken.
He has made his entire fortune running Berkshire Hathaway an investment consortium. He’s beaten every downturn in the market and never been caught in a crash of any kind. He was untouched by the .dotcom collapse, the mortgage market collapse, etc.
He also regularly shares his investment wisdom with other people. He has one tip if you want to invest without any specialist knowledge of investments and you don’t intend to develop that knowledge.
Here’s That Tip
Warren Buffet says if you want to beat the financial advisors and the hedge funds you should buy mutual funds which track the stock market.
They’re not considered sexy investment vehicles because they’re safe. But the S&P keeps going up and up and up over time. Annual average returns are in excess of 7%. These funds also have low commission fees, so no banker is making off with your wealth.
How confident is Warren Buffet in this advice? He was confident enough to bet a leading hedge fund broker $1 million that these funds would outperform the hedge fund. The bet was to run for 7 years.
In the first year, disaster struck and the hedge fund performed well. But by the time 7 years had passed? The hedge fund had been left in the dust by the boring old mutual fund. Warren Buffet won his bet.
So, in summary, if you want to retire with a decent income – invest as much as you can in an employer matched 401K (up to the employer’s maximum contribution level). Then find an IRA and use it to invest in a stock market tracking mutual fund. Easy, right?
I am going to come back to this article in the future and add even more ways to prepare for retirement but for now, I think this will get you heading in the right direction. Enjoy getting richer and let me know if you have any questions in the comments below.