I’m one of the most boring investors ever. My Roth IRA is composed of index exchange-traded funds (ETFs), and I automatically invest a set amount each month and let it grow. I don’t fiddle with it; I just let it ride.
Turns out, indexing in your retirement portfolio is probably one of the best things you can do for your long-term savings attempt.
Here is what a recent article in the New York Times reported about the difference between using an actively managed fund versus an index fund for your retirement savings.
Assuming an annual market return of 7 percent, he says, a 30-year-old worker who made $30,000 a year and received a 3 percent annual raise could retire at age 70 with $927,000 in the pot by saving 10 percent of her wages every year in a passive index fund. (Such a nest egg, at the standard withdrawal rate of 4 percent, would generate an inflation-adjusted $37,000 a year more or less indefinitely.) If she put it in a typical actively managed fund, she would end up with only $561,000.
A lot of that difficulty is in the fees. A two-earner household is likely to pay close to $155,000 in 401(k) fees over the course of a lifetime, according to a study conducted three years ago. A low-cost index fund held in an account without the administration fees that often come with employer sponsored retirement funds can save you a great deal of money.
There are a few other good reasons to consider switching to index funds for your retirement portfolio:
- Invest in the whole market: If you choose an all-market fund, your performance will mirror the entire market, rather than a portion of it. Actively managed funds attempt to beat the market — and often fail. When you consider that, over time, the market has yet to lose out, an “average” return doesn’t seem so bad. You don’t need to beat the market to be successful.
- Stay the course in times of trouble: One of the great things about using index funds is that it’s easier to stay the course in times of trouble. If you use an automatic investment plan like I do, you even get your shares at a discount during times of trouble. It’s easier to avoid panic selling if you know that your index is likely to recover in time.
- Less cost due to turnover: Another problem you run into with actively managed funds is cost due to trading. Fund turnover can result in fees and other costs. An index fund usually has less turnover, so the fees are lower.
- You don’t have to worry about stock picking: Stock picking gets many investors in trouble. Rather than worrying about picking a “winner” and paying transaction fees, it’s possible to take advantage of the entire market and pay less, especially if you use an index fund or ETF that doesn’t come with a transaction fee.
While you might want to try other things with “play” money, if you’re setting up for retirement, one of the best chances you have for building wealth for the long term is using index funds or ETFs.
Regular investment over time can really pay off, allowing you a better chance at a successful and comfortable retirement.
Do your investments include index funds? What strategy are you using to save for retirement?
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They developed this pretty nifty 401K Fee Analyzer that will show you whether you are paying too much in fees, as well as an Investment Checkup tool to help determine whether your asset allocation fits your risk profile. The platform literally takes a few minutes to sign up and it's free to use by following this link here. For those trying to build wealth, Personal Capital is worth a look.