13 Dec Write 2-3 paragraphs about how you hope to achieve your goal Include a screenshot of your calculation if possible. It is not necessary to apply a formatting style for this assignmen

Retirement Plans

I am reluctant to get too specific about the sequence to follow on this, because everyone has slightly different situations. If you are single, or you and your spouse aren't planning to have kids anytime soon, buying a house may not make sense immediately. If you have a low income–and are therefore in a low marginal tax bracket–it may not make sense to buy a house either. What I intend to do is show you the sequence that my wife and I followed, as modified by what I have since learned.

401(k) Plans

Especially if you are in a high marginal tax rate bracket, and especially the younger that you are, you want to put as much money into your employer's 401(k) plan as you can, as early as you can. The money that goes into a 401(k) plan is not subject to income tax. If you contribute $100 from every paycheck into a 401(k) plan, and you are in a 40% marginal tax bracket, your paycheck only drops by $60. However, you have put $100 into your 401(k) plan–and all the interest it earns in that plan until you withdraw (sometime after 59 1/2), is untaxed. Through the miracles of compound interest, if your 401(k) plan averages an 8% return over the next 38 years, that $100 will be worth $1862.

Of course, you don't just put in $100 once; you put $100 in every month. If you start early enough at this, it turns into a huge pile of money. Start at age 22. Put $100 a month into your 401(k). If your 401(k) averages 8% return (which is not a terribly high return, when you consider the last 60 years), it will have $299,470 and some change when you retire at age 60. I cannot emphasize too strongly how important it is to get started early. This is one of the few cases where time is on your side. Instead of starting at 22, what happens if you start contributing at age 32? When you retire at age 60, instead of $299,470, you have $126,621–or less than half the amount.

But in what sort of mutual funds should you invest your 401(k) money? The traditional model says that a young person should invest in the most aggressive stock growth mutual funds (which exchange high risk for high yield). As you reach your 40s, you start to move the money into more conservative stock funds. As you approach retirement, say, in your 50s, you move most of the money into bond funds (which have disappointing returns, and lower risk), and then, when you are ready to retire, any additional money going into your 401(k) should be in money market funds (almost no return, but no real risk).

There's a lot to be said for this model–and I kick myself that when I first start contributing to a 401(k) in the mid-1980s, I put everything into bond funds. I was so scared that the money might evaporate away. Even into the early 1990s, I was still far too heavily weighted towards bond funds and conservative stock funds. If I had followed the traditional advice on this, I would have benefited from the most amazing stock market boom in history–the 1990s bubble–and I would probably have another $40K-$80K in my 401(k) account than I have now.

However: there is something to be said for being cautious, especially when you are living in "interesting times." (There is supposedly an old Chinese curse, "May you live in interesting times.") A lot of people saw their 401(k) funds drop quite impressively in value since May of 2000, as the stock market bubble deflated with all the charm and grace of a tire running over a nailstrip. I think it is likely that over the next two to three years, all of this will be a painful memory (for most Americans). Those who cashed out their 401(k), or who had to retire, or moved 401(k) money from stock funds to bond funds–they are never going to forget this experience–and not in a positive way. DO NOT PANIC IN A BEAR MARKET! This not only wipes out the advantages of the bull market that you just enjoyed, but you, along with millions of other nervous nellies, cause the market to sink even faster, because you are trying to sell when others are doing likewise. The time to buy is when others are losing their heads in panic; the time to sell is when others insist that the market can only go up. (Thanks, Abby Cohen, the stock analyst who was talking about Dow 20,000 a couple of years ago, and persuaded me to stay in the stock market. Yes, that "thanks" is sarcasm.)

I am about 15 years away from the magic age where I expect to start using some of that 401(k) money, so I have been allocating my new contributions to medium-term bond funds–funds that invest in corporate and governmental bonds that will come due roughly when I will start to draw down on that money–and very conservative stock growth funds (the kind that emphasize stocks that pay a regular dividend). I generally leave money that is already in existing funds in place, hoping that the managers of those funds are smart enough to make sensible decisions with the money.

I still think that people in their 20s should be investing primarily in stock growth funds–but I would emphasize growth funds that buy stocks in blue chip companies–the kind that pay dividends; not the funds that invest in companies that have never made any money, but that everyone knows are going to be worth a lot one of these days. Yeah, those days of high tech companies losing piles of money while their stock rises 800% a year will come again–but it seems like a pretty risky thing to put much money into. This isn't play money; you are going to need this to pay for your health insurance in 30 years.

I emphasized "hoping that the managers of those funds know what they are doing" a couple of paragraphs ago. This is one of the reasons why I think it is best to have the money in your 401(k) plan distributed among several different plans. I don't think it is likely that any of these mutual funds is going to make the headlines when the fund manager cashes out everyone's money and moves to Brazil. Mutual funds tend to have lots of checks and balances to prevent that sort of thing. But it is not unknown for mutual fund managers to make very, very poor decisions–and it would be nice if only 10% of your 401(k) money ended up disappointing you, instead of 100% of it.

You may not have access to a 401(k) fund at your employer. There are Individual Retirement Accounts available to you. I don't know enough about them to tell you much, however. (Well I could, but I might well mislead you, and I would rather not do that.)

Indecent Behavior With Your 401(k)

Vitally important: way too many people put piles of money into a 401(k) fund, then, when they leave their current employer, instead of leaving the money there, or rolling it over into their next employer's 401(k) fund–they take a distribution of the money. They thus get taxed on all that money as taxable income, plus pay a 10% penalty for doing so. Remember: high marginal tax bracket means that if you pull $30,000 out of a 401(k) fund, that will be added to your income for the year, and suddenly, you may find yourself being taxed at a 45% marginal tax rate, plus the 10% penalty. Your $30,000 windfall, after the IRS gets done with you, is now about $14,000. Hmmm. Maybe it would have been best to leave it there.

Some people get especially screwed on this because they take the money out when their job evaporates, live on it for a few months, and forget about the tax problem. Come the following April, they are scurrying around looking for $10,000 to pay to IRS and their state income tax agency.

Another really amazing behavior that I will mention, because I've heard of people doing this: a guy leaves a job he has held for 15 years to go to work for a startup. He takes a huge wad of money out of his 401(k) plan because he is convinced the startup is going to make him rich. He buys himself a very fancy car (so he doesn't have to wait for the startup to be successful). The startup makes him a very disappointing amount of money (if it doesn't just go down the tubes, like my last startup did). Whoops! There went $65,000 on a fancy car–and it's not going to be available for his retirement in another 20 years. Dumb, dumb, dumb.