The only advice you will ever need to retire a millionaire is this. Invest as much as you can (at least 10% of every penny you ever earn) in a stock market index fund and forget about it. Simple as that. Of course, not all of us are taught about the power of compound interest at school, but we darned well should be. The earlier one starts the better. But as with many things in life, better late than never.
Everybody's financial situation is different. Some earn a regular salary, some such as contractors are in and out of work on a regular basis, but the crucial point is to put money away, ideally where it's not easy to get at, and leave it there.
It is important to keep track of expenses, to identify areas where costs can be cut, and cash freed up for investing. Small amounts spent on a daily basis can soon add up to big money. Do you really need a cappuccino every morning, or a couple of cokes a day out of a vending machine? Instead of spending “found money,” like raises and bonuses, add it to your retirement savings.
Be sure to invest the maximum in your retirement savings plan at work. Many schemes offer a match on your contribution, perhaps 1/2 up to 5% of what you contribute. This is free money. A pay rise. It never ceases to amaze me how many people do not take advantage of this. And, if you can, contribute the most you can to a Roth or Traditional IRA.
Beginning in 2002, you may be able to defer more of your salary each year into your 401(k), 403(b) or 457 plan. You may be able to defer additional amounts if you’re 50 or older. For example, in 2002, the contribution limit for workers under 50 will increase to $11,000 from $10,500; if a plan adopts the “catch-up contributions” provision, participants 50 or older can contribute $12,000. By 2006, the contribution limit will reach $15,000 for workers under age 50, and $20,000 for 50-plus workers.
The tax law also raises the amount you can contribute to a Roth or a Traditional IRA from $2,000 to $3,000 in 2002. This limit increases in future years, topping out at $6,000 by 2008. If you’re 50 or older, you may contribute an additional $500 for 2002 through 2005, and $1,000 more in 2006 through 2008.
Dollar Cost Averaging
The object is to invest a set amount of money at regular intervals so the
average cost of shares tends to even out the market's peaks and troughs.
Your dollars purchase fewer shares when the market is up, but they buy
more when it's down. While you may not achieve the positive results of
buying at the market's low point and selling at its high point, neither
will you suffer the consequences of doing the opposite. On average, in a
generally rising market, you have the opportunity to accumulate wealth
over time in a systematic, organized way.
Four things to remember about dollar-cost averaging
In the long run, it doesn't matter when you start, just that you start. Over a long enough period, it makes little difference whether the market was up or down when you began.
Making monthly additions to your account allows you three times as many opportunities to benefit from favorable market swings as investing on a quarterly basis. On the other hand, of course, it provides three times as many chances for your account to be adversely affected by market swings. The more frequently you invest and the longer you keep investing, the smoother the average-share-cost line becomes.
A market decline can mean bargain prices. Unless you are selling shares, a fund's price quote in the daily paper is not relevant for anyone who is not planning to sell, so don't panic if it is down. In fact, a downturn provides the opportunity to buy more shares at attractive prices -- shares that have the potential to grow in value when the market finally turns upward.
Be prepared to weather a sustained market decline. Keep in mind that in order for dollar-cost averaging to work, you must be prepared to commit the financial resources and have the resolve to make the contributions on each appointed date.
Regular investing does not ensure a profit and does not protect against loss in declining markets. Investors should consider their ability to invest continuously during periods of fluctuating price levels.
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© R Salter, 28 Sep 2003