Retirement for the 20-something saver

Don't let the bear market turn you off. If you've got 30 to 40 years until retirement, you should be saving more -- not less.

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By Walter Updegrave, Money Magazine senior editor

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

NEW YORK (Money) -- Question: My wife and I are 27 years old and have contributed to a Roth IRA the past two years. Our money is in a 2040 target-date retirement fund that has about 90% of its assets invested in stocks and the rest in bonds and money-market funds. Should we continue to contribute the maximum to our Roth IRA if this is our only retirement vehicle? And is a portfolio mix of 90% stocks and 10% bonds and cash right for this volatile market?  Joe, Lancaster, Ohio

Answer: Let's start with the more straightforward of the questions you ask: Is a portfolio mix of 90% stocks-10% bonds and cash appropriate given today's yo-yoing financial markets?

The short answer is yes.

You and your wife likely have a good 40 or so years before you'll be dipping into your savings stash for retirement. You don't need to be very concerned about short-term setbacks in the market -- even steep ones -- because you've got decades to recover from them.

Rather, your primary goal should be to grow the $5,000 maximum contribution you can sock away in a Roth IRA each year (an amount that goes up in $500 increments with inflation) as much as reasonably possible so your account will be large enough to support you in retirement.

Although there are no guarantees, your best shot at getting the long-term growth you need is to invest in a portfolio consisting mostly of stocks. That's because over very long periods, stocks typically generate much higher returns than bonds and cash.

The reason is that stocks are riskier than other investments, which means that they're usually priced to provide higher long-term gains.

This isn't always the case. Sometimes investors become overconfident, and bid up stock prices. When that happens, stocks become vulnerable to a downturn, which reduces their return. But once they flame out, as they've done recently, investors become wary of stocks again and are willing to pay less for them. This wariness (and the resulting low levels of stock prices) actually boosts stocks' long-term upside potential.

So even though keeping most of your money in stocks may seem like the most dangerous thing you could do right now, it's actually a prudent move if you're investing money you need to grow and that you won't be touching for decades.

Of course, the whole idea of a target-date retirement fund is that it automatically shifts more of its assets into bonds and cash as you approach retirement. But these funds don't all make that adjustment in a uniform manner. Some can be much more volatile than others just at the time when you most crave security -- prior to and during retirement. So as you and your wife get older, you'll definitely need to re-evaluate your holdings to assure the stocks-bonds mix is still appropriate.

How much is enough?

As for your second query -- should you continue to contribute the maximum -- there are actually two issues you need to consider. The first is whether the amount you're contributing is sufficient. The second is whether whatever amount you decide to put away should go into a Roth IRA or into some other type of account.

The best indicator of whether you're saving enough is to look at your savings rate -- that is, the amount you set aside for retirement as a percentage of your annual earnings. Once you know that, as well as the amount of money you already have saved, you can get a decent sense of whether or not you need to step up your effort.

Since you don't mention how much you earn, I can't translate a $5,000 IRA contribution to an annual savings rate. I also don't know the current value of your account. That makes it tough for me to know if your savings regimen is reasonable.

Not to worry. You and your wife can quickly see whether you're roughly on track to a secure retirement by going to our What You Need to Save Calculator. (You and your wife should go through this exercise separately, as the calculator is designed for individuals, not couples.)

If the calculator tells you that you should be saving, say, 12% of salary and you're saving around 8% (which would be the case if you earn $60,000 a year and contribute $5,000 to your Roth IRA), then you probably also want to save outside your Roth to get closer to that 12% target. On the other hand, if your $5,000 contribution puts you at or above the percentage suggested by the calculator, then you're on track, at least for now.

Keep in mind, that no calculator can pinpoint the exact amount you should save. There are plenty of other variables -- the returns you'll earn, how consistently you'll be able to sustain your savings regimen, the standard of living you'll want to maintain in retirement, etc. -- that make a high degree of precision impossible.

So my advice is to err on the conservative side -- that is, save a bit more than the calculator suggests.

To Roth or not to Roth

Finally, there's the matter of whether a Roth IRA is the best place for your retirement savings. With a Roth IRA, you pay taxes upfront on your contribution in return for tax-free withdrawals in retirement. With a traditional IRA, you get a tax deduction, but then pay income tax on your withdrawals. This means that a Roth account is generally a better deal if you expect to face the same or higher tax rate in retirement than when you make your contribution, while a traditional IRA or other account that gives you the tax break upfront (such as a 401(k)) is better if you expect to face a lower tax rate later.

You and your wife are young. So if you also expect your earnings to rise relatively steadily between now and retirement, a Roth IRA is likely a good choice, at least for now.

That said, I don't think it's a good idea for most people to have their entire retirement stash in one type of account. Ideally, you want to have some money in both tax-deferred accounts (401(k), deductible IRAs) and tax-free accounts (Roth IRA, Roth 401(k)) so that you can diversify your tax exposure in retirement.

So sometime in the not-too-distant future you and your wife should consider broadening your savings regimen so that all your savings aren't in a Roth account. At some point in your careers, you and your wife may work for a company that offers a 401(k) plan, and you'll be able to build a pot of tax-deferred savings to complement your Roth. You may also be able to contribute to a traditional IRA, assuming you're eligible.

For now, though, the single most important thing that you and your wife can do is make sure that you're putting enough bucks away on a regular basis. Because if you fall short on that score, it will be much harder to achieve a comfortable retirement no matter how you invest your money and regardless of what type of account you keep it in. To top of page

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