By Paul B. Farrell
First off, I'm glad you're finally committed to saving for retirement. It's a long journey. For a 25-year-old, it's 30 to 40 years down the road, to 2037 or 2047. Start by avoiding those silly online financial calculators and any financial planners who blabber on about needing $1,000,000 to retire ... that's darn discouraging when you're stuck with lots of bills and little in the bank.
Here's how Kevin Roth, an 8-year-old second-grader got started. He got a gift from grandma and a few hints from his father, Allan, a no-nonsense financial planner in Colorado Springs. It's a simple portfolio of three no-load, low-cost index funds.
Yes, it does cost a minimum investment of $3,000 in each of the funds, for a total of $9,000. But my advice to David is: You have to start somewhere, so shoot for this one.
The second-grader starter portfolio
| Fund | Initial investment | Allocation | 1-year return | 5-year annualized return | 10-year annualized return |
| Vanguard Total Stock Market Index (NASDAQ:VTSMX - News) | $3,000 | 60% | 15.5% | 7.42% | 8.57% |
| Vanguard Total International Stock Index (NASDAQ:VGTSX - News) | $3,000 | 30% | 26.6% | 16.1% | 7.79% |
| Vanguard Total Bond Market Index (NASDAQ:VBMFX - News) | $3,000 | 10% | 4.27% | 4.61% | 5.96% |
| Portfolio | $9,000 | 100% | 17.73% | 9.74% | 8.08% |
| S&P 500 Index (NASDAQ:VFINX - News) | 15.79% | 6.19% | 6.42% |
Please note that this second grader's portfolio not only beat the S&P 500 by two percentage points last year according to Morningstar's data, it actually beat all five of our lazy portfolios in 2006, so we may add it to our list! Read more on lazy portfolios.
And if you prefer to use exchange-traded funds for your portfolio, you could replace the mutual funds with Vanguard Total Stock Market Index (AMEX:VTI - News), iShares Lehman Aggregate Bond Index (AMEX:AGG - News) and iShares MSCI EAFE International Index (AMEX:EFA - News).
Also note there's less risk here than with the S&P 500 alone. Morningstar's risk analyzer says there's a 5% probability that the S&P 500 fund will decline by 12% or more. But there is only a 5% probability the three-fund portfolio will decline by 10% or more. Here's how Allan describes the advantages his son has over most adults:
- The calculations suggest Kevin's portfolio beats 95% of professional portfolios (the worst performing of the three funds beat 65% of its peers) in 2006.
- By owning the entire market, Kevin will beat the average dollar invested because his costs are so low.
- Don't confuse owning lots of funds with being diversified; three's enough.
- Kevin has other advantages over adults: He doesn't go to cocktail parties where people brag about their investments.
- No financial planners (a.k.a. salespeople) call on him to exploit emotions.
- He doesn't watch the financial shows on TV -- doesn't even know who Jim Cramer is.
The point is: Bite the bullet. It's time for some discipline, so forget about a new plasma TV and focus on a starter portfolio. There are a million ways to procrastinate ... but I promise you, once you start, it gets progressively easier (set up automatic deductions from payroll and get used to living on less). Just start! Do something! Action! Put a hundred bucks in the cookie jar. Buy one fund. Take responsibility.
Remember: Nothing saved equals nothing invested equals no compounding equals no comfortable retirement for you and your spouse. Heed Charles Schwab's caveat: For every five years you wait to start, you'll have to put aside twice as much annually to reach that million-dollar retirement nest egg.
Compounding: $68,800 grows into a millionaire!
But is it really that big a mountain? Do you really need to stash away one million one-dollar bills under your mattress for decades? No! Once you know the oh-so-easy magic of compounding, you can relax. Here's how Bill O'Neil, the publisher of Investors Business Daily, explains it in his classic "How to Make Money in Stocks:""Think you'll never have a million dollars? It's easier to obtain than you might think -- if you're young and patient. Thanks to the power of compounding, a 25-year-old needs to invest only $1,720 a year to reach seven figures by age 65. That assumes an 11% average annual return," and that's not even a fully funded IRA.
His next big point is the key: "For investors who start young, most of that $1 million is interest [and reinvested dividends]. By age 65, the 25-year-old has invested only $68,800 -- less than 10% of the ending balance." Please get it! That's the amazing magic of compounding: You'll retire a millionaire by investing a mere $68,800 total over the years, the other $931,200 "grows" magically over time, thanks to compounding.
Since "Wall Street portfolios are burdened with fees and taxes amounting to nearly four times greater than Kevin's, and since their portfolios are, therefore, mathematically destined to lose in this sum-zero game," says Allan, "this 8-year-old's basic understanding of simple arithmetic is giving him a clear advantage over us adults" who know too much and are too smart for their own good.
So, go slow. Forget about having a million bucks in the 2040's. People get so overwhelmed by such a huge sum, they get paralyzed and never start saving. Just focus on getting $1,720 for this year. Or fully fund your 2007 IRA with $4,000. Even better, go for that magical $10,000. Open an account somewhere, start with something.
Forget the million-dollar goal. Stay in today, 2007. It'll all work out. Meanwhile enjoy the family, picnics, movies, and keep putting a few bucks a day in the cookie jar.
The laziest of all 'portfolios' for the laziest of investors
The truth is, most Americans have little interest in investing, stocks, funds and portfolios of any kind, active or lazy. But they do know they have to do something or they'll have nothing for retirement. So here are the absolutely laziest-of-the-lazy portfolios for them, a one-fund miniature portfolio that for the next few decades can work like a simple savings account that you just deposit money in on a regular basis, year after year, and let fund managers do all the heavy lifting."Lifestyle" or "target retirement" funds are perfect for people retiring in three or four decades who don't want to bother with all the nonsense they hear from Wall Street and the mutual fund industry. The idea is simple: They have more equities in the early years, then gradually shift to more fixed-income securities later. You can start with just a few thousand:
| Fund | Minimum investment | 1-year return | 3-year annualized return | Assets (in billions) |
| Fidelity Freedom 2010 (NASDAQ:FFFCX - News) | $2,500 | 9.46% | 7.53% | $12.2 |
| Fidelity Freedom 2020 (NASDAQ:FFFDX - News) | 2,500 | 11.6 | 9.63 | 16.8 |
| Fidelity Freedom 2035 (NASDAQ:FFTHX - News) | 2,500 | 12.94 | 10.95 | 2.0 |
| T. Rowe Price Retirement 2010 (NASDAQ:TRRAX - News) | 2,500 | 12.84 | 10.03 | 2.8 |
| T. Rowe Price Retirement 2020 (NASDAQ:TRRBX - News) | 2,500 | 14.66 | 11.5 | 3.8 |
| T. Rowe Price Retirement 2035 (NASDAQ:TRRJX - News) | 2,500 | 16.18 | n/a | 0.8 |
| Vanguard Target Retirement 15 (NASDAQ:VTXVX - News) | 3,000 | 11.42 | 8.43 | 4.3 |
| Vanguard Target Retirement 25 (NASDAQ:VTTVX - News) | 3,000 | 13.25 | 9.55 | 4.6 |
| Vanguard Target Retirement 35 (NASDAQ:VTTHX - News) | 3,000 | 15.24 | 11.10 | 3.0 |
| S&P 500 | 15.79 | 6.19 |
Source: Morningstar Inc. data as of Dec. 31.
You can find more details on these lifestyle or target retirement funds online. But whether you settle for one of these funds or you start with Kevin's "super-small" three-fund lazy portfolio -- or you begin building one of our five lazy portfolios -- it's time for action! Only 20-35% of Americans are saving enough to retire, so remember: Nothing saved ... equals nothing invested ... equals nothing compounded ... equals a less than dreamy retirement.
