The best time for a young person to start saving for retirement is as soon as possible. So if you've secured your emergency savings account, thumbed through your employer's benefits package, and decided you're interested in stocks, where do you go from there?
The good news: People are saving more
According to the U.S. Bureau of Economic Analysis, the personal savings rate -- saving as a percentage of disposable income -- was 3.8% in March 2012, compared with -1% in 2006. Individuals are saving more, but the secret lies in what you do with the money. Some savings strategies prove smarter than others.
Start by contributing to your 401(k) to the point where you fully take advantage of any match offered by your employer. Many employers grant a match up to a certain percent of your salary. So in a 3% match situation, when you contribute any amount up to 3% of your salary, your employer matches this dollar for dollar. Notice what a difference increasing the contribution just a percent or two can make over the long haul in the example below:
Total Out-of-Pocket Contribution From Employee Over 40 Years
Value at Retirement (at age 65)
|1% contribution and 1% match||$16,000||$234,297|
|2% contribution and 2% match||$32,000||$468,559|
|3% contribution and 3% match||$48,000||$702,856|
Source: American Funds Tax-Deferred Investment Calculator. Author assumed a $40,000 annual salary with no raises, tax-deferred contributions beginning at age 25, and an 8% investment rate of return.
If you do nothing else to save for retirement, do this. Don't leave free money on the table.
Strongly consider a Roth IRA for your extra cash. Like a 401(k), a Roth IRA is a retirement account in which you can own investments like mutual funds and stocks. Although you don't get the same immediate tax break with a Roth that you do with a 401(k), the Roth lets you withdraw money down the road without paying a cent in income taxes, so long as you meet requirements for tax-free withdrawals. Contributing to a Roth IRA now sets you up for tax diversification for your retirement income streams.
Start with what you know
A good way to start investing in your Roth is to consider what you know. While familiarity with a company doesn't necessarily warrant investing in it, it provides a starting point. Evaluate the company and decide whether it is a great business with solid growth prospects that trades at a good value.
Walk down any city street and take note of the people proudly toting Coach (NYS: COH) bags or pecking away on their Apple (NAS: AAPL) iDevices. Both companies' products are stylish, trendy, and expensive. But instead of spending money on the companies' products, consider buying pieces of the entire companies. Both have solid businesses with the numbers to back them up.
The SEC's EDGAR system database is an example of a good place to start researching companies. There you can find company filings which contain information to help you evaluate a company. Yahoo! Finance is another great resource. Here's what I found.
Last quarter, Coach sales in China grew spectacularly as the company took advantage of the exploding luxury goods market in Asia, while North American same-store sales grew 6.7%. Gross margins for the company expanded, but the stock still appears undervalued compared to the rest of its industry.
Net sales per square foot in Apple retail stores grew almost 20% in 2011. Apple's stock price has pulled back in the last month and currently trades 14% off its 52-week high, making it look extremely cheap compared to the rest of the tech sector. Apple has a ton of cash on the balance sheet and will soon start rewarding shareholders with some of it in the form of a dividend.
Don't fall into this trap
While it might be tempting to invest in what's familiar, don't blindly let your approval of a company's products drive investing decisions. Green Mountain Coffee Roasters (NAS: GMCR) , the company behind Keurig brewers and the accompanying K-Cups, exemplifies this.
Green Mountain is facing patent expirations, and doubts are surfacing about its sales channel. Its increasing opacity in financial reporting and negative free cash flow present major red flags. At first glance the company appears undervalued, but a bevy of problems are brewing.
Start with whom you know
Instead of starting with what you know, start with whom you know by turning to expert investors like billionaire Warren Buffett. His Berkshire Hathaway (NYS: BRK.A) (NYS: BRK.B) has returned nearly 20% annually, spanning back to the LBJ administration -- a time when the S&P 500 averaged less than half that return.
Berkshire's revenue and earnings grew considerably last quarter. And if the class "A" shares are too rich for your blood at $120,000 apiece, consider Berkshire's "B" shares, which currently trade around $80. If you can't be Buffett, consider investing in him.
Of these stocks, I think Berkshire appears most enticing right now. It's a great business with good growth prospects, and Berkshire's management team is incomparable. But don't take my word for it; do your own research and consider funding a Roth IRA with one of these stocks today.
If you're feeling a bit overwhelmed at the prospect of digging through SEC filings, don't fret. We've combed through research and made it easy for you by providing three great stock ideas. Read about them in a free report here.
At the time this article was published Fool contributor Nicole Seghetti owns shares of Apple. She does a happy dance whenever she sees someone use an iDevice. The Motley Fool owns shares of Berkshire Hathaway and Apple. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters, Coach, Apple, and Berkshire Hathaway, creating a lurking gator position in Green Mountain Coffee Roasters, and creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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