For many new educators, life is full of firsts: first jobs, first apartments, first cars, and in many cases, it's the first real opportunity to invest for the future. With so many new responsibilities – from organizing a classroom to managing a steady paycheck – it can be tough to start thinking about retirement. But spending some time early in your career learning the basics of investing can reap substantial rewards now and in the years ahead.
As a California educator, you participate in a defined benefit pension plan through CalSTRS or CalPERS. However, pension plans – even those as good as CalSTRS and CalPERS – are not designed to replace the 80% to 100% of pre-retirement income that many financial experts say you'll need in order to maintain your pre-retirement lifestyle once you retire. That's where participating in your district's 403(b) or 457 plan comes in, to give you the opportunity for voluntary savings to supplement your pension benefit.
Even if you can only afford to invest a small sum at regular intervals your long time horizon gives you a unique opportunity to maximize the benefits of compounding. Consider this example: If starting at age 25 you save $50 per semimonthly paycheck in a tax-deferred* 403(b) or 457 plan with an average annual gain of 6%, your balance could grow to more than $100,000 by the time you reach age 55.** You would have invested just $36,000 of your pay; the remaining $64,000 would be earnings.
Now that you recognize the value of long-term compounding, consider signing up for your district's 403(b) or 457 plan. Additionally, here are a few tips to get you started with your investment strategy:
Understand investment risk. In general, there is a relationship between risk and return: Historically, over the long term, stocks and stock funds have outperformed more conservative investments. However, stocks and stock funds tend to have more risk than other investments. There is also risk in playing it too safe. Choosing investments, such as fixed annuities, with returns that may not keep pace with inflation exposes you to inflation risk. It can quietly erode future spending power and reduce the value of your assets.
Stick with it. The inevitable highs and lows of the stock market can distress even the most seasoned investors – and they can be downright unnerving for newcomers. Using a systematic investment approach called dollar-cost averaging may help make the most of those ups and downs.*** With dollar-cost averaging, you invest a set amount at regular intervals, regardless of what the market is doing. This strategy allows you to take advantage of market fluctuations by purchasing more shares when prices are low. Owning more shares puts you in a better position to potentially benefit if prices increase in the future. By making regular contributions through payroll reduction to your 403(b) or 457 plan, you are practicing systematic investing.
Maximize tax advantages. Investing in a tax-advantaged account like your 403(b) or 457 plan allows you to reap additional benefits. Having pre-tax dollars automatically transferred from your paycheck to your plan helps reduce your taxable income and your tax bill. In addition, your retirement plan account grows tax-deferred, which further increases your current tax savings (you don't have to pay taxes on interest income, dividends and capital gains every year as you would for a taxable account) and allows your account to grow faster than an equivalent taxable account.*
Seek professional guidance. Investing your hard-earned money can be a challenging and emotional process, but you don't have to go it alone. A financial advisor can help you work out your retirement planning strategy. Before choosing a financial advisor, be sure to read "The CTA Guide to Working with a 403(b) or 457 Advisor."
* Taxes will be due at ordinary income tax rates upon withdrawal. Premature withdrawals from a 403(b) (generally, those made before age 59½) may be subject to a 10% tax penalty, too (does not apply to 457 plans).
** Rate of return is for illustration only and does not represent the return of any specific investment. Your returns will vary.
*** A program of regular investing cannot guarantee a profit or protect against loss in a declining market. You should consider your ability to continue investing during periods of low price levels.