The Bogleheads' Guide to Retirement Planning Read Online Free PDF

advantage of any raises you earn to increase your contributions. If your employer does not offer a plan, or if the only investment choices are high-expense funds with no employer match, you may be better off establishing a Roth IRA at an investment firm that offers low-cost plans and a low minimum investment amount. All of these concepts are discussed in other chapters throughout this book.
    Choosing the right mix of assets at the beginning of your career is not as important as getting started on retirement early and establishing good financial habits. At the beginning, it is the amount that you put into a plan that counts, rather than the return of the investment in the plan.
    It is not difficult to budget for retirement savings at an early age because your spending habits have not been developed. One core strategy that works is living below your means; this strategy entails distinguishing between wants and needs and deferring gratification (minimal use of credit and avoiding revolving credit altogether). There are also psychological benefits to getting started early. Money deferred from your paycheck has an out of sight, out of mind quality, and the quarterly statements that report your fund’s growth typically offer positive reinforcement for the decisions you have made.

THE TIME VALUE OF MONEY AND OTHER IMPORTANT CONCEPTS
    Letting your money work for you is a key component of saving for retirement. Compound interest, dollar cost averaging, tax-deferred savings, and diversification help lower your risk and boost your return on investment over time.
Compound Interest
    Compound interest is the interest on your principal plus interest on the interest you earned previously. For example, a single investment of $10,000 at 5 percent compounded annually earns $10,789 in interest over 15 years for a net amount of $20,789. Straight interest would accrue at the rate of $500 per year, $7,500 in total interest, for a net amount of $17,500. When interest is reinvested and compounds at 5 percent, it adds another $3,298 to the value. That is the magic of compound interest. To calculate compound interest, use one of the many compound interest calculators available on the Internet.
Rule of 72
    The rule of 72 offers another interesting perspective on compound interest. Divide the interest rate that an investment is earning into 72, and the quotient is the approximate number of years it will take for that investment to double. For example, an investment with a 7 percent total return will double in about 10 years and a 10 percent return will double in about 7 years.
Starting Early
    To illustrate the connection between compound interest and the importance of starting early, here is an example using a scenario from the Bogleheads’ Guide to Investing. Eric Early starts investing at age 25 and invests $4,000 each year in a Roth IRA until age 35 and then invests nothing. At 8 percent interest his $40,000 grows to more than $629,000 by age 65. Larry Lately begins at age 35 and invests $4,000 for the next 30 years. Assuming the same 8 percent rate of return on his $120,000 investment, Larry’s Roth account balance at age 65 is $489,000. It’s the power of compound interest over long periods of time that gives Eric the advantage.
Dollar Cost Averaging
    Dollar cost averaging is another math-based approach to investing that can boost returns over time. Dollar cost averaging is periodically investing a fixed dollar amount to purchase shares (usually a mutual fund). For example, if you set aside $100 each month and buy shares in the same mutual fund every month with that contribution, you are dollar cost averaging. It works to your benefit by buying more shares when the price is down and fewer shares when the price is up. Over a period of time, it lowers the average cost of the shares purchased. If you contribute to a retirement account each year, then by default you are dollar cost averaging.
Tax-Advantaged Savings
    Taxes erode retirement savings