By timestaff
September 15, 2008

Question: I’m a 50-year-old woman who has yet to set up any retirement fund. I have $5,000 that I can invest now to get started, and I may be able to invest another $1,000 to $2,000 every quarter. But I wonder whether this is just a high-risk gamble considering that I have such a short time until retirement. Besides, I’m not even sure where to put the money if I do start saving – in a 401(k), a Roth IRA, a CD or some other option? – A. Gonzalez

Answer: Saving for retirement a high-risk gamble? Hardly. The real risky bet for you would be to continue putting off saving for retirement until a even later date or, worse yet, forgo saving entirely. In fact, that wouldn’t be much of a gamble. Barring a huge inheritance or hitting the lottery, you would be virtually guaranteeing yourself a meager retirement at best.

But if you start saving now – and keep it up over the next 15 years or so – you still have a shot at accumulating a decent nest egg. I’m not saying you’ll be as well off as you would had you started saving 20 years ago. It’s not likely you’ll be able to squeeze a career’s worth of saving into 15 years. But if you really bear down in this home stretch to retirement, you still have a good shot at dramatically improving your retirement prospects. And you will definitely be better off than if you procrastinate further or save nothing at all.

So let’s outline exactly what you must do. Basically, you’ve got to deal with three questions: how to save, where to save and how to invest your savings? Let’s take them one by one.

How to save

It’s relatively simple to get a ballpark estimate of how much you must put away each year to have a shot at a comfortable retirement. Just go to our What You Need to Save calculator, plug in your age, income and the amount you’ve saved to date (which I gather for you is zilch), and you’ll get an immediate estimate of the dollar amount and percentage of salary you should save each year between now and age 65 to achieve a decent retirement.

Don’t be surprised if the savings target you get is daunting. That’s what happens when you put off saving until the end of your career. You’ve got to really sock it away to make up for all the years of saving and compounded returns you missed out on.

But at this point, the important thing isn’t to focus on what you didn’t do, but what you must do. So just try to get as close to the recommended savings level as you can so you can at least start making some progress. And, in fact, if you follow through with your plan and put away the $5,000 you mentioned and then another $2,000 a quarter as you say you may be able to do, by age 65, you would have roughly $340,000, assuming an 8% return. That’s a pretty good-sized nest egg starting from scratch at age 50.

Where to save

Let’s start with that $5,000 you mentioned. To get the biggest savings bang for those bucks, you want to put it into a vehicle that has some tax advantages. Basically, you have two choices: a traditional deductible IRA or a Roth IRA. With a deductible IRA, you get a tax deduction for your contribution and the investment gains on that contribution grow free of taxes, although you are eventually taxed when you withdraw the money. With a Roth IRA, you get not upfront tax break, but you can eventually withdraw your contributions and earnings free of taxes in retirement.

As I explained in a feature I wrote on Roth accounts in Money Magazine’s October issue, you’re generally better off in a deductible IRA if you think you’ll be in a lower tax bracket after you retire, while a Roth is the better deal if you think you’ll face the same or higher tax rate. People who are diligent savers and build up sizable balances in retirement accounts tend to be better candidates for a Roth IRA. Given your lack of savings to date, I expect you’re more likely to move into a lower tax bracket in retirement, which would make the deductible IRA a better choice. But you can check out this calculator to compare the two.

This assumes that you qualify for either or both types of IRAs, which I expect will be the case, although you can find out here. If you don’t qualify for either, you can put this five grand into a nondeductible IRA – which anyone under age 70 1/2 with earned income can open – and then later convert it to a Roth IRA.

As for the $1,000 to $2,000 you think you can save on an ongoing basis, your best bet for that money is to get it into a 401(k), which I assume is a possibility for you since you specifically referred to a 401(k) as an option in your question. There are lots of advantages to 401(k)s. But for someone like you who obviously has some trouble saving, the main selling point is convenience. Your savings go directly from your paycheck into your 401(k) account before you have a chance to get your hands on the money and spend it. That’s a huge, huge plus when you’re trying to build a nest egg in a hurry.

The other possible advantage is an employer match. If your employer offers one – and most do, typically 50 cents on the dollar up to the first 6% of salary you contribute – contributing to the 401(k) leverages your savings effort and makes it more likely you’ll be able to meet your annual savings target, or at least get closer to it. So at the very least, you want to be sure to put enough in your 401(k) to take full advantage of any employer match.

Where to invest your savings

You need the long-term growth potential of stock funds so that you have a chance to boost the value of your savings over the next 15 years. But you also need some bonds so your nest egg isn’t totally devastated by market setbacks. There’s no single “correct” mix of stocks and bonds for someone in your position. But if you invest roughly 70% to 75% of your savings in stocks and the rest in bonds, that should give you the long-term growth you need while affording a bit of downside protection.

One caveat: Some people who are getting a late start on retirement planning are tempted to invest much more aggressively because they figure higher investment returns can compensate for their lack of savings and boost the value of their nest egg. Remember, though, that higher returns come with higher risk – and there’s no guarantee the higher risk will pay off. You could end up with lower returns and a smaller nest egg. So I’d be wary of dialing up your stock exposure much beyond the range I’ve indicated. (As I’d be wary of scaling back stock exposure, unless you’re willing to really ramp up the amount you save.)

As for how to put together this blend of stocks and bonds, you have several choices. You can put together a portfolio yourself with individual stock and bond funds, if you’re comfortable doing that sort of thing. Or you can buy a fund known as a target-date fund that does it for you. Just pick a target fund with a date that roughly corresponds to the year you plan to retire – say, 2025 in your case – and you’ll get a ready-made mix of stocks and bonds that’s appropriate for your age. The fund will also gradually shift a larger percentage of its assets into bonds each year so that the fund becomes less risky as you near retirement.

Of course, you also have the option of having a professional money manager create a portfolio for you, but that’s usually not very cost effective for someone just starting out investing small sums. That said, some 401(K) plans now offer a “managed account” option in which an investment firm essentially manages your 401(k) investments for you. Read more on this option and how it compares to target-date funds or just doing it yourself.

For now, though, the single important thing you can do to improve your retirement prospects is start socking away as much money as you can and keep it at year after year. Because if you don’t start some serious saving soon, all the decisions about where to save and how to invest your money won’t amount to a hill of beans – or result in much of a nest egg.

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