More Straight Talk on Investing. John J. Brennan

Most people should take the same point of view.) By continuing to pump money into her retirement plan at that level, Jane accumulated an impressive sum of money over her 30-year career. It takes discipline not to use all of that salary increase for immediate gratification, but in time you won't miss that “extra” money and will be better served in the long run by earmarking it for retirement.

      There are three great advantages to saving through an employer plan. First, your contributions will accumulate on a tax-advantaged basis. Second, the process keeps you saving without any effort of your own. You don't have to make yourself transfer money or write any checks, and you won't be tempted to spend the money before “paying yourself” first. Third, you will be investing a regular amount on a regular basis, a prudent and effective strategy known as dollar-cost averaging. (I'll discuss this strategy several times throughout the book.)

Plenty of ordinary people are saving an unbelievable amount of money through employer-sponsored retirement plans. In the 401(k) plans managed by Vanguard in 2019, there are more than 62,000 individuals who are millionaires. And thousands of other ordinary people are on the way to amassing extraordinary wealth.

      Baseline Basics: Accounts for Retirement Investing

      There are numerous retirement-oriented accounts to help achieve your investing goals. Similar to college savings programs, there are pros and cons associated with the various options, along with rules that may limit their use and availability. I will cover the two mainstays—IRAs and 401(k) plans—at a high level. However, you may have other options available to you depending on your employment status. For instance, if you work for a non-profit institution, such as a hospital or university, a 403(b)(7) plan may be an option. If you are self-employed, you'll have your pick of a SEP IRA, Simple IRA, or individual 401(k) plan.

       Individual Retirement Accounts. IRAs enable you to invest on a tax-advantaged basis for retirement. With a traditional IRA, you may be able to deduct some or all of your contribution from your current income taxes depending on your income. Once you start taking withdrawals, they are taxed as regular income. Note that you'll be required to take distributions as some point in your early 70s. Roth IRA contributions are not tax deductible, but your withdrawals in retirement will be completely tax-free and you will not face required minimum distributions. Your income, however, may limit your ability to contribute to a Roth IRA.You can establish an IRA at a bank, brokerage firm, or mutual fund provider and, therefore, have many investment options from which to choose. You can contribute up to $6,000 a year ($7,000 if over 50 years of age) in 2021 to a traditional IRA, a Roth IRA, or a combination of the two. For most people, though, the Roth IRA is the better bet because of the tax-free withdrawals in retirement.

       401(k) plans. If you work for a company, it is likely that a 401(k) will be among the benefits you receive as an employee. Like an IRA, you'll be able to sock away money on a pre-tax basis, which will then grow on a tax-advantaged basis. When you start to withdraw the money in retirement, it will be taxed at your then-current rate. With a Roth 401(k), your contributions are made with after-tax dollars and your account grows tax-advantaged. When it comes time to tap your account in retirement, your withdrawals won't be taxed. You can invest up to $19,500 in a 401(k) plan in 2021. You can kick in another $6,500 if over the age of 50.If you are fortunate, your employer will offer a matching contribution up to a certain level. For instance, you might receive a full match of your contributions up to 4% of your take-home pay. A good 401(k) plan will also offer you a full menu of low-cost funds from which to assemble a portfolio.

Your Debt Plan

      So far, I've been discussing how to manage the assets on your personal balance sheet. Now let's think about liabilities—the debts you owe in the form of credit card bills, car payments, mortgage payments, and so on. Part of a sound financial plan includes developing a philosophy on debt. My philosophy can be summed up with a simple proverb: “Loans and debts make worry and frets.”

      I've long had a strong aversion to debt. My wife and I started our life together with sizable loans from graduate school and no tangible assets other than a 10-year-old Volkswagen Rabbit. I loathed writing those loan payment checks every month throughout the early 1980s, especially because of the relatively high interest rates that existed at the time. As a result of that experience, my wife and I resolved to avoid debt whenever possible. Not everyone feels as strongly about debt as I do, but even if you don't, you should give serious consideration to several debt issues.

With debt, I recommend borrowing only for long-lived assets. An education serves you throughout your life, so college loans are okay, or “good debt.” A house will last a long time, so mortgage loans are necessary and sensible. You will also be building equity in your home. That said, be cautious about home-equity loans and other second mortgage borrowing. Cars also are relatively long-lived purchases, so car loans at reasonable interest rates make sense if the length of the loan is less than the length of time you expect to own the car. But borrowing for consumables—clothes, dining out, entertainment, and travel—is likely to get you into trouble and hinder reaching your investment goals. I would consider a credit card balance with a high interest rate as “bad debt.”

      Indebtedness is both an economic issue and a peace-of-mind issue, so the following are some other important debt considerations to weigh.

      Are You Mortgaged to the Hilt?

      For most people, the single biggest debt obligation is a mortgage. The question here is not whether to have a mortgage—few people could buy a house without one—but how to minimize the weight of that debt. Many people view their home as their biggest investment, hoping that it will appreciate in value and help to finance their retirement.

      But the debt issues of homeownership sometimes get overlooked. Taking out a big mortgage in order to buy an expensive house could create a debt burden that you'll regret later. What's more, you might become house poor, meaning that the expenses associated with home- ownership preclude you from spending on other things or, more importantly, saving.

      You can measure your mortgage burden by calculating your loan-to-value ratio. Think of the loan-to-value ratio as the percentage of your house that belongs to the mortgage company instead of to you. Suppose that at age 30 you buy a home for $250,000. You make a down payment of $25,000 and take out a 30-year mortgage for $225,000. Your loan-to-value ratio is 225/250, or 90%, because you've paid for only 10% of the house's value. As you make payments over the years, you will steadily build up equity in your home, and your loan-to-value ratio will decline. If your home also grows in value over the years, the ratio will shrink faster. Suppose you still own the house when you're 50 and your remaining mortgage is $125,247, but the house is now worth $350,000. Your loan-to-value ratio is just 36%.

Most homeowners don't worry much about their mortgage debt because they count on their house rising in value over time. It doesn't always work that way. The bursting of the housing bubble in 2007 was one of the key catalysts of the Global Financial Crisis and led to a tidal wave of foreclosures. Here's what happened. Housing prices were on the rise. Relaxed lending standards enabled many individuals to purchase a home, and many overextended themselves. When housing prices then declined dramatically, many homeowners found themselves upside down, meaning their home was valued less than their mortgage. Some had trouble making the monthly mortgage payments; others became forced sellers in a down housing market.

      Returning to our example, consider the home you purchased for $250,000 is now worth $175,000, or 128%! With a mortgage of $225,000, your loan-to-ratio is 225/175. Consider a house a place to live, not an investment. If you are fortunate, it will rise in value over time, but don't bank on it.

      If you are in a high-risk profession that is subject to industry downturns and periodic layoffs, it is sensible to avoid a heavy mortgage burden because you don't want the fixed cost of a large monthly mortgage payment if you are out of work for a time. But if you have some reasonable level of job security, you may not be as concerned about the size of your