The following post was originally published on Wealthminder
For most people in their 20′s, retirement is an abstract thing to worry about some time in the future. Because it is so far away, it’s easy not to think about it. That would be a mistake. Here are 7 retirement tips to help get 20 somethings on the right track.
Get started now
The #1 thing 20 somethings can do is to simply get started. Over 45 years, every dollar you save now will turn into 32 if you get an 8% annual return. You may not know exactly what your goals are or how much you will need at this point, but thepower of compounding is your biggest ally.
If you don’t feel you make enough to save anything now, use raises as an opportunity to get started. You were hopefully getting by on your current salary, so save some (or all) of your raise instead of increasing your consumption level.
Take advantage of free money
If you work for an employer that offers a 401k match, you should at least contribute enough to get the full match. This is free money. Say you make $50,000 and you employer matches 50% of your contributions up to 6% of your salary. By contributing $3,000 (6%), your employer will give you an extra $1,500 a year. It’s like you got a 3% raise without even trying. Even better, the earnings on this money grow tax-deferred.
To see just how lucrative this can be, look at the chart below. If our employee from above is 25 years old, gets a 3% cost of living raise each year and earns 8%, the value of these matching dollars will be over $575,000 by the time he turns 65. That’s a lot of free money.
Use tax advantaged accounts
As you can hopefully see from the preceding example, the power of tax free compounding is tremendous. If you have a 401K at work, take advantage of it. If not, fund an IRA or Roth IRA. In addition to tax-deferred growth, you’ll also reduce your current tax bill. Finally, because you can’t touch this money (with a few exceptions) until you turn 59 1/2, it will help you resist the urge to spend it.
Create a discipline of saving regularly. 401k accounts are great for this because your employer takes the money right out of your paycheck before you have a chance to spend it, but you can accomplish the same thing on your own. Set up automated transfers from your bank account to a brokerage account when your pay check comes in. The hardest thing for most people to do is resist the urge to consume today. The more you can do to take your emotions out of the equation and enforce discipline through automation, the better.
You are young. Use that to your advantage. Stock markets are volatile and can experience significant short-term losses. As we get older, we may not have sufficient time to ride out the storm and wait for the inevitable rebound. As a result, we put more in safer, lower returning assets. In your 20′s though, time is your friend. Outside of the emotional roller-coaster of seeing your assets go down, there is no reason not to be in higher returning equities for the bulk of your portfolio.
Have an emergency fund
Unexpected things happen to all of us. People get laid off. Medical emergencies happen. Cars break down. Once you’ve taken advantage of any free money you get from your employer’s 401k plan, your next financial priority should be to establish an emergency fund. At your age, this should be at least 3 months of income. Without this in place, you will have to scramble in the case of an emergency and likely either raid your retirement savings or take on credit card debt. Neither of these are good. Pulling from a retirement plan typically comes with a 20% tax penalty. In addition, you might be forced to sell holdings at the worst possible time, a market bottom, as layoffs and bad times for the stock market are often highly correlated.
Avoid credit card debt
Speaking of credit card debt, you should avoid it at all costs. There is no investment you will make that consistently generates returns higher than the interest rate you will pay on your credit card. If you do have credit card debt, pay it off before you start to invest. The quickest way to becoming poor, and worse, staying poor is to take on credit card debt. If the only way you can afford something you want is to finance it with a credit card, it means you really can’t afford it, so don’t buy it until you can.
Wrapping it up
If you follow these 7 pieces of advice, you’ll be well ahead of most people your age and on your way to a happy and prosperous retirement.
Have other retirement tips for 20 somethings? Have questions about what we’ve suggested? Are you a 20 something yourself with an investing related question? Feel free to add to the discussion through our comments section.
Embarrassed to ask your question publicly? No worries. Just send us an e-mail at [email protected].