This is the fifth and final post in my Personal Finance in Your 20's series. It's all about making sure that when you are finally ready to quit your day job you are able to do so.
Most people in their 20's are not yet thinking about planning for retirement. That's a shame because the earlier you start saving, the less you need to invest in order to assure yourself a comfortable retirement. It's all about that famous magic of compound interest.
From my conversations with young employees in my company, and from what I remember about myself from just a few years ago, many people in their 20's don't save for retirement not because they can't or don't want to do so, but because they are either overwhelmed by the topic, are afraid of making a mistake or simply don't know where to start. In my opinion, not saving is the biggest mistake of all.
Below are five strategies that I would follow if I were in my 20's and starting to save for retirement today:
1. Figuring Our What You Will Need - if you research the topic of retirement planning online, you are bound to come across advice telling you to figure out what your financial needs will be in retirement and to build your plan accordingly. Trouble is, in your 20's there really is no way for you to know how much you will need forty years down the line. So I say, forget about figuring out your needs. Save as much as you can afford, and at least 10% of your gross pay. If at some point in the future you decide that you are saving too much, saving less is always possible. Going back in time to save more is a bit more tricky.
2. Invest in a ROTH IRA - the great thing about making a pittance is that your taxes are low... OK, there is nothing great about making a pittance, but the point I am trying to make is that it is likely that you are paying less tax now than you ever will in the future. That means, that if you invest your retirement money in a ROTH IRA, you will be paying very little tax now (because your tax bracket is lower) and you will be paying NO taxes when you withdraw the money. Not paying taxes rocks.
3. Invest Aggressively - if you are starting to save for retirement in your 20's your time horizon for your investment can be as long as forty years or more. With that vast amount of time, I would be quite aggressive in my investment strategy, investing close to 100% of my assets in the stock market. If you have enough time for your investments to recover from eventual bear markets, stocks tend to outperform other investment options.
4. Sign Up for Your Company's 401(k) & Get Matching Funds - Who said there is no such thing as a free lunch? If your company matches your 401(k) contributions, or even a part of them, you are getting free money. Take it. I am always amazed that about 20% of the employees in my company are not signed up for the 401(k) plan. These people are essentially refusing a gift of cold, hard cash.
5. Keep it Simple - If you are overwhelmed by all the investment options that you have, the best strategy for you is to keep things simple. If your company offers a target retirement fund in its 401(K), put all your money in the one fund that matches your planned retirement date. The asset mix in such funds shifts as you age, to reduce your level of risk. If you are investing in an IRA or other account that you manage yourself, put your money in a highly diversified stock equity fund, such as Vanguard's VTSMX. Over time you can improve your investment strategy and become more sophisticated. If you wait until you feel more confident in your investments, you may never get started, and that is the biggest investment mistake you can make.