Saturday, June 23, 2007

Planning for Retirement in Your 20's

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.


dtoomey said...

all good ideas - i wish i had read this blog back in my 20's... at least i jumped on that matching 401K band-wagon back then... curious to know how things will end up for those currently in their 20s who have greater access to insightful blogs like this one - vs. increasing consumerism driving the nation's negative savings rate. Hmmm...

Super Saver said...


Looking back to my twenties, I fully agree.

Anonymous said...

Thanks for the great series. I read it very carefully as I AM in my 20's, fell into a GREAT job, and realize there is great financial potential if I make the right choices now.

Everyone says "start young" or "don't make mistakes when you're young" or "i wish i would have... when I was young." But not very many people offer practical advice of what to do WHILE your young, have a great paying job, and need to know what to do with all that disposable cash.

A few points of reaction:
1. House. I bought one. The housing market where I live was far too tempting not to, I couldn't stand living with family a second longer, and I wasn't about to throw away thousands in rent. I think if you're planning on staying with your current job for at least 5 years, and you are in a strong growth area, you can't do any harm purchasing a house. It also helps TREMENDOUSLY at tax time, since I have no dependents to claim on my return.

2. Savings: I currently contribute 6% to the company 401k and my company kicks in an extra 4% (yay for free money), but having non-taxable savings seems VERY attractive. I will definitely look into the ROTH IRA. I hadn't considered IRAs, since I have pretty much maxed my current paycheck out.

3. Stock: I have several thousand shares of options in my company, and have just started participating in the company stock purchase program which allows me to purchase stock every 6 months at 85% of the lowest market value. I am maxed out at 10% of my gross in that program.

4. Charitable donations. This is one you didn't mention that I think you should have. Young people, no matter how poor, should get in the habit of giving back. I give between 10-12% to my church and other charitable organizations. It helps at tax time and it's the right thing to do. If you wait to be "rich enough" give back, you will wait forever.

I wish I could do more... like start a ROTH, or diversify my portfolio, but I'm pretty maxed out. I had to give up my glamorous vacations to start doing the stock purchase program. Now I just go home for the holidays. I have to constantly evaluate my life/money balance, and certain things like gym memberships and cable tv have all met the chopping block.

Also, I really liked your post about investing in yourself/career; spending the extra time and effort while you don't have attachments. I spend my evenings doing work on my own startup company, and while it gets tiring, I'm hoping it will all pay off in financial independence in the future.

Any ideas, feedback, suggestions are welcome...

Online Retirement Gift Ideas said...
This comment has been removed by a blog administrator.
Online Retirement Gift Ideas said...

I am agree with this post...Nice One....

Nannie Laferriere said...

Yes, it’s very possible to retire around your 20s. Starting up a business then would be a great idea, especially since you still have a ways to go. Your skills and talent in managing a business will be sharpened to excellence since you already have experience in the executive world.