Some pros say your early investing years are among the most critical, including whether you set up a 401(k). Learn how to work toward your financial goals.
When you're a young investor, retirement may seem far away. But there are good reasons to start preparing now through sensible budgeting, contributing to a 401(k) plan, and other practical steps. The years go by quickly, but in your case, the calendar is an ally.
“The nice thing about being a young investor is you have time on your side,” says Christine G. Russell, senior manager, retirement, at TD Ameritrade. “It may take a while” to reach your financial goals, “but you have that time if you start today.”
Putting yourself on the right path requires long-term focus and consistent investing over many years to help ensure your savings are there when you need them.
Everyone knows the rent is due at the beginning of the month—no reason you shouldn’t be prepared. Paying your bills on time and regularly tracking income and expenses are foundational principles of retirement planning, Russell says. Another good idea: build an “emergency” fund covering about six months’ worth of expenses.
Also, credit card debt at potentially high interest rates may derail your budget. Be sure to "pay off that debt every month," Russell says. Additionally, there are many choices when it comes to credit cards, with a wide range of interest rates, fees, perks, rewards, and credit limits, so it is important to do your research and understand what you are signing up for with the credit card company you choose.
Contributing as much of your monthly income as you can to a 401(k) or other savings plan is a worthy goal, Russell says (for 2017, the annual contribution limit for employees in a 401(k) or similar plans is $18,000, according to the IRS; in 2018, the limit will be increased to $18,500). And if your company offers to match a percentage of your contribution, take them up on it – it’s the closest thing to a free lunch out there.
“Contribute something, whatever it is, to get the match, because you’re not going to get last year’s match back,” Russell says. Every time you get a raise, increase the amount you’re saving by a commensurate amount, she adds. With a bonus, tax refund, or other windfall, consider spending half today and saving half for yourself tomorrow.
Compound, or compounding, returns are calculated based on both the initial investment and on accrued returns from earlier periods. The sooner you start compounding returns, the better off you may be.
For example, suppose one investor, starting at age 25, puts $2,000 into the market every year for eight years; another waits until age 33. At an average annual return of 8%, the first investor would only need the initial $16,000 to build a nest egg of $125,000 by age 55. The second investor would have to invest nearly three times as much, and still would be several thousand dollars behind the first investor once the 55th birthday rolls around.
Even a small amount of money socked away each month makes a “huge difference, thanks to compounding,” Russell says. “It absolutely adds up for someone who’s got 40 years to save, and it could make the difference between not having enough in retirement and having $1 million.”
Once you’ve got a foundation, Russell suggests considering a Roth IRA, which can provide tax-free income once you retire. A Roth IRA can be a good option if your company does not offer a 401(k). Medicare premiums, she notes, are based on taxable income in retirement.
“This is important down the road, because it can help reduce your health care costs in retirement,” she says. "After all, in retirement, it's not just the money coming in each month, it's the money you can actually spend that matters."
"Caution is always advisable, but if you have a multi-decade, long-term strategy — depending on your risk tolerance — it may not always be necessary to be overly conservative," Russell says. U.S. Treasuries, for example, are considered stable by some investors, but yields have been grinding around or below 2% for years, which is close to the inflation rate.
One of the first things to do is get a handle on your appetite for and comfort level with risk. “You don’t need to be entirely in fixed income,” Russell says. “But exactly how much risk you take depends on the individual.” Consider discussing this with a financial professional if you’re not sure.
Overemphasizing any particular investment—whether it’s an index fund, your company’s stock, or something else—may not be a good idea, Russell says. This is where diversification comes in, based on the rationale that many investors potentially might benefit from having their portfolio spread across different types of assets.
As a young investor, time is one of your most valuable assets, but it goes by quickly (as you may have heard). All the more reason to establish healthy savings habits and get going on a nest egg – not next week or month, but as soon as possible.
The important thing is to start and be consistent. Even small contributions made each month can grow and you can increase your contributions as your financial situation changes throughout your life. Saving early and making regular contributions can give you a head start on planning for retirement, which may allow you to reach your financial goals sooner.
We have retirement planning tools and resources that can help you get started or check if you're on track.
A 401(k) is typically a qualified employer-established retirement savings plan to which eligible employees can, in most cases, make pre-tax contributions (the number refers to the subsection of the federal Internal Revenue Code that established these plans in 1978).
The money held in 401(k)s has grown sharply over the past four decades, although many businesses, particularly smaller ones, do not offer these plans. IRAs remain popular, as do other government and private-sector defined-benefit plans.
At the midpoint of 2017, Americans held $5.14 trillion in 401(k) plans, out of $26.6 trillion in total retirement plan assets. By comparison, there was about $1.74 trillion in 401(k)s in 2000.
Source: Investment Company Institute
Bruce Blythe is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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