Retirement planning for 20-somethings

It’s easy to understand why retirement doesn’t loom large on the horizon for 20-somethings. Young workers are more concerned with kick-starting careers, not ending them in the long-distant future.

But it’s worth noting that the very fact that you’re young gives you a huge edge if you want to be rich in retirement. That’s because when you’re in your 20s, you can invest relatively little for a short period and wind up with far more money than someone older who saves much more over a longer period.

Consider this scenario: If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you’ll have around $560,000, assuming earnings grow at 8 percent annually. Now, let’s say you wait until you’re 35 to start saving. You put away the same $2,000 a year, but for three decades instead, and earnings grow at 8 percent a year. When you’re 65 you’ll wind up with around $245,000 — less than half the money.

Seems like a no-brainer, right? Save a little now and reap big rewards later.

Unfortunately, many of today’s youngest workers pass on the opportunity to save for retirement early, when the beauty of compounding interest can work its magic and maximize savings. A recent study by human resources consultant Hewitt Associates found that just 31 percent of Generation Y workers (those born in 1978 or later, now in the thick of their 20s) who are eligible to put money into a 401(k) retirement savings plan to do so. That’s less than half of the 63 percent of workers between ages 26 and 41 who do invest in employer-sponsored savings accounts.

1. Start saving ASAP

There are plenty of reasons you may have yet to save, such as cash flow. If you’re struggling to pay off student loans or cover rent, funding a 401(k) may seem difficult, if not downright impossible.

But be wary of letting expenses become an excuse, says Brian T. Jones, a Certified Financial Planner and author of “Getting Started: The Financial Guide for a Younger Generation.”

“These years of saving in your early 20s are your prime years. If you deny yourself the opportunity, it will just set you back with retirement planning in the long run,” says Jones. “You’ve got to have balance.”

2. Sign up for that 401(k)

Make the most out of those few dollars you can get hold of by allocating them wisely. Don’t squirrel them away under the mattress. You will want them to be invested in a way that will encourage your assets to grow as quickly as possible.

Where to start? If you’re eligible to participate in a 401(k) at work, do so. There are plenty of reasons to love these plans but No. 1 by far is that most employers match your contributions in order to encourage your participation. The hitch: Oftentimes, you’ll need to save enough to trigger the match.

In a typical plan, employers match up to 3 percent of your salary, according to the Profit Sharing/401(k) Council of America. When you do sign up, the money you save will be automatically deposited into the plan before it’s taxed, so less of your income will be taxed now. That saves you money, too.

That’s what Rebecca Lamb has discovered. The 28-year-old Connecticut resident works in a nonprofit organization so she saves in a 403(b), which is similar to a 401(k) though they often don’t allow company matching. These days, Lamb can’t afford to plow huge sums into the plan, but she saves what she can. She also has a savings account that she opened when she got her first job at 15.

“I’m a disciplined person. I put in little amounts and save what I can. If it’s $20, I put that in. If it’s $100, I put $100. I’ve always done that,” she says. “I’m just trying to save what I can right now. Hopefully, in years to come, I’d like to think I could put more way. But right now I’m just trying to save what I can because every little bit counts. I don’t get caught up in the numbers.”

3. No company retirement fund? Use a Roth instead

If you aren’t eligible for a retirement fund at work that gets you matching funds, sign up for the next best thing: a Roth IRA. You’ll fund this with money that’s already been taxed as part of your normal paycheck. But money in a Roth IRA withdrawn later is tax-free.

This year, you can put up to $4,000 in a Roth, but don’t let that number scare you off if it seems far too rich for you today. Save what you can. It will add up. If you are able to sock away $4,000 a year into a Roth for 40 years, and if it earns 8 percent annually, you’ll be a tax-free millionaire at retirement.

To make sure you stick to saving, have a portion of your paycheck or payments from your bank account automatically deposited into the Roth each month or every few weeks.

4. Be aggressive with your investments

Make sure to invest your money shrewdly. According to Hewitt, workers 18 to 25 typically invest 35 percent of their retirement savings in bonds. Yet bonds have historically returned 5.4 percent a year — right around the risk-free rate and just ahead of inflation. That’s practically sticking it in a jelly jar! Stocks, meanwhile, traditionally have grown at an annual clip of 10.4 percent, according to Ibbotson Associates, an asset allocation service that’s part of investment ratings agency Morningstar.

Instead, play it aggressive, and put 90 percent of your investments in stocks, says Ellen Rinaldi, executive director of investment planning and research at mutual funds giant Vanguard. Stocks are interchangeably referred to as equities, since as a stockholder you own a slice of the company’s value in the market, its equity.

“From an allocation viewpoint, someone in their 20s has a very long horizon, so they can handle the ups and downs of the market,” says Rinaldi. “They can recover from a downturn. As a result, they should be heavily invested in equities.”

You can hedge against the risk of loss by diversifying your investments. That’s a fancy way of saying you want to own as many different types of stocks as possible, and it’s a message that will hold true throughout your lifetime. That means steer clear of buying a single stock and look to mutual funds, a tradable vehicle made up of sometimes hundreds of different investments in widely varying quantities. They could be made up entirely of stocks, bonds, a combination of both or simply track the market by holding equal amounts of all shares in a given index, known as an index fund.

So-called lifestyle or life-cycle mutual funds make it especially easy for novice savers to buy a diversified array of stocks that are tailored to their age and retirement goals. That’s because these funds are set up to automatically pick and choose the equities in the fund, and to rebalance those holdings over time, buying and selling shares in order to maintain the advertised mix of risk and return (or caution and predictability) by age bracket.

“Look for retirement funds targeted to your age bracket. They’ll be much more aggressive for someone in their 20s,” says Rinaldi. “If you just look for a balanced fund, you may wind up with 40 percent of your money in bonds, which is a typical mix for these funds.”

5. Get educated

Meanwhile, don’t be embarrassed to admit that financial talk can seem confusing. After all, financial know-how is not genetically encoded and, unless someone has taken the time to teach you about finance, you’ll need to do a little learning. And now that you’re starting to make and save money, this is the perfect time to educate yourself.

More than a third of companies now offer employees access to advisers who can help choose investments that will be most appropriate, according to Hewitt. These advisers can explain what holdings are in a particular fund and why they’d recommend one investment over another. Read books, articles or financial Web sites. The more you know, the easier it will be throughout your career to make solid, informed decisions.

“I think the reality is most parents are more inclined to talk to their kids about sex education than talk to them about finance or saving for retirement,” says Jones. “That’s just not a conversation people have, so a little Finance 101 is probably a good idea.”

6. Build a strong defense with an emergency stash

What’s next? Start amassing an emergency fund so you don’t have to rely on credit cards — and possibly bury yourself in debt — in the event that your car dies, your roommate comes up short on rent or you suffer some other financial mishap. Ideally, you’ll stash up to three months living expenses, but the important goal is to save something. You can help stay on track by having automatic deposits made to your emergency account.

In the meantime, keep an eye on spending. Those splurges can add up fast and will prove to be a huge drain on future savings. What’s more, if you pile on debt, you’ll wind up wasting a lot of money on interest and fees that could be better spent elsewhere.

7. Avoid debt

If you’re really struggling to stretch the paycheck to set something aside for retirement, this is the time to make some changes.

Give your budget needs a major overhaul. Consider getting a roommate or picking up an extra job for the time being. Big changes now, coupled with consistent saving over time, will reap huge rewards down the road, says Jones. He speaks from experience. Jones took a year off from college to work so he could pay off credit card debt. It wasn’t easy but, he says, “I graduated debt-free.”

Lamb has already seen how a little financial discipline reaps big rewards.

“Making my bills is my No. 1 priority before anything else. I don’t buy new clothes. I cook at home. And I don’t drink, which is a big money-saver. People go out and will spend $100 on alcohol in one weekend. I don’t do that,” she says.

Yet she does let herself have occasional “big purchases,” like a house recently bought with her fiance.

“I really wanted one,” she says. “And I made it my goal.”

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