The following is a post by MPFJ staff writer, Kevin Mercadante, who is a freelance professional personal finance blogger for hire, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.
If you’re in your 20s, planning for retirement is probably not very high on your list of things to do. Starting and advancing your career certainly seems more relevant, as does buying the things that you need to live your life.
But somewhere in the mix there needs to be an emphasis on retirement planning. Retirement is one of those areas of life where the sooner you start, the better you finish. It has everything to do with the time value of money, and you should want to get that working in your favor as early in life as possible.
Here are some ways to plan for retirement in your 20s. Most don’t require a lot of money to do either, but are based instead on getting into good money habits.
Save Up to the Employer Match on Your 401(k) Plan
If you have an employer sponsored retirement plan, you should participate in it, at least at a very low level. The most important step when it comes to a savings plan of any kind is just getting started. If 2% of your pay is all that you can afford, then go with it, and increase it over time.
One way to do this is by increasing your retirement contribution each time you get a raise. Let’s say that you start contributing 2% of your pay into your employer’s 401(k) plan. One year from now you get a 2% increase in pay. Cut that in half, allocating 1% to your 401(k) plan contribution – increasing it to 3% – and keep the remaining 1% in your regular budget.
Under ideal circumstances, you should aim to participate in the employer plan to the point you maximize the employer matching contribution. For example, if your employer has a 50% match (3%) up to a contribution by you of 6%, your goal should be to contribute 6%. The employer match is like free money. You’ll get $1 added to your plan by your employer for every $2 that you contribute. That’s too good to a pass up.
If you delay participating in retirement savings until a time when you can afford it, you’ll probably never get started. Throughout your life, there will always be major expenses and challenges that will compete for your income. The only way to rise above it is to start saving money as soon as possible – as in now.
If You Don’t Have an Employer Plan Start an IRA – Even a Small One
Not all employers have a 401(k) plan. If yours doesn’t, create an alternative strategy by setting up a self-directed IRA. You can contribute up to $5,500 to an IRA each year, and your contributions will be tax-deductible if you do not have an employer plan (and may be partially or completely tax-deductible if your income is within certain limits).
Don’t worry that you can’t make the maximum contribution. Start by adding $50 per pay period. If you are paid twice a month, that will be $100 per month, or $1,200 per year. As your income increases, allocate a larger amount of money to go into your IRA.
Just as is the case with a 401(k), getting started is more than half the battle.
Make Getting Out of Debt a Priority
This is certainly a tall order when you’re in your 20s. After all, if you already have student loan debt, and you need to buy a car, you’re virtually guaranteed to be in debt. But as difficult as it is to avoid the debt trap as a young adult, avoid it you must.
There are two major reasons why getting out of debt is important when you’re in your 20s:
- Debt becomes a pattern early in life – if you “get comfortable” being in debt in your 20s, you might spend the rest of your life there, and it can get progressively worse
- By getting out of debt, you gain full control of your income, and free up money to invest for retirement and for your long-term prosperity.
This isn’t necessarily to say that you need to make getting out of debt an all-consuming activity – seeing it through until the last dollar of debt is paid in full. But you should establish a pattern of paying down your debts ahead of schedule. The idea to set a goal of getting out of debt within a specific time. You can make that five years from now, or at a certain age, say when you turn 30.
The sooner you defeat the debt monster, the easier it will be to do all things financial in your life, including preparing for retirement. And as you get your debt situation under control, be sure not to add any new debt to your life. Once again, you’re trying to avoid bad habits that can become a lifestyle.
Develop a Life of Thrift
Now is a good time to spend a couple of minutes on the topic of lifestyle inflation. If you’re in your 20s, you’re likely to see a steady increase in your income in the coming years. Lifestyle inflation describes a financial process in which your standard of living rises as your income increases. You get a promotion with a substantial increase in pay, and you upgrade your car, move into a more expensive living arrangement, and adopt some expensive hobbies.
That’s a typical pattern, but it’s also one of the major reasons why people find that they don’t have any more money even though they’re earning more, often a lot more. Lifestyle inflation is one of those habits that’s best avoided when planning for retirement, or working out any financial goal you can think of.
The basic idea should be to keep your living expenses as low as possible, while using pay increases to fund saving and investing, and getting out of debt. And again it’s important to remember that this point in your life, you should be trying to establish the kinds of habits that will enable you to move forward, rather than getting trapped in a financial mess.
Don’t Try to Beat the Market
Millions of people – including investment managers – try to beat the market, and fail miserably. Unless you work in investments professionally, it’s probably not worth your time to even try to figure it out. In fact, you can lose a lot of money trying to learn how to beat the market. That’s probably something you don’t want to try to do until you have a large portfolio, and can allocate a small percentage of it into a small secondary account where you can try your hand at it.
In the meantime, and especially as a new investor, stay with funds, particularly exchange traded index funds. You won’t beat the market with these, but you won’t get clobbered by it either.
And if you would like to try active management, look into low cost robo advisors, like Wealthfront and Betterment, that offer professional management at very low fees and are specifically tailored for new and small investors.
At this stage in your life, retirement may seem so far away that you have plenty of time to ignore it. But it’s worth repeating – when it comes to retirement planning, or any other financial endeavor, the sooner you start, the better you finish. Get working on retirement planning now.
How about you all? If you’re in your 20s, have you started saving for retirement? What age did you start your retirement planning process?
Share your experiences by commenting below!
***Photo courtesy of https://www.flickr.com/photos/digitalsextant/4491928640/sizes/n/
