Fundamentals of Investing
Your First Job? Think About Retirement.
Most People in the 20s aren't planning for when they will leave the workforce. That's a big mistake.
by Georgette Mason, Wall Street Journal, December 3, 2012
For most 20-somethings, the idea of retirement isn't front and center. It isn't even a glimmer. But it ought to be. In fact, a first job is precisely when younger people should start preparing for the time when they will retreat from the workforce. So if you are a 20-something, or have one in your life, here are some thoughts on why it's important to start saving for retirement now, as well as some tips on how to get started.
Just do it. Yes, retirement may be 40 years away, and your paycheck is small. Your rent may be high, and you may have student loans to repay. But saving even small amounts early on can make a big difference. A 25-year old who starts saving just $600 a year could have $72,000 at age 65, nearly twice as much as someone who saves $1,200 a year beginning at 45, according to calculations by LearnVest, an online financial-planning service.
"It's the power of compound interest," says Maria Bruno, a senior investment analyst at Vanguard Group. " It's important to start with what you can and be disciplined, increasing the amount automatically over time." The question shouldn't be whether to start saving now, but rather how much to save, where to invest and in what kind of account.
Get the Match. If your employer offers a 401(k) plan, embrace it, says Russell Bailyn, a wealth manager with Premier Financial Advisors in New York. A 401(k) plan typically offers participants a range of mutual funds in which they can invest. Contributions typically are made with pretax money and are tax-deferred until the money is withdrawn. Some employers automatically enroll new workers (although they can opt out later), and some offer to match part or all of your contribution, depending on how much you put in. For instance, your employer might match each dollar you contribute, up to 3% of your salary, or kick in 50 cents for each dollar, up to 6% of your salary.
Whatever the match is, put as much into the plan as you need to get it, financial advisers say. A dollar-for-dollar match is "a 100% return on your investment," says Alexa von Tobel, founder and chief executive of LearnVest.
Partly because of auto-enrollment, many young workers do participate in 401(k) plans. Some 43% of employees under age 25 and 63% of workers between 25 and 34 are contributing to their employers' plans, according to a report early this year from Vanguard, based on the defined-contribution plans it administers. But few invest as much as Vanguard recommends 12%-15% of their salary, including the value of a company match.
Many young workers are choosing target-date funds, typically a mix of stocks and bonds designed to gradually reduce exposure to risk as the investor gets closer to retirement. A professional fund manager does the asset allocation, and the portfolios are rebalanced over time. In many plans, target-date funds are the default investment for automatic enrollment, giving younger workers significant exposure to the generally higher return on stocks. If your 401(k) doesn't have auto-enrollment, find out what you need to do to sign up for the plan and fill out the necessary paperwork.
Consider an IRA. Not everyone has access to a 401(k) plan. Some young people are employed through fellowship programs, some work part time and some work for companies typically small, private ones that don't offer retirement plans. Those workers should consider putting money into an individual retirement plan, or IRA. Contributions to traditional IRAs are usually tax-deductible if you (and your spouse if you're married) don't have a retirement plan through an employer, and taxes aren't due until the money is withdrawn. You can make a contribution for 2012 as late as April 15, 2013, and still get a deduction on your 2012 tax return.
The contribution maximum - $5,000 for this year and $5,500 for 2013 is smaller than for a 401(k) plan, but participants have more investment options because they aren't limited to the selections offered by a plan sponsor. Still, some financial advisers say be cautious about investing in individual stocks. "People learn their lesson by investing in something that's rising and then turns down," says Mr. Bailyn. "Mutual funds or exchange-traded funds are probably safer."
You can research funds on websites such as Morningstar.com, or seek advice from a financial professional. There are several online financial-planning services, and some mutual-fund companies offer online planning tools.
Many financial advisers say young people should consider investing in Roth IRAs. They are different from traditional IRAs in that contributions are made with after-tax money and aren't deductible, but withdrawals are tax-free in retirement. Young workers, because they are just starting out, are often in a low income-tax bracket, which reduces the value of the tax deduction they would get with a traditional IRA, says Vanguard's Ms. Bruno. With a Roth, they will have more to spend when they retire, she says. Some companies offer Roth 401(k)s, which offer a similar advantage for young investors.
Consider having a small sum transferred from your bank account to an IRA every month, and increase it when your salary goes up, advisers say. Remember: The important thing is to start saving early, even if it's just a small amount. Albert Einstein has been quoted as calling compound interest "the most powerful force in the universe."