Preparing for retirement can seem like a daunting task, but the earlier you start, the more buffer that you provide to yourself. On your mark, get set – GO RETIRE!
Does this sound like you?
- Age: 18-25
- Married: Matter? Yep, but not for retirement
- Kids: Matter? Absolutely, but again, not for retirement
- Employed? Ok, kinda needs to be Yes
If you fall into this category (yes, it’s a big category), you should already be thinking about retirement. Not consumed by it, or even think about it monthly, but you should have a high-level strategy and occasionally think about looking at your retirement savings.
But First, Who am I and why would you trust what I say?
Hello everyone! My name is Steve Shuler. If you’re familiar with the Investing for Beginners blog, you probably have read some of Andy’s blogs. Well, Andy recently asked me to consider writing some articles because I might be able to add a different perspective. I am happy and excited to be doing so, and hopefully I can give you some nuggets of wisdom (or at least an occasional “hey, that’s something worth thinking about”).
I have a Bachelor’s degree in Finance from Ohio State and an MBA from the University of Wisconsin. I have worked in various financial roles in manufacturing companies since the age of 25.
I am not a CFA (Certified Financial Analyst), CFP (Certified Financial Planner) or anything like that…and don’t play one on TV (or You Tube or TikTok, or anywhere else…). I am just a person with an education in finance that has learned a lot during the way through life.
Ok, enough of that….
Believe it or Not, You are in the Perfect Position for Retirement.
You’re young, don’t have a lot of money and possibly a lot of demands on your money. You know…house, college, kids, etc. And I am telling you to think about retirement. WHY?
You have a huge thing working in your favor. Something that is just as important, if not more, than having a lot of money right now. TIME!!
You are not going to retire for a long time. Doesn’t sound like good news, but from a financial perspective, it is awesome news. Time is the best thing for your investments for two reasons.
1 – Compound Interest – the interest (or return) on your investment, which is then added to your principal, and continues to grow over time. The best analogy I can offer is:
Compound interest is like a snowball rolling down a hill. As the ball rolls, it adds, more snow, which then adds even more snow. It continues to get bigger and bigger.
The snowball (e.g., your routine savings) can be very small. That’s ok. What’s much more important (even critical) is the disciplined, routine and consistent additions to your retirement savings. Compounding will take care of the rest.
The table below shows the benefit of saving for retirement as early as you can. Assuming saving just $50 each month, someone starting at the age of 20, will kick in only $3,000 more but will you have $19,569 more by age 60. That’s over 34% more! Just by starting at 20 rather than 25.
The graph below shows just how much your money is working for you over time. Based on the same $50 per month savings and a conservative 5% return, the interest really grows…especially as you get older. THIS IS COMPOUNDING. The orange is the amount of money earned through compounding. The numbers at the bottom of the graph show the number of years your investment could compound before age 60.
To even further prove the importance of starting to save early (and sticking with it religiously), consider the following. If you put off saving for retirement until age 40, you will need to save $186 per month to hit the same total savings you would if you contributed $50 per month starting at age 20. That’s $136 more per month! 270% more!
2 – Increasing Contributions – consistently increasing your contributions makes a huge difference.
The second example shows same five-year age difference but assumes that you increase your savings by 3% each year. For example, when you get a raise, you carve off a little extra for your savings. That “little extra” results in you saving an additional $21,205 compared the first example over 40 years. But your total increases $42,751. If you start at five years later, the total savings is $85,079, which is $32,282 less on reduced savings of $14,713.
How Should I Save and Where Should I put my Savings?
- How to Save – Unless you are REALLY disciplined (I certainly was not, especially when young), you should set up automatic payroll withdrawals. Banks make this a very easy process. Once done, it’s like you don’t even realize the money is being taken out.
- Where Should I put my Savings – First, I am big on saving money for specified purposes because it helps keep you disciplined to not dip into the funds for other uses. Second, there is a prioritization that should take place for your savings. The guidelines shown below will cover the vast majority of situations.
1 – Emergency Savings – This comes first, before any other savings!
- The rule of thumb historically offered is 3-6 months of your savings. But I think that needs to be modified based on your specific circumstances, based on the theory of “what could go wrong”.
- If you are renting…
- You do have to deal with the potential of being laid off, automobile maintenance, child costs (if this applies to you…), medical expenses, etc.
- Savings Goal: $2,000 – 4,000.
- If you own your home…
- Well, with the help of a big mortgage
- You need to set more money aside to cover additional surprises like roof leaks, furnace issues, air conditioning, house maintenance, etc.
- Savings Goal: $4,000 – $6,000.
- Again, my advice is to set up a SAVINGS account just for this money. Save as much as you possibly can until you reach the goal.
2 – Credit Card Debt – Based on the amount of debt you have and your ability to pay it off, this may need to either take the place of or be in addition to Emergency Savings. Compound interest REALLY works against you here. This is too big of a topic for here, but it certainly deserves a very high priority.
3 – 401K Savings – To the extent that your company provides a match component, take full advantage. This is literally free money or, if you will, a huge immediate return on investment. Much higher than you can get on any other investment.
Generally, companies will match either 50% or 100% of your contributions, up to a certain percentage. The following example is quite usual, where the employer will match the employees’ contributions up to 3% and then match 50% of the amount employees contribute over 3% up to 6%. The table below shows how much money you can accumulate in just one year.
The graph below shows better just how quickly the 401 can grow:
The key to a 401k is to take full advantage of it and then let it grow. Just for fun (and yes, to further convince you to start saving… as much as you can…as soon as you can). Building off the prior scenario, let’s add a realistic twist.
- Your income (and thus your contributions) grows 3% per year
- The average annual rate of return is 7% per year (conservative).
Your 401k account will grow to over $650k by age 50! In fact, if your contributions earned an average return of 10% (which is still lower than the historic average annual return of the S&P 500 from its inception in 1957 through 2021 of 12.19%), your 401k total would be over $1,073,000!
Now, as my last piece of evidence, let’s keep contributing until the age of 60. With the same 7% average annual rate of return, your 401k is worth nearly $1.5 million. This is on an investment of $241k.
The numbers (graphs) really speak for themselves. Again, the key is consistently investing a little more than the year before.
4 – Additional Savings – There are a number of additional ways for you to save money for retirement. Depending on your available income after expenses, some or all of these might make sense.
- Roth IRA – This type of IRA is perfect for people in their 20’s all the way through their 50’s. In a Roth IRA, the initial contributions into the IRA are considered taxable income, meaning that you will have to pay taxes on that income during the year the income was earned. However, the original contribution and all capital gains and earned income from the Roth IRA are TAX FREE.
- This is a huge benefit over the original IRA, which is still in place, that allows contributions into the IRA to be tax deductive in the year contributed, but all earnings and income is taxed at the normal tax rate when withdrawn. There are a few qualifications to be met, such as income requirements, so do your research before setting up an account.
- Health Savings Account (HSA) – This account can be used to save pre-tax money for qualified medical expenses. This fund can be used only if you have signed up for a High Deductible Health Plan (HDHP) insurance. The beauty of this account is that you can choose to invest the funds in a number of different types of funds, and all gains accumulate tax free. This is really a great way to save for future medical expenses you will incur.
- General savings – While savings account returns are historically low, it makes sense to ensure you have additional money set aside to allow you to always pay your credit card balances off in the month the expense is incurred.
- Traditional IRA – Can still be useful in certain situations.
Where Should I Invest?
For young investors, the only place to put your 401k and IRA funds to work is the stock market. Yes, it can be considered risky over a short period of time. But the longer the time horizon until the funds will be withdrawn, the more compelling the case for investing in the stock market.
While there are many ways to invest in the stock market (perhaps another blog in the future), I want to focus on the two most common ways.
- Purchasing stocks. Actually, You ARE NOT investing in stocks! You are buying a small portion of a company. This may seem like semantics, but, in my opinion, it’s critical for successful long-term investing. Companies have management, customers, products, employees, capital assets and plans for the future.
- Thinking of it this way will naturally cause you to do two things. First, you will spend more time investigating the company and second, you will not be so quick to sell. For retirement funds, this absolutely must be your thinking
- Index Funds. If you don’t have the time, desire, or ability to do the research, Warren Buffet says the vast majority of investors will do just fine by investing in the S&P 500 through a low-cost S&P 500 ETF (Exchange Traded Fund), and then keeping the money there.
- He often cites that the vast majority of hedge funds and other money managers do worse than the S&P 500 because they have to continually move from one hot stock to another to try to stay ahead of the market.
The Bottom Line
- You do not need to save a ton of money to generate a large retirement fund.
- The key is start young. Don’t procrastinate
- Be a disciplined saver
- Take full advantage of a 401k if available
- Invest consistently, and try not to take the money out until retirement
- Don’t overthink your investment strategy. The S&P 500 is a great long-term investment.
I hope this helps. I would love to hear your thoughts!