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Start Saving For Retirement When You Are In Your 20s

September 3, 2021

When you’re in your 20s, retirement saving may not be the first goal on your financial checklist — if you even have one. Yet starting to save for retirement as early as possible can set you up for success in the long term.
 
“It’s totally understandable because it’s tough when you get your first job; it’s not like you have a whole lot of excess funds,” said Rob Greenman, a certified financial planner, and chief growth officer and partner at Vista Capital Partners in Portland, Oregon.
 

Still, beginning to put away just a little bit of money from an early age can mean that, over time, you could save less from each paycheck but still reach retirement earlier than you thought.

“Most people that I sit down with always say ‘I wish I started sooner,’” said Tess Zigo, a CFP at Emerge Wealth Strategies in Lisle, Illinois. “No one ever says, ‘gosh I wish I didn’t invest in my 20s.’”

 

The value of compound interest

The reason it’s important to start saving as soon as possible is that having a longer horizon gives compound interest more time to work.

 

Compound interest is when the interest you earn on a balance in a savings or investment account is reinvested, earning you more interest. It’s basically money-making money. Compound interest also accelerates the growth of your savings and investments over time.

Say you invest $100 and it grows at a rate of 10% annually, meaning you have $110 after one year. After the second year, you’ll have $121, and $133 after the third year. The amount will continue to grow by more each year due to compound interest.

This also means that you can save much less initially if you have more time for your investment to grow and compound. For those early in their career who may not be able to save consistently, putting what you can away as soon as possible can start you on the right track.

“The reality of the way compounding works is that the earlier you get going the less you’re going to have to save down the road,” Greenman said.

Using the “Rule of 72” — a formula to calculate how long it will take money to double — you can expect that money you invest will double in roughly 10 years, Zigo said. If you start saving in your 20s and expect to retire in your 60s, you could see four decades of doubling, she said.

But starting just a decade later means you’d miss out on one entire round of doubling.

 

Building solid habits

Even if you can’t save hundreds of dollars each month at first, putting some money away for retirement as soon as possible also helps young people develop solid financial habits.

It can help you see the benefit of saving and help you build up other funds, such as an emergency savings fund. You may also need to work with a budget, which can help you stay on track and avoid debt over time.

And, as you see the money you’ve saved for retirement start to grow, it can encourage you to continue the path towards financial freedom.

“You’re incentivized to keep going,” Zigo said.

Start in the easiest way possible

For most people, the easiest way to begin saving for retirement is in an employer-sponsored 401(k) plan.

Many people have these through work and are automatically enrolled in them, meaning they might not even realize that they’ve been saving part of their paycheck for later.

If you have such a plan, make sure that you’re putting in enough to get any match your employer offers, which is essentially free money that could double what you’re able to save.

“It’s pretty darn tough to beat a 100% return on your investment,” said Greenman.

If you don’t have an employer-sponsored retirement account, most financial experts recommend looking into a Roth individual retirement account. In this type of account, you’d put in money on your own (though most advisors would also recommend setting up an automatic transfer) and it would grow tax-free until retirement.

 
Roth IRAs

Roth IRAs are a good option for young investors for a few reasons. They are only available to people who meet certain income limits, so it makes sense to open one early in your career. In 2021, your modified adjusted gross income must be less than $140,000 for single filers and $208,000 for those married filing jointly in order to qualify.

Money that you put into a Roth IRA is post-tax, meaning that you don’t owe any more to the IRS when you withdraw for retirement. Any money you put into the account you can withdraw if you don’t touch the interest you’ve earned right away.

You may have to pay a tax on the earnings if you withdraw them before you reach the retirement age of 59½ or if you’ve had the account for less than five years. After you’ve had the account for five years, you can take any money out of it — your contributions or earnings — tax-free.

Roth IRAs also offer more flexibility in terms of trading than an employer-sponsored plan. This can be beneficial for people who want to trade more frequently or want to ensure their portfolios meet their ethical standards, said Greenman.

Of course, this can also be a problem if people add outsized risk.

“Be careful not to fall prey to some of the mistakes that a lot of folks make, which is trying to time the market and picking stocks,” said Greenman.



Source: CNBC