Financial Boot Camp for 20-Year-Olds: Day 5 of 5
It’s time to get your money in order.
When you’re in your 20s, retirement seems so abstract that it might as well be thousands of years away.
Maybe that’s how it feels for you right now. Why save for something so many decades in the future when every last dollar is accounted for in the here and now? In fact, saving for anything can feel impossible.
But what if you simply laid the foundation for making it easier to save? That’s what we’re going to work on today.
Starting retirement early makes sense for the same reasons you might want to put it off: time is on your side. If you set aside what you can now, the magic of compounding numbers—when you start earning interest on interest—can do more of the heavy lifting over time.
In other words, saving early can result in you having to save less in the long run, taking some of the pressure off of you as you deal with other demands that inevitably arise. Maybe these requirements involve the children and all the money they are siphoning off, or perhaps you need time off to care for an aging parent.
And (most of the time), no one wants to work forever – the sooner you start saving, the sooner you can stop working and spend more time on what matters to you.
The easiest way to save money – on anything, really – is through automation. If your money is transported to its destination automatically and regularly, you don’t have to do anything. This also applies to purely pleasurable financial goals, such as saving for a big trip.
It empowers you and brings you closer to the things that will make you happier and financially more secure. It will take some time and patience – but your future self will thank you.
Before you start, you need to figure out how much you have to work with.
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Dealing with debt. Before you start saving, make sure you have a plan to pay off any costly debts, such as: B. Credit card debt, whose interest rates (about 22 percent) are far higher than the money you could make if you invested your savings in the stock market (7 to 8 percent).
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Get organized. Get a copy of your pay stub or check your direct deposit to get an idea of your take-home pay. (Freelancers should calculate their average monthly income.) Then write down all of your expenses—rent, any insurance not already deducted from your pay, utilities, groceries, transportation costs, car payments, cell phone, student loans, and any other debts.
How much is left? Something? Congratulations! You have some room to save. Close? Is there anything you can cut back on a bit to make room for savings?
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Build a buffer. By creating a financial cushion – in the form of an emergency savings fund – you can avoid resorting to credit cards if you suddenly lose your job or find yourself in a financial hole, such as needing to cover a $1,000 car repair.
Financial planners recommend setting aside three to six months of your expenses as an emergency savings account (in a high-yield online savings account that offers the best interest rates). That may seem like a lofty goal when you’re living on an entry-level salary that barely covers your bills. So start small, even if it saves you $50 a month – $83 a month will get you to $1,000 in a year – and add more if you can afford it. Set up an automated plan that transfers this amount from your checking account to your savings account. Then don’t touch the money.
Saving for retirement
Many people with student loan debt often wonder whether they should focus on paying off those loans before saving for retirement. The short answer: probably not. (If you’re really struggling to pay your federal student loans, check out the income-driven repayment plans I mentioned yesterday.)
However, there are good reasons to invest and pay off your loans at the same time if you can.
The image below just shows why. Can you tell how much you’re likely to give up if you focus solely on paying off loans for ten years?
If you have access to a 401(k) or similar retirement plan at work, you’re in luck—only 69 percent of private sector workers have this plan.
You may have heard that some plans include a nice little perk: free money. Employers can make corresponding contributions when saving; For example, you could match every dollar you contribute, up to 4 percent of your salary.
That means you’re effectively contributing 8 percent of your income, which is pretty close to the 10 percent that experts recommend (often they recommend saving more, up to 20 percent, but 10 percent is a good start – consider that increase the amount by one percent). You will receive a point each year when you receive raises).
What if you don’t have a company retirement plan?
Roth individual retirement accounts (or Roth IRAs) are often the right choice for younger people (although they are subject to income and contribution limits). That’s because you’re contributing money that’s already been taxed, and you’ll likely be in a lower tax bracket now than later in life, when you’ll likely be earning more.
Compare that to the traditional IRA, which gives you a tax deduction now, but you pay income taxes when the money is withdrawn. This means you must spend your Roth IRA balance, while traditional IRA balances are reduced by the amount of taxes you later owe.
How should you invest your money? The short answer: A diversified mix of index funds. These are low-cost mutual funds that track broad swaths of the stock and bond markets (exchange-traded funds, which are similar to mutual funds but trade on an exchange, are a similar option). For more details on your investment options, see this guide.
More immediate spending goals
In addition to retirement, you probably have other savings goals. Maybe you’re saving for a car, a wedding reception or a special trip. Because these goals have a shorter time horizon than retirement or something you need to achieve within three years or less, you should take less risk with this money. The simplest strategy is to automatically transfer money to a high-yield online savings account every month, for example. For short-term goals, the amount you save is far more important than your return.
However, if you need the money in three to 10 years — call that a medium-term goal — you may have more options depending on how flexible you can be with your timing.
It can be tempting to invest your savings in the stock market, for example, in the hope of achieving a higher investment return. But that brings with it more risk. As one financial planner aptly put it: You need to think about what it might feel like to lose half of your stock investment in a given year, and it may take time, even years, to recover. Do you have the time (or courage) for it?
You can take a hybrid approach and invest in a mutual fund that’s, say, 60 percent bonds and 40 percent stocks, or you can explore bond investments, which offer more stability (though they carry their own risks). But proceed with caution.
Even if you don’t have large amounts to save now, building the infrastructure to save is the hardest part – and as your income increases, saving and investing more becomes much easier.
Action points:
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Do you have a high-interest online savings account? Some banks, including Ally and Capital One, allow you to set up different savings areas that you can label for specific goals (emergency fund, vacation, down payment). DepositAccounts.com offers a helpful guide to help you sort through the options.
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If you have a company pension plan and haven’t thoroughly reviewed investment options, you can set a reminder in your phone’s calendar to review it. What index fund options are offered? Also familiarize yourself with any target date fund offerings. (This is a ready-made mix of investments that you can choose and then forget about, and it is a mix of stock and bond mutual funds that gradually increase as you approach the year in which you expect to retire automatically become more conservative. If you were born in 2000, the 2065 or 2070 funds might be the right solution for your situation.)
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If you don’t have access to a company pension plan, look into roboadvisers, or companies that rely heavily on technology to manage your investments but often also have human financial advisors. These are nice options for people with simple needs or for people who want to create a savings and investment plan and implement it on autopilot. Morningstar has listed its top picks here.
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2024-05-17 18:00:06
www.nytimes.com
