When I was in my young 20s, retirement was just about the last thing on my mind. I had just graduated from college, started my first professional job, and had my whole life ahead of me to look forward to.
While that may be true, what I realized about a decade later was that your 20s is precisely the right time you want to begin retirement planning. The more you do in your early years, the more luxurious your golden years could be AND you’ll likely have more time to enjoy it.
If that sounds like the kind of life you’d like to have one day, then here are the top five ways you can start saving for retirement in your 20s starting today.
Define Your Goal
There was a time when the word “retirement” would have conjured up images in my head of old men and women eating early-bird dinner specials and playing bingo. But after I started reading books like “The 4-Hour Workweek” and “Rich Dad, Poor Dad”, I realized that your retirement can be anything you want it to be.
- You could figure out a way to becoming financially independent by the time you’re in your 30s (yes, that really happens for some people). With no longer having to go to work, you could spend the rest of your days traveling the world and learning new things.
- Or you could also use retirement as a way to launch into a second career or start your own business. Imagine trading in what you do now to pursue doing a hobby or passion that you’ve always loved.
- Or you could be like me and simply want to achieve financial freedom (regardless of whether I keep working or not).
The choice is yours! But to get there, you first have to determine what your vision of retirement will look like and how badly you want to get there.
Even if you’re in your 20s, spend some time reflecting on what you’ll want to do. If you’ve got a partner, make sure that you talk about it with them too since their idea of retirement may influence how the two of you ultimately decide to spend it.
Join Your Employer’s 401k Plan
Most young people will have no idea what a 401k is until they start their first professional job (I sure didn’t). But trust me – it’s something you’re going to want to start taking advantage of right away!
For starters, a 401k lets you avoid paying taxes on any income that you save towards retirement. You instead get to defer those taxes until decades later when the IRS says you can withdraw them after age 59-1/2.
With a maximum savings limit per year of $19,500 (as of 2021), that’s like getting a free pass to skip paying the IRS $4,290 in taxes (assuming you’re in the 22% tax bracket).
But then a 401k gets even better. As a way to encourage employees to participate, most employers will also kick in additional money called matching contributions. It’s basically free money that they’re giving you just for being a good saver.
Matching contributions can be as much as dollar-for-dollar (up to some limit). For the sake of argument, let’s say your employer is going to give you an extra $3,000 per year in matching contributions. If that was invested in a stock market index fund earning approximately 10% per year, then after 30 years it would be worth $493,482.
And all of it is also tax-deferred!
Open a Roth IRA Too
A 401k isn’t the only way to save for retirement. If you’d like to have tax-free income by the time you retire, then you can also open what’s known as a Roth IRA.
Roth IRAs work the opposite of a 401k. With a Roth, you pay taxes on your income now and then owe the IRS nothing later on. That means all the money you earn on top of your savings is also completely tax-free by the time you retire.
You can open a Roth IRA with any financial institution of your choice. In fact, most robo-advisors will give you this option if you open an account with them.
Save Until It Hurts
I remember when I started my first professional job, I started off saving 10% of my income for retirement. But with my retirement goal in mind, I eventually ramped that up to 15% followed by 20%. And then after a few years, I was saving as much as the IRS would allow!
Whenever someone asks me “how much should I be saving?”, my answer is always very simple: Save until it hurts. By this, I mean you should save as much money with every paycheck to the point where you’ve got almost nothing leftover when you’re done paying your bills.
Why do this? Because over time it will help you to become more disciplined with your spending habits and prevent lifestyle inflation from creeping in as your income starts to rise. Meanwhile, the more you increase your savings rate, the closer you will get to your vision of retirement.
One mistake a lot of my friends made when they started their 401k plans was to avoid investing in funds made up of aggressive stocks because they thought they were too risky.
But playing it safe cost them when my portfolio of aggressive-style funds was nearly double the value of theirs after just 3 short years.
Throughout history, the stock market has outperformed every other type of asset (bonds, currency, precious metals, real estate, etc.). This is all thanks to the awesome power of compound interest.
To illustrate this point, if you had invested $100 back in 1928:
- Putting it into the S&P 500 stock market index fund would have turned it into $592,868.
- Putting it into 5-year treasury bonds would have returned $8,921.
That’s quite the difference!
But aren’t stock funds risky? Yes, of course. But remember – you’re in your 20s! You’ve got plenty of time to ride out the ups and downs of the stock market.
Over the long haul, stocks are going to produce a positive return. So as long as you put any market jitters aside, you’re going to be giving your nest egg the best chance you can of letting it grow to its full potential.
Thinking about retirement in your 20s may seem like the last thing you should be doing at this age. But the sooner you begin, the easier it’s going to be to accomplish everything you’ll eventually want to do.
Let your vision of retirement motivate you to participate in your 401k plan and save until it hurts. Remember also to invest aggressively so that you’ll maximize your chances for growth.
Believe me – by the time you’re in your 30s or 40s with hundreds of thousands more dollars than your peers, you’ll be glad you got started when you did.
Contributor’s opinions are their own. Always do your own due diligence before investing.