A friend of mine is getting a later start on investing for retirement. She’s 27, and yes, these days, I’d say that’s getting a later start. People are living longer, which means whatever money we do have is going to need to last as long as we do.
Starting to save for your retirement right away is key due to a little thing called compound interest. Even on small amounts of money, compound interest means you’ll be building on a larger and larger base of money year over year.
Let’s say you start with $1,000 and invest it at a rate of 8% per year. At the end of year one, you will have $1,080. So, in year 1 you earned $80. In year two, you’re starting with a larger balance of $1,080, on which you earn another 8%… but it’s 8% of this new balance, not the old one. So, in year two, you earn $86.40. Each year, as long as the growth rate stays the same, you earn more money.
Anyway, so my friend missed out on almost five years of compound interest. She still wanted to get started and do what she could to best position herself to start saving money relatively aggressively. However, rather than shock her financial system—after all, this is the first time she’s had a job, since she’s been in graduate school since undergrad—I suggested the following:
- Start with a reasonable percentage of your salary to contribute to your retirement fund. Ideally, we’d all be setting aside 10% of our income, but that’s not necessarily realistic right out of school. Start with 6%, which ensures she gets her company 401(k) match, and then set her account to increase by 1% every year. Most programs let you do this automatically, and you can often align it with when you receive your merit increase. The 1% difference will hardly be noticeable, and in four years, you’ll be at 10%.
- Pick a target date retirement fund to invest in. This is where you set the year of your retirement and the fund determines the mix of stocks and bonds in your portfolio. I suggested picking a slightly later retirement—that would allow her to be more aggressive now, as the younger you are, the more stocks you’ll have.
- Set up an IRA (individual retirement account) for any extra money or windfalls. Setting up an IRA is easy, and, depending on your tax bracket, you can even have a Roth IRA, which allows you to pay taxes on your contributions now and then withdraw them tax-free later in life. Make regular contributions to this account whenever you have spare cash from a tax refund, gifts, etc. throughout the year. It’s like a little bonus plan to your established 401(k).
All in all, when it comes to saving for old age, its better “late” than never!