Who thinks about retirement in their 20s? The answer—you should. If you’re a 20-something or have a child in that age group, the bottom line is this—if you start saving now, and you save consistently, you’ll reach retirement with enough money to live comfortably plus have enough to do what you never had the time or money to do in your working years. But first, you need a strategy.
The chart below shows five types of investing strategies and asset allocations.
Learn About the 401(k)
The 401(k) is based on section 401(k) of the IRS tax code. It allows you to invest money into an account earmarked for retirement without paying taxes on the gains until you reach retirement age. Alternatively, another type of 401(k) allows you to pay taxes on the money now at your current (most likely) lower tax rate instead of later when your salary is much higher.
A 401(k) is only offered through an employer and often they will match your contributions up to a certain limit. If your company offers a 401(k) with a match, contribute enough to get the full match. If you’re self-employed, you can start your own 401(k) under your registered company name.
The advantage of a 401(k) over other retirement savings accounts is that the yearly limit is higher. You won’t reach your retirement goals without that higher limit but keep in mind that there are specific rules you have to follow with this money or face steep financial penalties. Read more about the rules surrounding a 401(k) here.
Start an IRA
IRAs have many of the same rules as 401(k)s but the contribution limits are lower. As of 2021, you can only contribute $6,000 annually or $7,000 if you’re over 50 but there are also distinct advantages—namely the fact that you can invest in almost any stock, bond, ETF, or other traditional investment. IRAs don’t have to go through your company. That gives you a lot more control over how your money is invested. If your company doesn’t provide a match, it’s probably best to max out your IRA first and put the remaining money into the 401(k).
Pay Off Debt
The best and safest investment you can make is in yourself. If your company is giving you free money (the 401(k) match), invest enough to take it but after that, pay off any high-interest rate debt. There’s no good financial reason to save extra money for retirement while paying thousands of dollars in high-interest credit card debt for years. Financial advisors say that if you can pay your student loan debt in less than 10 years put all of your focus there before saving extra for retirement but that’s not true of all financial situations. Get some advice from a pro before making decisions like this.
Keep Some Cash
In most cases, you can’t withdraw from your retirement accounts without paying a stiff penalty. You might be able to borrow from your 401(k) but you have to pay that money back. Keep an emergency fund outside of your retirement accounts to cover unplanned expenses. Experts recommend keeping 3 to 6 months' worth of living expenses.
Let’s be clear—in your lifetime and before you reach retirement, you will experience some scary plunges in the investment markets that will put your retirement account in freefall. That’s no reason to invest conservatively in your 20s. Experts recommend being at least 80% invested in stocks in your 20s because you have 30 or 40 years to recover from those short-term scary stock market downturns and still make plenty of money.
Make Saving Automatic
It’s easier to stay disciplined when something happens automatically. Give HR a call or email and ask for paperwork on how to set up automatic withdrawals that go straight to your 401(k) or IRA each month. Don’t be stingy. Make it a significant amount, especially while you don’t have a big family. You’re not going to go through the hassle of calling HR when you don’t want to contribute this month so automatic withdrawals are the best way to stay disciplined.
Be Proud of Yourself
Aggressive retirement savings in your 20s will mean a super impressive balance long before you retire. Keep an eye on your account and watch it grow and multiply. Be proud of your accomplishment and allow that to be motivated to save even more. Nothing beats the effect of compounding gains because the simple passing of time makes you richer and richer. Wealth in later years means security and security. Want to give money to somebody in need? That will feel really good knowing that a lifetime of good choices allowed you to carry out your financial dreams.