Premium ContentMouse over Home then click on Premium Content for information.Steven Covey once said: "Begin with the end in mind." For people in their 20s, that is about the best retirement advice you will ever get.
Why? Imagine your life 40 years from now. If the past is any guide, you will just be getting ready to transition out of work and into retirement.
Assuming all goes well, Future You will have a nice, comfortable nest egg set aside and will be on the cusp of an exciting new phase in life.
There's just one thing: In order for Future You to have a shot at that comfortable retirement, Current You has some work to do. Thankfully, you have a lot going for you. What are the key ingredients to getting a healthy start?
Start early
Early in life, your biggest asset is time. Those extra years can make a huge difference when it comes to your investments.
The first chart on the left shows a hypothetical example of the benefits of starting early. It compares five people saving for their eventual retirement at age 65. They save identical amounts each month ($500) and earn identical rates of return (8 percent per year, compounded monthly) on their investments. The only difference is when they start.
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Molly starts at 20. It's a stretch, but she makes it work. Kelly, on the other hand, spends his extra income on a steady diet of video games and Mojitos and doesn't get around to saving until he hits 30.
How much of a difference do those 10 years make? About $1.5 million. Said another way, Molly saved $60,000 more than Kelly ($6,000 per year for 10 years) on the front end, but that extra money resulted in an extra $1.5 million on the back end.
The crazy thing? She could have stopped saving at 30 and never added another dime to her account and she still would have ended up with more than Kelly. Behold, the power of compound interest.
The longer you wait, the more drastic the difference and the more you need to save to catch up. The second chart shows how much our fictional characters would need to save each month to end up with the same amount as Molly.
Waiting until 50 to start means that Pat would need to save more than $7,500 each month to catch up. Niel would need to put away the equivalent of a new car each month. As you can see, starting early allows time and compound interest to do most of the heavy lifting.
Make it automatic
Saving for retirement takes discipline. That is especially true if you are in your 20s and won't see the payoff for decades to come. It's like making a car payment each month for a car that you won't be able to drive until 2057.
Rather than relying on willpower, make your saving automatic. Have your employer take money from your paycheck each month to add to your 401(k). Set up a Roth IRA that systematically pulls money from your checking account. You can start with as little as $25 per month.
After a while, you will get used to living without the money and you won't even think about it. I believe it was Newton's Third Law that said: "For every dollar earned, there is an equal and opposite way to spend it." Or something like that. Make it easy on yourself. Make your saving automatic.
Save enough
One of the most common questions that people have about setting aside money for retirement is "How much should I be saving?" The answer, of course, depends on your specific situation.
Recently, a professor by the name of Wade Pfau did some interesting research on this topic. He calls it the "safe savings rate."
At the risk of drastically simplifying his research, this is the question he was trying to answer: How much does a person need to save in order to safely fund retirement even after the ups and downs of the market are taken into account?
His conclusion for someone in his or her 20s (aka someone who can save for 40 years)? Using historical market data and assuming an allocation of 60 percent stocks and 40 percent bonds, he found that someone saving for 40 years and then living for 30 years in retirement had a 100 percent chance of replacing 50 percent of his pre-retirement income if he saved 8.77 percent per year. Increasing the savings rate to 12.27 percent resulted in a 70 percent replacement rate.
Of course, past performance is no guarantee of the future, but his research is helpful in that it gives you a specific number to shoot for.
Saving 10 to 15 percent of your income might seem like a stretch, but you don't need to get there overnight. Start with something small, like 1 percent per year, with the goal of increasing it each time you get a raise. Combine that with the employer match on your plan (most employers will match a certain percentage of what you put in) and you'll be at 10 percent before you know it.
Allocate properly
Asset allocation (the breakdown among stocks, bonds and other asset classes) is a critical element to investment success. In fact, research shows that it is responsible for as much as 90 percent of the return. The remaining 10 percent is determined by the specific investments you buy and when you buy them.
Work with a trusted adviser or the representative assigned to your plan at work to make sure your allocation is appropriate for your situation. Then review that allocation regularly and make changes as necessary.
Don't raid the piggy bank
The average person changes jobs five to 10 times over a lifetime. Each time you change, it's tempting to take the money from your 401(k) rather than rolling it over to an IRA or to your new employer's plan. This is especially true if you have things such as moving expenses or if you lost your job involuntarily and need some resources to make ends meet.
Do everything you can to avoid taking these premature distributions. Not only will you pay taxes and a penalty (assuming you're younger than 59½), but it also means that the advantages you gained from starting early go out the window.
The secret
The biggest objection to starting early is that it's not easy to save at the front end of your career when your income is limited and you have so many expenses, such as a new work wardrobe or furnishing your house or apartment.
I'll let you in on a little secret: It doesn't get any easier. There will always be wants and needs competing for your limited resources. The key is deciding to start, no matter the amount, and then making saving a lifelong habit.
One more thing
Do me a favor. You probably have a friend, child or grandchild who would benefit from this article. Take a moment to share it with them. You can give them this copy or go to www.omaha.com where you can easily email them a copy or share it to your social networks.
Joe Hearn is an Omaha financial planner. He can be reached at 402-331-8600 or joe@intentionalretirement.com
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