You're just starting your financial life as an adult — let's say you're 25. You hope to live 70 more years, with several decades in...
You’re just starting your financial life as an adult — let’s say you’re 25. You hope to live 70 more years, with several decades in retirement.
How do you get started with a financial strategy that will serve you seven decades from now?
If inflation continues at the historical average of about 3 percent a year, when you retire in 40 years it will cost $3,262 to buy what $1,000 gets you now.
The accompanying chart titled “Saving Enough for Retirement” shows how much you will have to invest each year to build a nest egg that will give you a monthly income equal to $1,000 today.
If your retirement is 40 years away, and assuming an investment return averaging 8 percent a year, you would need to invest $2,888 this year. In each of the next 39 years, you would have to increase the figure by 3 percent to keep up with inflation.
Of course, $1,000 a month is not much, so you might have to save three or four times as much to be assured a comfortable retirement — a tough task on an entry-level income.
But as you can see from the chart, it is a lot easier to build a big nest egg if you start early, gaining many more years of compounding.
So here are some ways someone in their 20s can get a financial plan off to a good start:
Build a rainy-day fund. You should have enough to cover six months’ expenses, and it should be in a safe, accessible place, such as a bank account or money-market mutual fund with check-writing privileges.
List your financial goals. You should probably start saving for a down payment on a home and children’s college educations, in addition to retirement.
If your employer offers a 401(k) or similar retirement-investing plan, put as much into it as you can afford, especially if the boss will match your contribution.
Money you put in is tax-deductible, and there is no tax on investment gains until money is withdrawn.
Invest in your career. If you need more education, or have to relocate for a better job, now is the time. It will be harder when you have a family or other obligations tying you down.
Clear away high-interest debt, such as credit-card balances. Paying off a loan that charges 15 percent is like getting a 15 percent investment return.
If you have student loans, investigate ways to reduce interest charges. Often, that can be done by consolidating loans and arranging for automatic payments from a bank account.
If these loans are at low rates, make only the minimum payments required until you have paid off high-rate loans and built up your rainy-day fund.
In your investments, any money that can be tied up for at least five years should go into stocks. Over long periods, stocks earn better returns than bonds and cash, and you have enough time to wait out the downturns.
Invest in index-style mutual funds rather than individual stocks or “managed” funds.
Instead of hunting for hot stocks, index-fund managers buy and hold stocks in well-known market gauges such as the Standard & Poor’s 500.
Over time, indexers tend to beat most managed funds, which incur big expenses seeking out investments.
Build a good credit history by paying bills on time. This will make it easier — and cheaper — to get loans in the future.
Resist the temptation to dip into long-term investments for fancy vacations, expensive cars and other extravagances.
Remember that whenever you hear figures for long-term investment returns, they assume investments are left untouched to compound, and that money received from dividends, interest and capital gains is reinvested.
Do not get discouraged. Although the numbers in the accompanying chart is sobering, you may enjoy two or three booming bull markets in your lifetime.
Also, as your income rises over the years, you will find it is not that hard to meet your investment goals.
The sooner you start, the easier it will be.