But a poor widow came and put in two very small copper coins, worth only a few cents. – Mark 12:42
Retirement. Imagining where we will be in 40+ years seems impossible. Yet just because it feels like a lifetime away doesn’t mean you shouldn’t start thinking about it now. We often assume that having a big salary is the key to having a comfortable retirement, and that if you work in a helping profession you can’t retire as a millionaire.
However when it comes to retirement, time is your greatest asset, not money.
In early adulthood time is on your side, and in that sense we have all the advantage over those middle age folk with six figure incomes. Let me run a quick scenario for you:
Let’s say that a 28 year old works full time at a job where they make $35,000 annually. They have paid off their high interest consumer debt (credit cards, auto loans, personal loans) and are ready to start investing for retirement. They are able invest $292 monthly ($3,500 annually, 10% of their income) until they retire at age 65, giving their retirement savings 37 years to go to work for them. If they earn a 9% average return on their investments (the stock market average for a good index mutual fund) their retirement account will have grown to over $1 million. This is a luxurious sum of money for any of us. If you don’t believe me feel free to check it out for yourself.
To convince you that time is your greatest asset, let’s run another scenario. Let’s say that a 35 year old earns $70,000 annually and is able to save $584 monthly ($7,000 annually, 10% of their income) for retirement, but they have waited until now to start their retirement savings. Because this person waited until 35 to save for retirement they only have 30 years for their invested retirement money to go to work. If they earn the same 9% average return over the course of that time they will also have over $1 million for retirement. See the difference? By waiting an additional 7 years it required this person to invest double the amount annually to have the same amount at retirement.
If you commit to a little bit each month now, it will relieve the pressure to contribute large sums of money when you’re in your 40s and 50s.
It can be easy to make excuses about not saving for retirement, and those excuses will cost you. Even $50 a month can make a huge difference. The key isn’t how much you can invest regularly, but when you choose to start investing, and we would encourage you to start right now. There will always be reasons not to, you want to preserve your going out money, you’re saving for a new car, you want to buy a house soon etc. Find room in your monthly budget to invest in your retirement, no matter how little it is.
Many young people see retirement saving as a luxury and only contribute when they land a job that has a retirement plan. We are here to say that EVEN when you have to do all the work yourself, you MUST start your retirement savings now. Right now. If you don’t have anything set aside for retirement, read this post and then go invest. It’s that important.
You have a plethora of options to start saving for retirement, specifically different ‘types’ of accounts. These aren’t specific investments, they are the vehicles through which you purchase investments for your retirement. You want to invest in retirement accounts because of the significant tax advantages they offer. I am all about simple investing, and I am going to lay out for you a straight forward explanation of the investment accounts that we would recommend. These accounts are all long tem based accounts, the money you put in them cannot be pulled out until you are 59.5 years old or you face big penalties. To see annual contribution limits for these accounts click here.
Employee sponsored retirement plans, 401(k), 403(b), SEP-IRA, Keogh etc:
These plans are offered through employers as retirement accounts for their employees, and they are an excellent place to start if your employer offers one. They have several advantages.
Individual Retirement Accounts, Roth IRA, Traditional IRA.
These plan are accessible for everyone and for almost all of you reading this post we would recommend using a Roth IRA as your primary investment account. Here’s why.
Now we come to the part you are probably most interested in, specifically where you should you invest in. In early adulthood you should be pretty aggressive with your investment portfolio, having as much as 75-80% in stock mutual funds with the remaining 25-20% in bond mutual funds. Remember you are investing for the long term, these are buy and hold investments, meant to be held until age 60 or later. Our retirement accounts are invested almost completely in index mutual funds, which we would advise you to do as well. You will also probably notice that all of the funds we recommend come from the Vanguard company, let me briefly explain why.
Vanguard funds have the lowest expense ratios and fees of any mutual fund company, their philosophy is to keep their fees low so that investors can enjoy maximum profit. Check out their investing philosophy here. We don’t work for Vanguard, we don’t have family members that work for them, and we have no incentive to recommend them other than the success we have enjoyed investing with them.
Index mutual funds seek to replicate the performance of a stock market index like the S&P 500. The funds we recommend here also have built in diversification, protecting you against market fluctuations. They have affordable minimum investments, have very low costs and fees, and have a solid proven track record for returns. If you want a more complete explanation of what an index mutual fund is and why you should invest in them check out this Forbes.com article written by one of my favorite contributors.
So here we go, 4 great mutual funds to start with.
Vanguard Star Fund (VGSTX)
This fund is a fund of funds, meaning that it invests in several of Vanguards other mutual funds. It keeps about 65-70% of its holdings in stock mutual funds and the rest in bond mutual funds. If gives you good exposure to the total stock market and bond market. If you only choose to invest in one mutual fund this would be it, because it allows you to invest in multiple securities, has has built in diversity, and a low minimum investment.
Vanguard Total Stock Market Index (VTSMX)
This index fund gives you total exposure to the U.S. stock market, has a razor thin expense ratio and is an excellent mutual fund to begin your portfolio with. Note however Its only downside is that it has a higher minimum investment than Vanguard’s Star Fund.
Vanguard Total International Stock Index Fund (VGTSX)
This fund invests in emerging and established markets around the world. It can be used as a partner for a the Vanguard Total Stock Market Index, as international markets don’t always move in tandem with U.S. markets. Investing in international funds is a little bit riskier but offers the chance to earn higher rewards, if you are an investor willing to absorb some risk this may be a fund to consider having in your portfolio.
Vanguard Total Bond Market Index (VBMFX)
Your portfolio has to have some bonds in it for diversification, and this is a great fund for that. Bonds are much less volatile than stocks but also offer lower returns. As you age your portfolio should contain a higher percentage of bonds as these don’t go through the huge fluctuations in value stocks do.
There you have it, a crash course in retirement investing for young adults.
Tell us your investing story, what are some of your favorite low fee mutual funds? How have you begun saving for your retirement?