Some of you reading have likely just passed your licensing exams and are just starting off in your new career. One of the last things you are probably thinking about is retirement. However, now, more than ever, is the best time to start saving for retirement.
If retirement is decades away, why do people make a big deal about starting now?
It’s called compound interest.
USA Today revealed a study that demonstrated two-thirds of Americans do not know how compounding works.(1) I will save you the math, but basically: the earlier you start saving for retirement, the better. Particularly, the first years can make the biggest difference.
Person A starts investing $200 a month for retirement at age 25. Meanwhile, Person B starts investing the same amount, but 10 years later at age 35. If both retire at age 65, Person A has put in $96000 into retirement while Person B put in $72000. Assuming both have the same 6% rate of return (which in the market is a relatively low and conservative figure), Person A will have over $400000 at age 65 while person B will have just over $200000.(2)
Here’s another example from Mint.com that talks about two people: person A maxes out their 401(k) ($18000 annually) for the first 10 years of their career and never contributes another cent, and person B doesn’t contribute anything for the first 10 years of their career and then maxes out their 401(k) ($18000 annually) for the next 33 years until they retire. In the end, Person A wins by a couple hundred thousand despite contributing $400,000 less over their lifetime.(3)
The key concept is to start early!
How can I start investing for retirement?
A simple way to begin investing for retirement is through your employer’s 401(k) plan, if available. Typically, an employer-sponsored 401(k) will also have preset funds or allocations, so you usually do not have to worry about selecting specific stocks, bonds, ETFs, or mutual funds.
At the very least, take your employer’s 401(k) match. By not doing so, you are literally throwing away free money from your employer.
My first job did not offer a 401(k), but even so, I still regularly contributed to my Roth IRA (Individual Retirement Account). An IRA is a way for individuals to begin to invest for retirement on their own. There are two common types of IRAs: Roth and Traditional. The main difference between Roth and Traditional is when taxes are taken. In a traditional IRA (or 401(k)), taxes are taken when you withdraw your money in retirement. In a Roth IRA (or Roth 401(k)), you use your post-tax dollars (i.e. money from your paycheck after taxes are taken out) but do not owe any taxes when you withdraw your money in retirement.
Which one is right for you (Roth or Traditional) will vary by individual situations. However, the rule of thumb is:
- If you are in a lower tax bracket now compared to when you will retire, the Roth option might be best for you.
- If you are in a higher tax bracket now compared to when you will retire, the Traditional option might be best for you.
Both the Roth and the Traditional offer their own set of pros and cons.(6)
And you do not have to choose just a 401(k) or IRA; you can decide to participate in both if you want to reap the benefits of both types of accounts! Many people will contribute to both their employer’s traditional 401(k) and own Roth IRA. Also keep in mind that there are also other retirement vehicles out there (especially for self-employed individuals), but 401(k)s and IRAs (both Roth and Traditional) make up the large majority of accounts
However, unlike most 401(k)s, IRAs often require you to choose the stocks, bonds, ETFs, and mutual funds you wish to hold. So…
How do I get started with an IRA?
Betterment offers a self-run “robo” IRA which might be best for those who do not wish to choose different funds to invest in (https://www.betterment.com/401k-and-ira-rollover/) Otherwise, other big-name brokerage companies, like Scottrade offer ways to open your own IRA as well.
Different funds to choose for an IRA can be overwhelming. And you will get different advice from everyone you talk to. However, there are a few fan-favorites out there.
Some funds to look into:
- A low-cost S&P 500 exchanged-traded fund (ETF) (as recommended by the legendary Warren Buffett)(9)
- Target Date Funds
You buy into a fund that corresponds with your estimated retirement year. The fund is actively managed, meaning that the portfolio will be actively rebalanced and properly allocated to recommended risk levels based on how close you are to retirement.(10)
There are many different types of Target Date Funds. Due to their low expense ratios (fees), Vanguard is a popular financial institution through which you can buy into Target Date Funds. For many recent graduates, the Vanguard 2060 fund is likely the most recommended choice, for example:
But of course, I am not here to recommend any specific stocks, bonds, mutual funds, or ETFs. It is best to do your own research and see what fits best in your own individual portfolio. Furthermore, a chat with a financial advisor might be helpful for this particular subject.
But what if I have student loans?
Chances are, especially if you have completed any type of post-undergraduate education, you have some amount of student loans. And as badly as you’d like to pay off those student loans as early as possible, the power of compound might suggest otherwise.(12) (https://learn.stashinvest.com/paid-off-student-loans-investing).
Therefore, instead of throwing ALL your money at student loans, it is likely worth more to make sure you are contributing at least something towards retirement. As seen in the example earlier about starting at age 25 vs 35, these first few years of your career make a big difference. It is extremely important to pay the minimums on your student loans each month, and a little more if you can, but definitely do not completely neglect your retirement savings. Even just 1% of your salary or a couple bucks a month is a good starting point for retirement if finances are tight.
But what if I’m not a new grad? What if I’m starting late?
Better late than never! You still have time to reap some of the benefits of compounding. Furthermore, those over the age of 50 can participate in Catch-Up Contributions. In short, this allows those age 50 or older to contribute more than the set maximum contributions for both 401(k)s and IRAs.(13)
But what if I have kids and I’m saving for their college education?
The legendary Chris Hogan also states in his podcast that statistics show, “there’s a 50% chance your child will go to college, but 100% chance that you will retire.” (https://www.chrishogan360.com/podcast/). Just like the flight attendant says before every flight, you have to put on your own mask before assisting others.(14)
So now that I know the importance of investing for retirement, how much do I actually need to save?
As you have hopefully learned from reading this, the earlier you start investing, the less of your own money you need to contribute overall. Russ Wiles from the Arizona Republic tells us that $.05 invested at age 25 could be worth $1 at age 65. At age 35, you’d have to save $.10 for every $1 in retirement. And at age 45, you would have to save $.21 for every $1 at age 65 (This assumes an 8% average annual return, which is not uncommon in the stock market).(15)
In the compounding equation, time is a very valuable component. Everyone’s retirement goal will vary greatly based on multiple factors, such as cost of living, living expense, etc. There is no one-size-fits-all approach; however, Kathleen Elkins at CNBC has laid out these recommended guidelines for the amount of money you should already have saved for retirement:(16)
- By age 35: Have twice your annual salary saved.
- By age 40: Have three times your annual salary saved.
- By age 45: Have four times your annual salary saved.
- By age 50: Have five times your annual salary saved.
- By age 55: Have six times your annual salary saved.
- By age 60: Have seven times your annual salary saved.
- By age 65: Have eight times your annual salary saved.
Even if these numbers seem daunting, remember that something is better than nothing. You do not want to end up like the nearly 50% of Americans with NOTHING saved for retirement.17
How can I save money?
To invest for retirement, you may need to re-tool your budget, as statistics show 47-73% of Americans are living paycheck-to-paycheck.18 I highly recommend using a free budgeting app like Mint or Personal Capital. With these, you can easily see over time where your money is going. Some people also find different types of monthly budgets to be useful, such as the 50/30/20 Plan(21) and Envelope System(22).
You could save some money by reducing or eliminating monthly expenses. A popular option among Millennials, and even some older people, is to get rid of cable (costing roughly $100 per month, on average) in favor of streaming services like Netflix (about $10 per month) and using an antenna for local channels. Unless you insist on having those 300+ channels at your disposal, this money move alone can save you over $1000 a year (and a lot of headaches on the phone with the cable company).
Also, take a look some other monthly subscription services you might not be taking full advantage of, such as Spotify, SiriusXM, workout classes, Blue Apron, etc. Reducing or eliminating a few of these monthly expenses can free up a little extra money each month. Bringing your lunch to work instead of eating out is also a great way to save money each week.
A couple bucks a week might not seem like much, but it can really make a difference in the long-run. For example, saving just $10 a week can lead to over $500 saved in one year.
Another way to save some cash is buying a used car versus a new car. In particular, many new grads like to reward themselves for all those years of school with a brand new car. And while a new car is nice, it will cost you a lot more in the long-run. The average 5-year car payment for a new car is roughly $500, while the same payment for a used car is roughly half that amount.
New cars also depreciate at a much higher rate compared to used cars. Philip Reed at NerdWallet lays this scenario out nicely in this example: (23)
Take a look at two similar cars, one new and one used.
New-car depreciation: You buy the car for $30,000 and sell it three years later for $15,000. The car has cost you $15,000 in depreciation.
Used-car depreciation: Now let’s say you buy the same car, but it’s 3 years old when you buy it. You could buy the car for $15,000. Three years later you could sell it for $10,000. So the used car depreciation cost you only $5,000.
Now, if you’re paying attention, you would quickly say, “But driving a brand new car is much better!” You’re absolutely right. So, if driving a new car is worth an extra $10,000 to you, go for it. (23)
Bottom line: New cars are nice, but with a new car, you are paying more for an asset that is dropping quicker in value as opposed to a used car. With a used car, you are paying less (compared to a new car) for an asset that is dropping in value more slowly than a new car, as most of the depreciation has already been done (a win-win financially!).
This seems like a lot to manage… Would a financial advisor help?
All this info above regarding retirement assumes that you will be working until at least 59.5 years old. This is the earliest you can start taking withdrawals from your retirement accounts without penalties. If you do desire to retire earlier, then you definitely need to start saving and investing a bigger chunk of your paycheck early and often. You will also need to look into brokerage accounts and/or other retirement and investment vehicles. Therefore, in these cases, a free consultation by a financial advisor may help.
Note: Will Butler, DPT is a PT-turned-financial advisor (we prefer to call him a clinicians’ advocate) and he’s always available for free phone consults, too.
As a physical therapist, my older patients often talk about their retirement during our sessions. Some patients are set for retirement since they started saving young, and remind me to continue to do the same. Other patients did not save early for retirement, and now, they will either be working well beyond the retirement age or scrimping to get by when in retirement (if they can even work at all, depending on their health). They too, also tell me to keep saving now as a young adult. None of my older patients ever regretted saving too much for retirement.
“The ability to delay pleasure is a sign of maturity.” -Dave Ramsey
Bonus read: Some people go above and beyond when it comes to saving in general, especially for retirement. For their efforts, some people have been able to retire in their 30s (even with kids!).24 It’s not easy, but it is possible, and an interesting read nonetheless: https://www.cnbc.com/2017/04/10/couple-that-retired-in-their-30s-share-their-no-1-money-saving-tip.html
- Backman, M. USA Today. Compounding: 66% of us don’t understand crucial financial concept. 6 June 2016. Available at https://www.usatoday.com/story/money/personalfinance/2016/06/05/compounding-financial-concept-saving/85295910/. Accessed 30 August 2017.
- Kiersz, A. Business Insider. Saving at 25 vs Saving at 35. 25 March 2014. Available at http://www.businessinsider.com/saving-at-25-vs-saving-at-35-2014-3. Accessed 1 September 2017.
- Campbell, H. Mint.com Think It’s Too Early To Plan for Retirement? Wrong!. 25 August 2017. Available at https://blog.mint.com/planning/think-its-too-early-to-plan-for-retirement-wrong-082517/?utm_source=iosapp. Accessed 4 September 2017.
- Hogan, C. Chris Hogan. When Should I Start Saving for Retirement? 2017. Available at https://www.chrishogan360.com/when-should-i-start-saving-for-retirement/. Accessed 22 September 2017.
- Frankel, M. The Motley Fool. Roth IRA: Pros and Cons of this Tax-Advantaged Retirement Account. 18 March 2017. Available at https://www.fool.com/retirement/2017/03/18/roth-ira-pros-and-cons-of-this-tax-advantaged-reti.aspx. Accessed 7 September 2017.
- Turner, M. Business Insider. Warren Buffett Best Investment advice on Low-Cost Funds. 4 MAy 2017. Available at http://www.businessinsider.com/warren-buffett-best-investment-advice-on-low-cost-fund-2017-5. Accessed 23 September 2017.
- Investopedia. Target Date Fund. Available at http://www.investopedia.com/terms/t/target-date_fund.asp. Accessed 24 September 2017.
- Kumok, Z. Stash. “I Paid Off My Student Loans in Three Years! Did I Make a Mistake?” 14 August 2017. Available at https://learn.stashinvest.com/paid-off-student-loans-investing. Accessed 9 September 2017.
- Investopedia. Catch Up Contribution. Available at http://www.investopedia.com/terms/c/catchupcontribution.asp. Accessed 24 September 2017
- Wiles, R. USA Today. Want Financial Success in Retirement? Choose Wisely. 6 October 2017. Available at https://www.usatoday.com/story/money/personalfinance/2017/10/06/want-financial-success-retirement-choose-wisely/710077001/. Accessed 6 October 2017.
- Elkins, K. CNBC. Here’s How Much Money You Should Have Saved At Every Age. 22 February 2017. Available at https://www.cnbc.com/2017/02/22/heres-how-much-money-you-should-have-saved-at-every-age.html. Accessed 30 August 2017
- Elkins, K. CNBC. Here’s How Much the Average American Family Has Saved For Retirement. 12 September 2016. Available at https://www.cnbc.com/2016/09/12/heres-how-much-the-average-american-family-has-saved-for-retirement.html. Accessed 1 September 2017.
- Peach, C. Grow from Acorns. Stop Saying You Don’t Earn Enough to Retire a Millionaire. 7 September 2016. Available at https://grow.acorns.com/how-to-retire-a-millionaire/. Accessed on 3 September 2017.
- Shin, L. LearnVest. How to Budget Your Money: The 50/30/20 Guideline. 30 June 2014. Available at https://www.learnvest.com/knowledge-center/your-ultimate-budget-guideline-the-502030-rule/. Accessed on 17 September 2017.
- Ramsey, D. Ramsey Solutions. The Envelope System Explained. Available at https://www.daveramsey.com/blog/envelope-system-explained. Accessed on 29 September 2017.
- Reed, P. NerdWallet. Compare the Costs: Buying a NEw Car vs. Used. 28 April 2016. Available at https://www.nerdwallet.com/blog/loans/compare-costs-buying-new-car-vs-used/ Accessed on 23 September 2017.
- Elkins, K. CNBC. Couple that Retired in their 30s Share Their No. 1 Money Saving Tip. 10 April 2017. Available at https://www.cnbc.com/2017/04/10/couple-that-retired-in-their-30s-share-their-no-1-money-saving-tip.html. Accessed on 11 September 2017.