After graduating and starting my first “real” job, we were presented with our 401(k) investment options which caught me off guard a bit. Hold up, I’m 23 years old, and you’re already telling me about investing for my retirement? Whoa. I imagine quite a few of us out there were also caught off guard. I’ll venture that some of us out there are actually not saving anything at all, and just are ignoring it. I thought I could try to separate fact from fiction, and explain retirement a bit.
I’m just got out of college, why should I be thinking about retirement?
Fair question. Retirement for most of us is 40-60 years off. Let’s look at a scenario: A 25 year old financially savvy young professional wisely contributes $2500 each year to his 401(k). Assuming an 8% return and normal inflation, he’ll have around $625k waiting for him when he’s 60. Contrast that to a young professional who put this off until he was 35, and put away $2500 each year. He’ll only have $255k in retirement savings. In fact, to catch up to his wiser counterpart, he’ll have to contribute three times the monthly amount to have the same amount at retirement. Check out http://www.ultimatecalculators.com/401k_calculator.html if you don’t believe me.
Whoa, that’s a big difference, why’s that?
The reason for this is known as the principle of compounding interest. In year one of saving, you’ll get a return on your investment, and that return will be rolled over and re-invested. So instead of having $100, you’ll be investing with $108. Keep this going and it starts to really add up.
What exactly am I investing in?
Your 401(k) retirement has a ton of options. Essentially as long as you are investing in your retirement, you can find an investment to suit you. The vast majority of us, will put our money into mutual funds. A mutual fund is just a collection of variously similar stocks. One of my mutual funds in my retirement is the Fidelity Contrafund. It is a mutual fund that invests in bigger companies, like Coke, Apple and Google. By investing in lots of companies, you minimize your risk, while maintaining a steady return. Other options in what’s called an Individual Retirement Account, involve actually investing in one single stock.
What’s a 401(k)/Roth/IRA?
A 401(k) is an employer sponsored retirement plan. Your company works with Fidelity/Vanguard/TDAmeritrade to set up a plan for you. Your employer then takes a certain percentage of your paycheck (as much as you tell them to) and deposits in into your retirement account. You have options into a selected number of mutual funds to invest your retirement money. Certain tax benefits apply, which I’ll discuss in my next post.
A Roth can either be an IRA (Individual Retirement Account), administered by you or part of your company’s 401(k) package. Roth plans also hold certain tax benefits.
Can I use that money before I retire?
Yes but it is highly recommended that you don’t. There are only few qualifying events that will allow you to do so without large tax penalties and include buying a house. You’ll end up taking a “loan” from yourself to do so. Although allowed, I wouldn’t do it.
Its shocking the number of 50 somethings in this country now that have very little saves up for retirement. Don’t be like them! By starting off small but steady, you can set yourself up for a cool million or two at retirement. Hopefully this post answers a lot of your questions and will encourage you to start putting money away!