Youth is Wasted on the Young
Published On: June 22, 2018
Written by: Ben Atwater and Matt Malick
It’s never too early to start planning for retirement.
Thanks to the power of compound returns, even modest savings in your early working years can grow to a small fortune over several decades. From an investment standpoint, there’s no greater advantage than a long-time horizon.
Alternatively, procrastination or early financial mistakes can become major impediments to a comfortable retirement.
Many of our clients are already enjoying retirement. For others, retirement is within reach. As a result, most of our updates are geared to investors who have already accumulated a large nest egg. The following five recommendations, however, are for younger savers. We encourage you to share this note with family and friends who are beginning to save.
Create a Budget. According to a 2013 Gallup poll, only 32% of Americans prepare a detailed household budget. Meanwhile, about 62% have less than $1,000 in a savings account, according to a 2015 Google Consumer Survey. Without knowing where you spend your money, it’s impossible to determine where you can cut back and divert funds for savings. A budget can be eye-opening and help young (and even older) savers identify areas for improvement.
Maximize Your Workplace Retirement Plan. 401(k) and 403(b) plans are the most powerful savings vehicles for most investors. Contributions are tax-deductible (although many plans also have post-tax Roth options) and the contribution limit is much higher than with IRAs – participants under age 50 can contribute up to $18,500 in 2018. Furthermore, employees make contributions through payroll deductions, automating the saving process. Most employers also provide a limited match for its employee’s contributions. As an example, some plans will match – dollar for dollar – the first 4% of an employee’s contributions. At the very least, young savers should try to contribute enough for the full employer match, which essentially serves as a 100% return before you even invest the funds.
Invest Aggressively. The longer an investor’s time horizon, the less short-term market fluctuations matter. If anything, market volatility is a young investor’s friend as market declines offer opportunities to buy more shares at lower prices. And stocks have historically offered robust returns because they’re volatile. In other words, patient investors are rewarded for enduring short-term price fluctuations.
Buy Term Life Insurance. Most young investors have not accumulated sufficient assets to provide for their families if they die unexpectedly. A life insurance death benefit can address this risk by providing a pool of funds to help replace lost wages or satisfy debts. Term insurance provides a death benefit throughout a specific period of time, often 20 years, as long as you continue paying the premiums. Unlike permanent life insurance (e.g. whole life, variable life, universal life, etc.), term insurance does not build cash value or provide a permanent death benefit and is therefore significantly cheaper, making it an affordable option for many young investors.
Use Debt Prudently. Debt is often necessary and sometimes beneficial. For example, it would take most homeowners a lifetime to save enough cash for a home purchase. A reasonable amount of debt even helps build good credit. But imprudent debt serves as a major headwind to long-term retirement saving. Carrying high interest rate loans, such as credit cards, should always be avoided. Just as compound returns help build long-term savings, compound interest forces borrowers to pay much more than the original principal over the life of a loan. Long-term financing of depreciating assets is also not advisable, such as a 7-year car loan or a 14-year boat loan, as it typically carries high interest rates and diverts funds away from saving.
Most investors wait too long to consider retirement. It’s easy to procrastinate in your 20s, 30s and 40s, only to find yourself scrambling to save in your 50s and 60s. Implementing some basic financial planning strategies early in your career can help ensure you don’t waste the advantage that a long-time horizon offers young investors.
Please visit www.atwatermalick.com/ria for full disclosure materials related to recommendations contained in this update.
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