One of the most common questions people ask their financial advisors is, when should I start saving for retirement? Virtually across the board, financial advisors will say that you should start as early as possible—ideally when you’re in your 20s and have just launched your career.
Of course, there’s no reason to despair if you didn’t start a retirement fund right out of college. Not everyone in their 20s has the foresight to start saving for something decades in the future, especially since many employers do not offer a savings-matching program. If you started saving for retirement later in life, the situation certainly isn’t hopeless, but it is a bit more urgent. You’ll need to save more and be more focused to meet the same goals, since you’ll have less time to achieve them.
However, if you start early, you’ll enjoy a wide range of benefits, including the increased flexibility that compounding interest provides. You’ll also be able to take more chances with your investments, because you’ll have more time to recover from losses. Another major benefit of starting early is that it instills good habits early on.
When you start to plan for retirement in your 20s, you’ll learn several lessons that will serve you well for the rest of your financial future. These include:
Learning the value of compounding.
If you’re in your 20s, you have a lot of time before you retire and can use this to your advantage. Making money grow over the course of 40 years is much easier than achieving the same thing in half that time. Even when your money just sits there, over time it can double, triple, or quadruple. The best way to understand the value of compounding is to think about the math behind it.
As a hypothetical situation, imagine you save $6,000 toward retirement each year until the age of 65 at a 7-percent rate of return. If you start saving at age 45, you will have about $246,000 in the account when you reach retirement age. If you begin saving at 35, the account would have about $567,000. However, starting at the age of 25 means you’ll amass nearly $1,198,000. In other words, starting at 25 nearly quintuples the final amount saved, compared to starting at 45. This happens even though you would only contribute an additional $120,000, or $6,000 annually, for the 20 years between age 25 and 45. This math underscores that your savings depend not only on how much you contribute, but also on how long you’ve been contributing.
Understanding how to maximize employee benefits.
Employers often provide some sort of retirement benefit for full-time employees. Most commonly, you’ll have access to a 401(k) plan through your company. Understanding these accounts and how they work sooner, rather than later, will make it easier to use them strategically down the line, when choosing the right investments becomes extremely important. When you start contributing to your 401(k) early, you’ll have some time to play with the account without serious consequences.
A 401(k) typically rises and falls with the stock market and continues to grow over time. Money for the account is taken directly out of your paycheck, so you never see it. If you’re lucky, your employer will match your contributions to the account at some percentage—this can be a major boon and add up quickly. Plus, this matching is essentially free money, so it makes sense to take advantage of it. Some employers will offer profit-sharing instead, which means that a portion of the company’s profits is put into your 401(k) account, reducing your tax liability.
Keeping meticulous records and budgets.
People save money when they spend less than they bring in. The concept is simple, of course, but it’s a lesson many of us learn the hard way. However, saving for retirement will encourage you to become more discerning with your money, and you’ll soon learn to keep track of exactly where it goes. This skill will become more important over time, especially when it’s time to save for a down payment on a house or pay off a big debt. Ideally, people in their 20s should strive to live on about 85 percent of their income and save or invest the rest.
Keeping track of spending has become simultaneously more and less difficult. It’s easier than ever to buy things today; sometimes it only takes a few taps on a screen or one click of a button. Because of this, impulse spending can be hard to avoid.
At the same time, technology does a lot of the recordkeeping for us. Most of us no longer have to spend time adding and subtracting columns of numbers to balance a checkbook. In addition, smartphone apps can help track your spending; basic spreadsheets on your desktop computer are also effective. Whatever method you use, keeping track of spending can help you stay out of debt or pay off a large debt that must be wiped out before you can begin saving for retirement in earnest.
The Bottom Line: When it comes to saving for retirement, there really is no such thing as too soon. People who start saving early will set themselves up for success down the line by learning critical lessons about finance and investing. In addition, starting to save early, even if only a small amount, leads to significant gains because of compounding interest. If you think you can’t save, re-examine your finances to see if you can cut back on spending in some places. Putting aside even a little bit of money each month will help you establish a lifelong habit that will pay off enormously in the end.