3 Essential Retirement Planning Moves to Make in Your 20s
Being young has its advantages. You can play sports without feeling sore the next day, for example. You can also put in a productive day at work on very little sleep. And, more practically, you can lay the groundwork for a wealthy retirement.
Your advantage as a retirement saver is the 35 or 40 years between now and your 65th birthday. Time is a powerful resource for investors. The more time you have, the more your earnings compound.
Time also enables you to build wealth from small monthly investments vs. large, budget-killing monthly investments. As an example, $600 invested monthly for 35 years grows to $1 million, assuming 7% average annual growth. If you only have 25 years to invest, it takes $1,318 monthly to reach that same balance.
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To use the time you have (before it's gone), make these three retirement planning moves now.
1. Automate your retirement contributions
There are two transactions that should happen automatically each month:
- Your money gets deposited into a tax-advantaged retirement account. Save 8% or more of your income to a 401(k). If you are saving in an IRA, see if you can max out your annual contribution. In 2021 and 2022, you can contribute up to $6,000 per year.
- Those deposits are invested in financial securities.
You want these transactions to happen on their own, without any additional action from you. Doing so puts your retirement savings plan on autopilot, which is proven to support higher savings rates. A 2021 Vanguard report finds that the savings rates in automatic enrollment 401(k)s are 57% higher than in voluntary plans.
All 401(k)s and many IRAs support automatic deposits and investments. If you don't have a 401(k) at work, shop IRAs to find one that has low fees and the automation features you need.
2. Invest according to your timeline
You shouldn't need to access the funds in your retirement account for 35 or 40 years. That timeline allows you the freedom to invest more aggressively.
Here's why. When you invest to maximize growth, you're likely to see more volatility. Volatility can either be financially destructive or a non-issue, depending on whether you need access to your funds. If you need the cash right away, volatility may force you to sell your securities at lower-than-normal prices. If you don't need the cash, you don't need to sell. You can do nothing and wait for share prices to recover.
So, what does it mean to invest aggressively? For retirement savers, it normally means investing 80% to 90% of your retirement contributions in stock funds, with the remainder in low-risk Treasury funds. You can diversify your stock funds to gain exposure to different sectors, capitalizations, and geographies. Or you can keep things simple by using an S&P 500 index fund as your core holding.
3. Start saving cash
Cash plays an important role in your retirement plan. When financial emergencies happen, cash on hand keeps you from tapping your retirement portfolio to make it through. That's why it's smart to ramp up your cash savings as you build your retirement wealth.
Again, automation is your friend here. Set up automatic deposits to a high-rate cash savings account. Leave those deposits in place until your emergency fund balance is enough to cover six months of your living expenses. If you use the funds for anything, restart your automatic deposits to replenish those reserves.
Time is on your side
Some might recommend you spend your 20s enjoying your youth. That's good advice, but keep an eye on your future, too. The investments you make today can earn far more than the investments you make five or 10 years from now. If you wait to save, you lose that advantage -- potentially putting your wealthy retirement at risk.
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