The earlier you start saving for retirement the better off you’ll be. Investing in your employer-sponsored retirement plan and hiring a financial advisor will help you get there.
What We'll Cover
- Steps to take with your savings before you start investing
- How to save for retirement
- Retirement account options if you do not have an employer-sponsored retirement plan
- Where to open a retirement account
In 2022 over 1,000 retirees were surveyed to find out about their financial worries and both their preretirement and postretirement reflections. Not surprisingly, 70% of those surveyed stated they wish they could go back in time and tell their younger selves to start saving and investing earlier in life.
Time is the main ingredient when it comes to wealth building. A famous parable emphasizes the importance of investing early.
The story is about two friends, Ben and Arthur, who are both 19 years old. At age 19, Ben decides to start investing $2,000 per year for the next eight years – from age 19 to 26. At age 26 Ben stops investing but never touches the investment and allows it to grow. Ben invests a total of $16,000.
When Arthur turns 26, he decides to start investing $2,000 per year for the next 39 years until he reaches age 65, for a total of $78,000 invested.
When they turn 65 years old, Ben – who only invested $16,000 – has an investment balance of $2,288,996. Arthur invested $78,000 and has a balance of $1,532,166. As you can see, Ben saved $62,000 less than Arthur but still came out $700,000 ahead of his friend.
Ben comes out ahead because he started earlier and took advantage of compound interest.
Compound interest is when you earn interest on both the money you've saved and the interest you earn. Another way to think about compound interest is when your money starts saving money for you.
Do you see the power of starting early with saving and investing? Let’s walk through a guide to investing for success.
The First Step: What to Do Before You Start Investing
People commonly put off investing because they don’t have money leftover to invest at the end of the month. There’s a way around this: instead of trying to invest whatever you have leftover at the end of the month, pay yourself first, and then spend what is leftover after you have set something aside for investing.
This means creating a monthly budget where you give every dollar a job each month.
Once you’ve created a written budget, the next step is to build a buffer between you and the next financial hiccup. You do this by creating an emergency fund, or a savings account, earmarked for emergency expenses only.
After you’ve saved up your three-to-six months worth of emergency expenses, your next step is to pay off all of your consumer debt. Get rid of all high-interest credit card debt, auto loans, and student loans if you can. Loan payments eat away at your ability to invest and build wealth. The longer you remain in debt, the further you move away from your ability to build long-term wealth.
When you follow a monthly budget, have a fully funded emergency fund and zero debt, investing and building wealth becomes automatic.
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Invest Into Your Employer-Sponsored Retirement Plan
The first place to start investing is through your employer-sponsored retirement plan. These plans are often called a 401(k), a 403(b), a 457, or could also be called a TSP. As of 2023, you can contribute up to $22,500 into any of these employer-sponsored plans when you are younger than 50 years old.
Why Should You Invest into Your 401(k) First?
There are two main reasons for choosing to invest into your company’s retirement plan. First, you get the company match. Nearly all companies today offer some sort of company match in the range from 3% to 8%.
This means for every dollar you invest, your company will match you up to a certain amount. This is FREE MONEY added to your retirement account every paycheck. Always invest enough to get the company match.
The second reason is because your employer will automatically take the money from your paycheck and send it to your 401(k) for you. This simplifies the process and takes away the desire to use your savings on something other than your retirement account.
Consider a ROTH 401(k)
Many employers are now offering a ROTH 401(k) in addition to a traditional 401(k). The term “ROTH” determines how the taxes are paid on your retirement savings.
All of your employer-sponsored retirement plans (401k, 403b, 457, TSP) are tax-advantaged accounts. In a traditional 401(k), the money that leaves your paycheck and goes into the 401(k) is not taxed and therefore lowers your taxable income. The money can then grow tax-deferred, and you will pay taxes when you withdraw your savings at age 59½ or later.
On the other hand, a ROTH 401(k) has you paying the taxes today and then enjoying tax-free growth and tax-free withdrawals in retirement.
So, would you rather pay taxes today or in retirement?
If you prefer to pay taxes today, choose the ROTH option. If you want the tax savings today and would rather pay taxes later in retirement, then avoid the ROTH.
Open an Individual Retirement Account (IRA)
The IRS actually uses the term individual retirement arrangement when referring to an IRA, however most people know the IRA as an individual retirement account. Whichever you prefer to call it, opening an IRA is another great option for investing in your 20s.
If you’re self-employed or your company doesn’t offer an employer-sponsored plan, you can open an IRA for retirement savings. To keep things simple, an IRA is a retirement savings tool that allows you to save into many different investment types, including:
- stocks
- bonds
- mutual funds
- exchange-traded funds (ETFs)
- real estate investment trusts (REITs)
- gold
- silver
The contribution limits for 2023 are $6,500 for both a Traditional IRA or a ROTH IRA.
Open an Account with a Robo-Advisor
Now that you understand the different retirement tools, it’s time to think about where to open your account so you can start investing.
As mentioned above, if you have an employer-sponsored retirement plan, start there. But if you don’t have access to a 401(k), then opening an IRA or ROTH IRA through a robo-advisor is a great option.
Robo-advisors are online service providers that provide automated investment portfolios based on your personal preference with little-to-no human interaction. Although robo-advisors have only been around since 2008, they have rapidly grown in popularity and are expected to have $2.3 trillion assets under management in 2023.
What makes robo-advisors appealing to younger investors is the access to professional management services that were at one time reserved only to those individuals with a certain net worth, or assets, to be managed. Also, the fee structures with robo-advisors are much lower because there isn’t the human interaction you would otherwise have with a professional investment advisor.
Today, new and young investors can choose from many different robo-advisors with $0 to start, and have access to stocks, bonds, mutual funds, and ETFs.
Consider Hiring a Financial Advisor
Although robo-advisors are a great option, you’ll need expert financial advice from a financial advisor at various points in your life.
The biggest downfall to a robo-advisor is not having that human interaction when the markets go down, when financial goals need to be corrected, or when it comes time to prepare for retirement.
Looking for a wealth management advisory?
OneAZ Wealth Management offers professional investment advice, retirement planning and insurance needs.
A financial advisor helps you make the best decision for your finances because they can remove the emotion and inject experience into your investment strategy. Not only will a financial advisor help you make better financial decisions, but they’ll more importantly save you from making costly financial mistakes throughout your wealth-building years.
Continue Increasing Your Investment Contributions
For those who are in their young 20s or even early 30s, the chances are high that you will only increase your income as time goes on. Therefore, maintain a strategy to continually take a portion of your income growth and increase your retirement contributions.
A good rule of thumb is to “split the raise.”
Pro Tip: Every time you get a raise or your income increases, split the increase in two – half goes to retirement contributions and the other half goes in your pocket to enjoy.
Over time, you’ll notice you are contributing the maximum amount to your employer-sponsored plan and also the maximum amount to your IRAs. For example, in 2023 the maximum contribution amounts for a 401(k) and IRA are $29,000 combined for those under age 50. As you can imagine, $29,000 set aside each year to grow inside tax-favored retirement accounts is a great strategy to building wealth.
The Longer You Wait to Invest, the Harder It Gets
The best time to start investing was yesterday and the second-best time to start investing is today. Remember, the longer you wait to invest, the harder it becomes to build wealth.
Example:
Let’s assume your goal is to have $2 million saved in your retirement accounts by age 65. For simplicity, we will also assume your average rate of return for your investments is 10% annually. At age 20, you will need to set aside $225 per month. If you wait five years, that number goes up to $375 per month. As you can see, the longer you wait, the amount you must save increases exponentially.
**assuming 10% annual return
Frequently Asked Questions
Do I have to have investment knowledge before I begin investing?
While it’s not a bad idea to have a basic understanding of how stocks, bonds, mutual funds and ETFs can help you reach your retirement goals, investing can be done by anyone. If you have an employer-sponsored retirement plan, you’ll have tools available to help you make your investment elections inside your 401(k).
Pro Tip: If you are self-employed or don’t have access to a 401(k), your best option is to utilize a robo-advisor or seek professional advice from a licensed financial advisor.
How do I choose a financial advisor?
When considering a financial advisor, keep in mind you are interviewing them to see if they can help you learn and reach your financial goals. Don’t be afraid to ask your financial advisor how they get paid and what their fee structure looks like. Also, make sure to choose a financial advisor that is a fiduciary, or an advisor who works in the best interest of the client.
What amount should I start investing?
Base your investment amount on your long-term goals. Your current age also factors into how much you will need to save. But when you’re just starting off, 15% is a good rule of thumb.
Isn’t investing risky?
When it comes to investing, there is never a guarantee that your money will grow over time. However, the one thing we can use to predict the future of the markets is the past performance of the stock market. While there will always be years that are up and years that are down, the stock market has had an average return of 11.88% since 1957.
This is another reason why investing in your 20s and 30s is so important — you have plenty of time to make up for the down years of the stock market.
Key Takeaways
- Automate your retirement savings by paying yourself first.
- Set aside enough savings for an emergency fund and pay off your debt before focusing on investing.
- Take advantage of your employer-sponsored retirement plan.
- Open an IRA if you’re self-employed or your company does not offer a retirement plan.
- Consider using a robo-advisor or a financial advisor to assist you with investing.
Remember, one of the greatest regrets for current retirees is not investing early enough in their lives. The longer you wait to invest, the more difficult it becomes to reach your financial goals for retirement.
By starting early, you pave the way for long-term investing which is the key to building wealth over time.
By Chris “Peach” Petrie,
Founder of Money Peach
Chris “Peach” Petrie is the founder of Money Peach. Money Peach partnered with OneAZ to provide free financial education to members across the state. To learn more about OneAZ’s partnership with Money Peach, click here.
APR = Annual Percentage Rate
