None of us plan to be poor when we retire, especially when we are young and starting our first jobs. Getting that first paycheck, no matter what amount it is, generally feels like a million bucks just to have your own money in the bank. But considering how many poor retired people there actually are, better planning may be needed, starting as early as those first few checks.
In fact, new studies indicate younger workers are more likely to be unprepared for retirement even than current retirees who were hit hard by the economic downturn. Even though young people have many years left to work, save and invest, studies show 80 percent of Generation Y, those between the ages of 18 and 30, will not have enough money for their retirement years unless they make changes to their money handling and investment behaviors.
How Should a First Time Worker Get Started with Investing?
Make a Budget
How can I invest for retirement on my salary, you may ask. True, most people make between $10,000 and $30,000 a year in their first job, which doesn’t leave much disposable income. But with a good budget, you can start your financial planning early, and it will pay off exponentially later. Making a budget can be a simple process. List all of your monthly expenses on one side of a sheet of paper and all of your monthly income on the other side. Whatever is left when you subtract your expenses from your income is your disposable income. Instead of looking at this strictly as your “spending money,” plan to designate as large a portion of it as possible for investments.
Create a plan
It’s better to establish a retirement goal while you are young—it will make reaching it much easier over the years. Try determining an amount you want to reach by retirement. With a figure in mind, you will be more motivated to work toward the goal than without one. Studies show most people should save between 11 and 15 percent of their total salaries during their careers in order to have an adequate retirement fund. Keep in mind, however, the better the funds are invested—and the longer—the more they will multiply over time. As a young worker, there are several investment plans available to you.
The first thing any employee should do to plan for retirement is enroll in his or her company’s 401(k) program, if one is offered. These company-sponsored programs allow employees to contribute pre-taxed money withheld from their paychecks. Employees generally choose a percentage of their wages to invest, ranging from 1 to 10 percent. Many company’s match funds, as well, which is ultimately free money for the employee and the easiest positive return on an investment you will ever get. Once the funds are contributed to the 401(k), they are invested into a variety of stocks or mutual funds. Don’t let the term pre-taxed mislead you. The funds are not tax free. When you withdraw them at a later date, the funds will be taxed.
If your employer doesn’t offer a 401(k) plan, or even if they do, you can open an IRA account at your bank to start investing toward retirement. To contribute to an IRA account you can either send money to the bank or have automatic deductions made from your checking or savings account, or even from your paycheck if available.
IRA accounts come in two varieties: Traditional and Roth IRAs. Traditional IRA accounts allow you to deduct your contributions from your taxable income, lessening your annual income tax burden. You can contribute up to $5000 per year to one of these accounts.
Some people prefer Roth IRAs because you invest money that has already been taxed. Therefore, if, in 30 years or so when you retire, taxes are much higher than they are now, your money has already been taxed so you can withdraw it free and clear. The maximum amount a person younger than 50 can invest in a Roth IRA is $5,000 a year. Keep in mind as your start saving, these are maximum amounts. Many people establish a plan where they begin investing small amounts and over time increase the amount as their salary increases or their school loans are paid.
Investment Options for First Time Workers
Regardless what type of retirement account you open, you will want to decide how you want your money invested. A popular investment option is mutual funds, available in either index fund varieties or life cycle funds. Many people prefer mutual funds because they offer the benefit of professional management and diversification of investment. Sometimes mutual funds require a substantial initial investment. Don’t be discouraged, however, as other mutual fund programs are available with an initial investment as little as $25 or $50, if you also agree to make regular monthly investments. These options are beneficial for young investors because they assist you in keeping track with your long-term goals in an affordable manner.
An index fund basically parallels the performance of a particular market segment and generally requires low fees from the investor. For example, Standard & Poor’s 500 Index Fund follows the stock prices of 500 large companies.
A life cycle fund, on the other hand, is assigned to investors by age. If you don’t plan to retire until 2055, you would likely choose the 2055 fund. The fund will adjust your account balance and investments in stocks and bonds based on the number of years until your retirement.
Investing in the stock market generally provides a better long-term average return than depositing funds into accounts such as bonds. Furthermore, evidence shows that investors who actively manage their stocks receive a lower return than those who “let them ride,” long term. Therefore, a benefit of investing young is knowing you have a longer “investment horizon.” By having a longer time period before the funds are needed, you can outlast short term market fluctuations with the knowledge that returns will be strong in the long run. Then, as retirement approaches, you can move funds into safer portfolios. Another benefit to a young investor of the stock market, compared to other account types, is stocks will almost always account for long-term inflation, much more so even than compounding interest.
Generally, stock purchases are made through major stock exchanges or brokerage firms. Some companies will also give employees stock purchase options. If you work for a company that offers a stock purchasing plan, taking advantage of that option is one of the easiest ways to establish yourself in the stock market. Generally through an employer sponsored program, you can invest a certain dollar amount, rather than purchasing a number of shares, and you can also avoid additional costs such as brokerage fees.
Don’t withdraw Funds
Throughout your life you will more than likely meet up with many financial hurdles: A change in job, a new home, a new baby, some sort of disaster or death in the family. During these situations you will find yourself tempted to pull money from your retirement account. Remember, the longer the money is allowed to remain in the account, the more it will grow. Even in an account earning between 6 and 8 percent compounding interest, $10,000 could grow tenfold if left alone over a 35-year period.
According to the U.S. Department of Labor, young workers have many demands on their small paychecks such as rent, credit card debt, school loans and car payments. Although saving for short-term goals is important, it’s also vital to remember and save for long-term goals while you are young. Workers who invest money early will allow those investment years to grow and have to save much less in the future.
Although your budget may be tight on your meager starting salary, the DOL recommends looking at incidentals that can be cut, and putting that money toward retirement. Consider taking your lunch, making your own coffee, skipping happy hour or canceling your cable. Those small expenses, if invested early, could amount to a large retirement balance 40 years from now.
Guest Post By Daniel
Daniel is a respected blogger with a passion for all things related to finance. You can find more articles by him at Capcredit.com where he is a regular content publisher.