There are countless headlines circulating in the financial media about millennials' poor financial outlook. After reading about the soaring student loan debt, stagnant wage growth, and other issues, it may seem like financial freedom is just a dream that is no longer reachable, but nothing could be further from the truth. As long as you make the right financial moves while you're young, it's still 100% possible to turn that dream into a reality.
Don't turn down free money
When you're in your 20s, it's understandable that retirement could be the last thing on your mind. However, the early years of your career are by far the most important to your long-term financial health, so it's important to get a few major decisions right.
One that is particularly important is making sure you take full advantage of your employer's 401(k) match, even if it feels like a stretch to have that money withheld from your paycheck. According to a TIAA-CREF survey, 23% of employees who have the opportunity don't contribute enough to receive the full match.
If you don't get the full amount your employer is willing to match, it's like giving away free money. You wouldn't be happy if your salary was cut by say, 4%, but that's exactly what you're doing by turning down the free money that's offered to you. And, keep in mind that the true value of those 401(k) contributions are more than they seem. If you're 25 years old and earn $50,000 per year, a 4% employer match is worth $2,000 per year. Over a 40-year career, those employer contributions alone can balloon into a six-figure nest egg.
But, that's just a starting point
Saving enough for your retirement to take advantage of your employer's match is a good first step, but should be looked upon as a bare minimum. If you really want to achieve financial freedom, you'll need to save and invest beyond this amount. Why do I say that you should save and invest aggressively while you're still so young?
The mathematical fact is that the money you invest now is more important than the money you'll invest later on. Historically, the stock market has averaged a total return of about 9.5% per year. Based on this figure, every $100 you invest at age 35 could be worth $1,390 by the time you're 65. However, every $100 you invest when you're 25 could grow to $3,445. Simply put, building wealth is easier to do over longer periods of time.
Fortunately, there are several smart ways you can do this. If you prefer to invest on auto-pilot, you can simply increase your 401(k) contributions beyond the amount your employer will match. For 2015, you are allowed to contribute up to $18,000 of your salary to your 401(k), and while it may not be practical (or necessary) to contribute that much; the point is that there is a lot of room to boost your savings rate. I generally recommend younger workers aim to save at least 10% of their salary, but any increase is better than none.
Consider an example of an employee who earns $50,000 per year and whose employer is willing to match their 401(k) contributions dollar-for-dollar up to 4% of salary. Assuming 7% annual investment returns -- a conservative estimate -- take a look at the effect of even a small 401(k) contribution increase over a long career.
|
Employee's contribution |
Employer's contribution |
Total contribution (% of salary) |
Value after 40 years |
|---|---|---|---|
|
2% |
2% |
4% |
$650,549 |
|
4% |
4% |
8% |
$1,301,098 |
|
6% |
4% |
10% |
$1,626,373 |
|
8% |
4% |
12% |
$1,951,647 |
|
10% |
4% |
14% |
$2,276,922 |
Note: Assumes 2% annual salary increases.
As you can see, the long-term difference can be quite impressive. Also, bear in mind that although these numbers may seem enormous -- maybe you don't think you need $2.3 million to retire comfortably -- inflation will make your money worth less over time. In other words, $1 million in 40 years will be worth a lot less than $1 million today.
If you want to take a more active role in your investing, an IRA could be the best place for your extra savings. IRAs are tax-advantaged retirement accounts, and come in two forms -- traditional and Roth. Unlike your employer's plan, an IRA allows you to invest in any stocks, bonds, or mutual funds you want. My personal favorite is the Roth IRA, even though contributions aren't tax deductible, because your withdrawals in retirement will be tax-free. Plus, a Roth IRA allows you to withdraw your original contributions whenever you want, without penalty -- essentially providing you with emergency savings as well as a retirement nest egg.
Invest the right way
Many millennials are scared of the stock market, and understandably so. After all, the market's performance during their lifetimes hasn't exactly been encouraging -- the tech crash and financial crisis have left many younger investors with a negative perception of stocks.
However, stocks are still the best long-term investment. Your portfolio will be more volatile than say, bonds or CDs, but over the long run, you'll come out ahead. Since 1965, the S&P 500's average annualized return is about 9.8%, and over any long (20+ year) period of time, stocks have outperformed any other asset class.
Here's a look at the S&P 500's performance over the past few decades, notice that the index has produced a 1,340% return, including two of the worst crashes in history.
As a rule of thumb, take your age and subtract it from 110 to find out about how much of your investments should be in stocks (or stock-based mutual funds in your retirement plan).
The foolish bottom line
If you save and invest early and aggressively, and trust the long-term compounding power of the stock market, the dream of financial freedom could become a reality for you. Take advantage of the free money (employer match) offered to you and the tax-advantages that come with retirement accounts, and save as much as you can reasonably afford. Your future self will thank you.
