This was originally published on the MintLife blog in May; It was edited slightly here.
In the spring of this year the Class of 2015 ushered more than 1.8 million college graduates into the workforce. For most of these graduates, getting a job was priority number one. A first job provides a new kind of independence: the ability to move into one’s own space, pay for expenses and budget. It also opens the opportunity to create financial independence for the rest of your life.
All too soon, these ‘new-hires’ will be like the Baby Boom today, staring down the barrel of retirement. The Baby Boom wished they had a ‘Do-Over’ button. They lament, if I had only known then, what I know now, I would have had essentially the same life AND, I would now be a great place financially. But alas, they squandered the early, most important years of their financial plan, and their ‘golden years’ are anything but golden.
But if they had that ‘Do-Over’ button where would it land them? Right where you are today. Take strength in that and don’t waste this moment. Learn from them (as in what they did not do) and see if the following information helps you get off to a better start.
Where to Begin?
First, there are very few pensions today and even those who are eligible for them, pensions aren’t what they used to be, so it is up to you get this right.
I am going to use 401k as an example and metaphor for ‘defined contribution plans.’ But this advice applies to them all.
#1. What is my 401k Initial Percentage? When you sign up for a 401k account, you’ll need to determine the percentage of your compensation to automatically divert from your paycheck into your 401k (or other retirement savings instrument offered to you.) This number should be set prior to making decisions about two other big expense categories: housing and transportation. Too often, people make this decision backwards and feel they don’t have enough money left over to invest in the future. But there’s a big advantage to start investing in your 20s: compound interest. If your employer offers a ‘match’, put aside at least the maximum percentage the company will match. If there is no matching, begin with a minimum of 3 – 6%.
What is my 401k Goal Percentage?
Now is a good time to also set the Goal Percentage to eventually divert to your 401k. Financial experts such as Dave Ramsey suggest you invest 15% of your compensation. Other financial experts suggest numbers from 10 – 15%. Too often, people sign up for a 401k with a flurry of new-hire documents with little thought and no strategy. Years later, they look at their balance and wish they had been bolder. Having a predetermined goal for your eventual percentage is smart – be sure to review and revise your withholding annually.
Am I willing to keep my lifestyle flat until I reach my Goal Percentage?
The most efficient way to achieve your goal percentage is to apply ALL annual pay raises to your 401k at the early moments of your career. If you do, it will be only 3-4 years for you to get to that goal percentage and have the power of compound interest strongly on your side. After that, 55% of every raise goest to enhancing your lifestyle and 15% of that raise should be diverted toward retirment.
The biggest decision is to start and have a plan. Let’s take a look at the math – you will see the massive advantage of time when growing your future nest egg. As an example, I’ve picked a state school from the salary report at PayScale.com that will project average early career salary and mid-career salary (age 42.) I am using Ohio University in Athens, Ohio, but you can pick any college just head over to PayScale.
* Early career salary: $43,600
* Mid career salary: $77,000
* Begin with your Initial-Percentage of 6% into your 401k (in this example your employer does not match)
* Set your Goal Percentage at 15%
* The 401k is in equities and yield (on average), a conservative 7.5% return
* If you apply 100% of your 2.88% annual raise, you will be at your 15% goal in 4 years
At 65, you will have just over $2.9 million dollars in your account!
Once at retirement age:
* Ratchet down the risk of your portfolio to a 5% annual return during your golden years (less volatility)
* Withdraw 4.5% annually
* At retirement you are making more money (nearly 20%) than your last year of working
* As you pay yourself, your investment portfolio grows annually
Now if you are really on the ball, over the course of your career you have gotten ALL debt out of your life so the cost of being you is the lowest it has been in your life. You have most of the ‘stuff’ you want, and now it is time for fun and then more fun!
Yeah, I know what you’re thinking: “I just graduated and now you’re asking me to think about retirement?” Remember, a bit of strategy and early sacrifice assures that your golden years will truly be golden. You now have enough discretionary time and discretionary money to follow your heart’s desire. So have fun and be good with your money!