Friday, May 30, 2008

Retirement Planning at 20-years-old

Retirement saving is best done early and consistently. Retirement planning, the roadmap to how you will spend your after-work life is not as easy ­ especially when you are in your twenties.

Alyce P. Cornyn-Selby once wrote, "Procrastination is, hands down, our favorite form of self-sabotage." And who can deny that this is the single biggest hurdle we will need to jump in retirement planning.

As twenty-year olds, fresh out of school, whether it be high school, trade school, or college, we see the world in terms of the here and now. We are young and that youthful exuberance gives us the false sense that time is endless. We are undeterred, full of hope and rich in the belief that time is on our side. And in a way, it is.

We have our first job and with it, our first taste of financial independence. We divvy up our paychecks in terms of what it will buy: x-amount of dollars for rent, transportation, clothes and entertainment and not always in that order. Few twenty-year-olds are able to see the value of saving at this age. There are simply too many opportunities to seize and fun things to experience.

And your retirement plan should not take away from that time in your life. It should compliment it. But there are three things you must confront first before you begin the party that twenty is.

First, you need a financial mentor. This can be your parents, an uncle, aunt, grandparent or even a co-worker. This person will need to be older and wiser than you and someone you can trust.

This person will be nothing more than a sounding board for your financial decisions. They will, if they do the job correctly, play a sort of devil's advocate. Many of the big financial decisions we will make at this age will involve the use of credit. A financial mentor will allow you to ask yourself, while asking them, "do I need this now or can I wait until a time when I can afford it?" They will offer you a look at the mistakes they have made and what they would have done differently. Their experience becomes your lesson plan.

The second element of a retirement plan requires a clear understanding of how compounding works. When I am explaining compounding to beginning investors, I often tell use the story of the "Sultan'.

President Jackson once gave a gift to the Sultan of Muscat (now called Oman) after the ratification of a treaty between the two nations.

The gift was a silver coin with the minted date of 1804 (although the coin was actually struck in 1834) that was "sneaked" out of the country via secret emissary. Remarkably, the coin remained in its original condition for almost 150 years before it was purchased by the family of the late Walter Childs of Brattleboro, Vt. in 1945 for $5000.

The coin was then placed in a vault for the next 54 years. Until, of course, it was auctioned off for 4.14 million dollars!

Despite the "wow" factor of that fortune, many of you would be just as surprised to know, had that $5,000 been invested in a simple index fund that follows the S&P 500 (the 500 largest companies trading publicly in the US), you would have made $400,000 more than Mr. Child's family did when they took the coin to auction.

The key to compounding is beginning small, doing it consistently, and starting early. If your first job offers a 401(k) plan, a tax-deferred investment plan, sign up for at least a 5% deduction. In all likelihood, that small of an amount of pre-tax income will not affect your take-home pay.

The last thing you will need to do is avoid using credit for purchases under $500. That's right. Put the cards away until you absolutely need it.

At this level of borrowing, the purchase in more likely to be financed with a fixed rate, more apt to come after serious consideration, and it will probably be more of a necessity than a whim. A purchase of that size is much easier to add to your budget ­ the available money you have to spend on your life¹s necessities.

The best thing you do at twenty is develop a retirement philosophy that let¹s you live within your means ­ cash for everything that costs less than $500 to avoid unnecessary and unsustainable debt. When you do this while investing a small portion of your paycheck each week ­ just a 5% deduction from your payroll, you will be on the right road to retirement. If your employer doesn¹t offer a tax-deferred plan, have $25 a week automatically deposited into a savings account that you can set-up for automatic deductions to an IRA.

We will return to our retirement glossary next week.

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