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.

• What is a 401(k)?
  

• What is an IRA?
  
  
• What is an index fund?

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.

Retirement Planning and Star Stuff

As our discussion with time progresses, there is no better way to explain the effects of time better than a look to the stars. Stars are a window to the past. They offer us a glimpse of what was and although we perceive them in the present, what we see is actually an event that has traveled across space only to appear as a fixed apparition in our night sky.

There are 400 billion stars in the Milky Way galaxy, most of which are clustered at the center. Our little solar system of which the sun would be considered not much more than typical is on the outer reaches of the spiral. In fact, we are mostly guessing what the Milky Way looks like. When we depict the galaxy as a spiral, we are actually assuming that we are much like Andromeda or M31.

As I introduce the section just before compounding, I mention a celestial event that took seven years to reach our night sky. When SuperNova 1987A exploded into the night sky astronomers were thrilled.

It was the first "nearby" supernova to appear in the last 3 centuries. In addition to the light show, astronomers were able to detect 19 of the elusive neutrinos produced by the collapse of the star's core. It is estimated that for an instant in 1987 on the earth the neutrino luminosity of SN1987A was as large as the visible-light luminosity of the entire universe.

Compounding has similar astronomical qualities. The savings socked away at an early age literally explode as time progresses. In the same way the light from SN1987A traveled, compounding offers a chance to illuminate an other wise inanimate lump of cash.

Einstein, yes, the same one with those revolutionary theories about relativity and time and space is credited with the following quote: "compounding is the most powerful force in the universe". But it is doubtful that he actually said exactly that. With his death occurring in 1955 and closest attachment to the quote appearing almost 25 years later and in numerous versions, his affiliation to the quote appears remote.

He may have appreciated the elegance of the math, the way money can grow as if by magic using compounding. What he wouldhave been marveling at was the mathematical simplicity of the Rule of 72.

Rule of 72 works like this: If you wish to find the number of years required to double your money at a given interest rate, you just divide the interest rate into 72. For example, if you want to know how long it will take to double your money at six percent interest, divide 6 into 72 and get 12 years.

If you are curious at how far that beam of light from SN1987A traveled in a year, you would be required to just a little math. A light-year is the distance that a beam of light, uninterrupted and in empty space, would travel in a year -- which is about 9, 470, 000, 000, 000 (nine million million, four hundred seventy thousand million) kilometers. Multiply that by seven.

Douglas Adams' The Hitchhiker's Guide to the Galaxy described the vastness of space as "Really big. You just won't believe how vastly hugely mind-bogglingly big it is. I mean, you might think it's a long walk down the road to the chemist, but that's just peanuts to space."