You have just started making some real money and you have so many ideas what to spend it on. But at the same time, everyone says you should always put part of your income aside and save for retirement, even when it’s 35 or 40 years away (seriously?). One of the first things a young professional learns about adult life is that we are often supposed to achieve multiple goals which are in conflict with each other, like paying off your student debt, buying a house, starting a family and saving for retirement.
If you are like the typical 20-something (and neither have rich parents nor have accidentally started the next big internet company from your dorm room), your finances may have the following characteristics:
1) You start with nothing. No house and very limited savings. Yes, retirement planning is all about building and growing these things. But not so fast…
2) Unless you have studied in a country with free education, you probably have some student debt to pay off. Paying your student debt (and not getting into additional debt) should be your first priority. Debt is negative wealth, which means that by paying off your debt you are actually growing your wealth, even when it’s not as visible.
3) Your income is low compared to your more experienced colleagues. To some extent it should grow automatically over time. Nevertheless, you can help maximize its growth by investing in your skills and knowledge. When you are young, these investments (costing money, time or both) will most likely make much bigger difference to your future wealth than buying stocks or bonds.
4) Your cost of living is relatively low. Maybe you don’t even mind sharing a flat with your friends or staying in hostels when on vacation (these things will get more difficult and less desirable as you get older). A good way to boost your finances is to always make your costs lag behind your income. When you get promoted and your salary increases, you don’t need to immediately move to a bigger apartment or eat at more expensive restaurants. Naturally, you will want to improve the quality of your life as your income grows and that is completely fine (and a good way to reward yourself for your hard work), but if you resist the temptation to have everything immediately, you will be able to save more and enjoy an even higher quality of life later.
5) You don’t have anyone else to support. If you are like most people these days, you won’t start a family until your very late 20’s or early 30’s. From a strictly financial perspective, there is never the right time to have children, because they will always cost you a lot of money. But there is more to life than money – children have a way of providing things that money can’t buy. Anyway, starting a family will be much easier and more enjoyable when made after a conscious decision and when you are ready for both the responsibility and the costs.
6) You have (hopefully) good health. Although most young people don’t appreciate it enough, your health is your greatest asset. Treat it as such. Even if you saved millions and retired rich, you wouldn’t be able to enjoy your retirement with poor health. Moreover, bad health means extra costs and possibly lower earning potential during the rest of your professional life.
7) Time is on your side. This is your greatest advantage. With more than three decades left before your expected retirement, even when you make mistakes or bad things happen, in most cases it won’t be the end of the world (or of your retirement dreams). When buying investments, keep in mind that with such a long time horizon you can afford to take greater risk than someone in their 50’s. Keep most of your savings in stocks rather than bonds or savings accounts – their return is higher in the long run and even if a stock market crash comes, you will have plenty of time to let your portfolio recover.
With lack of experience it is easy to feel overwhelmed by the variety of investment products. If you only have limited amount of money to invest each month, first focus on those with the greatest tax or other benefits, such as a pension plan where your contributions are tax-free and often matched by your employer. This is free money and it adds up over time, so start now. Talk to a financial adviser if you need some guidance.