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It’s Never too Early to Think About Retirement

Author: Michael Williams

Most young Americans are poorly educated about financial planning, retirement and preparing for a life without work. Even if many 20-somethings don't explicitly think or say that it's too early to think about retirement, most act as though retirement is something to worry about later in life. However, if millennials learn to maximize their earnings potential, pay down debts responsibly and build good savings habits, it's possible to live a healthy financial life – and maybe even retire a little early.

Retirement Planning in Your 20s

Young workers don't know what kind of retirement they want or need, and even fewer understand their savings options. Most 20-somethings don't make a ton of money and are busy with social life or trying to start a family. Increasingly, the high expense of higher education is leaving young Americans in a mountain of student loan debt.

Nevertheless, this is exactly the time to start saving. The power of compounding interest on an investment over decades can mean that investors don't have to gamble as much in the stock market when they get older. A healthy savings rate also prevents younger workers from collapsing in debt, improves their creditworthiness and allows for a rainy day fund to pay for unplanned costs or emergencies.

There are a few simple steps that any 25-year-old could do tomorrow. First, find out if your employer has a 401(k) or another retirement plan. If it does, contribute at least enough to max out any matching contributions; it's like free money for your retirement. Second, make a budget of all incoming funds and all common recurring expenses, and try to save more than you earn.

Becoming a Young Investor

There are two related concepts that every aspiring young investor should familiarize themselves with: the time value of money and compound interest.

The time value of money is an economic concept that essentially means money is worth more today than it will be in the future. Inflation eats away at the real purchasing power of the dollar over time; $1 in 2013 was worth about the same as 4 cents in 1913. The other reason is people prefer present money to future money. Think about it: would you rather have $1,000 today or a voucher guaranteeing access to $1,000 in three years? After all, $1,000 today could be saved or invested and earn interest over the next three years.

Compounding interest is the phenomenon of interest earned on previously accumulated interest. For example, if you have a $10,000 investment account and earn $500 in interest, you can add the $500 back in so that the next round of interest is calculated on a $10,500 base.

Think of compound interest as an accelerator on future interest earnings. If you combined compound interest with the time value of money, you realize that $1,000 saved today might be worth tens of thousands of dollars by the time you retire.

Other than an employer-sponsored retirement account such as a 401(k), young investors can look to establish their own individual retirement accounts (IRAs) or brokerage accounts. Unless you plan to be an active trader, stick to well-known and passively managed mutual funds that don't charge you high fees.

Don't Leave 401(k)s With a Prior Job

The days of working for the same factory for 35 years and retiring with your golden watch are over. Most young Americans switch jobs every two or three years, and most studies suggest that changing jobs can have a positive effect on income.

It's critical for young investors to move their old 401(k)s into new and active qualified retirement accounts. Funds left with old employers can be subject to fees and should be rolled over into more active accounts.

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