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Many of us spend our days working hard, dreaming that one day we can retire; only a few of us take the time to plan for retirement strategically. We all have reasons, ranging from lack of time to lack of knowledge about the topic.
Yet, planning for it in your 20s and 30s can be one of the most important decisions you can make.
Retirement may seem decades away, but getting a head start on savings and investments will not only help you retire early but will also help you retire more comfortably.
Having assets outside government programs like Social Security, Medicare, and Medicaid, will allow you more control over your income and life.
If you’ve pondered why retirement planning is essential, you’re in the right place.
In this post, we will go over 7 reasons why you should start investing and planning for retirement early in life.
This article was submitted by Jorge Sanchez, MD
1. Higher Return on Investment
One of the biggest reasons you should start planning for retirement early in life is to take advantage of compound interest. For those unfamiliar with compound interest, this is the exponential process that grows your money at an increasingly faster rate over time.
Compound interest has a larger impact the longer you allow your money to grow. Vanguard provides a great example of compound interest over time. To illustrate just how powerful it is, consider investing $1 into your retirement account at different ages to see how much it would be worth at 65 years old when you are ready to retire. Investing $1 when you are 20 will translate to nearly $6 at age 65, whereas investing $1 when you are 35 would only be worth about $3.25. By investing your money early, you experience nearly double the gains to your portfolio.
This is why investing early into your retirement accounts is so important. Early investments will yield much greater returns than later in life.
To maximize the impact of compound interest, you should invest as much as you can between the ages of 20 and 35. In the later years of your life, you should still contribute, but at this point, you can lower your contributions. The high contributions you made early in life will carry your retirement plan when you are older.
The key is to avoid waiting until you’re older to contribute to your retirement accounts. The impact of these contributions will be diminished because of the lack of time they have to grow.
2. Take advantage of Employer Contributions
Employer contributions are something that every working professional should take advantage of. Most companies will match 401(k) contributions and some offer additional matching contributions to other retirement accounts as well.
You should start taking advantage of these opportunities as soon as they become available. This is because your company offers free money that you can use later in life. By not taking advantage of employer contributions, you are letting free money go down the drain.
For example, if you start contributing at a younger age – in your 20s vs. your 40s – and your employer matches contributions, your retirement account could have exponentially more money due to your and your employer’s contributions compounding over those 20 years.
However, it’s important to be aware of the guidelines or restrictions that your employer has in place when making contributions. For example, employers may have a maximum amount to contribute per month or year. It’s also important to factor in the IRS contribution limits.
The IRS maximum contribution to 401(k) accounts for employer and employee is $66,000. Assuming your employer matches your contributions, this means you would only need to contribute $33,000 each year to max out your 401(k) account.
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3. Start When You Have Fewer Responsibilities
Another key reason to start planning for retirement early in life is you likely have fewer responsibilities. With fewer responsibilities and financial obligations, you can contribute more to your retirement plans.
When you are young, you are less likely to have children, a mortgage, or other financial responsibilities that make investing in your retirement more difficult. With fewer responsibilities, you can contribute a greater portion of your income to your retirement without having as significant of an impact on your current living conditions or situation.
Earlier in life, it’s not uncommon for individuals to spend their discretionary income on entertainment, luxury goods, or other non-essential items that they can enjoy. However, as a young working professional, the wise decision is to allocate more of your discretionary income to planning for retirement, including retirement accounts and investments. Even deciding to invest an additional 5% or 10% per month in your retirement can have a huge impact over the longer term.
As mentioned in the section above, investing early will allow you to take advantage of compound interest and will allow your portfolio to grow much larger than if you were to start investing later in life.
4. Increase the Likelihood that You Retire Early
We all want to retire early, but how many people are taking action to achieve that goal? One way to help make that goal more realistic is to plan and invest in your retirement when you are young. You are far more likely to be able to retire at a younger age if you start investing a large portion of your discretionary income as soon as you can.
You’ll also benefit from compound interest and wouldn’t need to earn large amounts of money before you can retire. Oftentimes, investing small amounts early allows you to have more savings in your retirement account than if you invest a large amount but start 10-15 years later.
5. Social Security Isn’t Guaranteed
Investing early is a great way to protect yourself against the uncertainty of social security and other government-funded assistance programs. While many generations before us got the privilege of enjoying social security benefits during their retirement, future generations may not be so lucky.
Unfortunately, the likelihood of social security serving you in its current form if you are younger than 40 years old is extremely unlikely. According to analysts, the social security fund is expected to be depleted by 2041.
This doesn’t necessarily mean that social security will completely vanish, but it’s very likely that there will be significant modifications to the program that will either result in smaller benefits or severe inflation from the government printing the difference.
6. Long Life Expectancy
Over the last 200 years, life expectancy has doubled in the United States – a trend that isn’t expected to change anytime soon. So why does this matter when talking about retirement?
The longer you are expected to live, the more money you will need during retirement. Living an extra five to ten years could require hundreds of thousands of extra dollars, so it’s crucial to consider that as a possibility. One way to combat the additional funds you will need during retirement is – you guessed it – to start investing earlier.
This is more important than ever because many people are not investing sufficiently when they are young or not investing in their retirement at all. A recent study by Morning Consult found that only 4 out of 10 workers started investing for retirement in their 20s. The remaining 60% of workers either started investing after the age of 30 or not at all. With longer life expectancies, it’s more important than ever to save early so you can account for the additional years of expenses you might have.
While challenging to predict, it’s important to deeply consider how much you will need in retirement. The exact amount you need will vary depending on your lifestyle and living expenses, but you can likely arrive at a reasonable estimate. It’s often recommended that you have a minimum of $50,000 per year of retirement, whether through savings, income, or a combination of the two.
On average, most people are retired for about 15-20 years. If you want to retire 10 years early, you need to compensate for the additional years you will be in retirement. For example, if you want to retire at 50 and you live until 85, you will be in retirement for 35 years. At $50,000 per year, you will need approximately $1.7 million dollars in retirement.
To reach a goal of $1.7 million dollars in retirement, you would need to save roughly $490 each month starting at the age of 25(assuming an average yearly return of 8%). Keep in mind that if you started investing at 30, you would need to save approximately $760 per month to reach that same goal.
7. Diversify your Portfolio
Investing in your retirement early is a great way to diversify your portfolio. So how does investing early allow you to diversify your portfolio?
When you are young, you can invest in riskier investments that would be ill-advised when you are older. When you’re older, you need to be more conservative with your money to ensure you meet your goals, but in the earlier stages of life, you have the luxury of going further out on the risk curve. In other words, you can risk more to potentially make more because you have your whole life to recoup any losses.
That being said, investing a significant amount of your savings into safer, more traditional investments is still important. This will ensure that a good portion of your savings is invested for the long term and continually compound at the standard market return. However, some of your savings can still be dedicated to higher-risk, non-traditional investments with greater potential for higher returns.
For example, if you’re still relatively young and investing approximately $600 each money, you can allocate $400 to traditional investments and the additional $200 to less traditional or more speculative investments as a way to diversify your portfolio.
This specific type of diversification becomes more risky and, as a result, less likely to be worth the gamble as you get older because you have less time to maximize your contributions or benefit from compound interest. You’ll also have less time to compensate for any potential losses you might experience investing in those riskier assets. As you get older, you will want to stick to investments with more reliable returns to ensure you can meet your retirement goals.
Conclusion
There you have it, seven reasons why you should start investing and planning for your retirement while still young. It may seem like a distant concern now, but adopting a forward-thinking approach can set you up for a well-funded and potentially early retirement, even 10-15 years ahead of typical timelines. Time is an asset in itself, so don’t hesitate any longer. Embark on your retirement planning today, and reap financial security benefits in your golden years.
2 thoughts on “7 Reasons Why You Should Plan for Retirement in Your 20s and 30s”
I can add another reason: If you save a nest egg earlier rather than later, you’ll be better prepared for unexpected health issues that could force you to exit the workforce earlier than originally planned. Much better to comfortably coast to the finish line (retirement), than be dropped abruptly over it.
That’s a great addition Lynne! Thank you for reading.