Investing

The Gen Y Guide to Personal Finance

(Aaron Geller)

If you’re like most young people, chances are retirement and investing aren’t exactly your top priorities.

To an extent, this is natural. Someone in their early to mid-twenties could plausibly argue that they will not need investment or retirement income for many years, even decades.

However, young people might do well to pay attention to what older people wish they did when they were young. Personal finance author Ramit Sethi provides a chart displaying the results of a survey about what people in different age groups wish they had saved for earlier in their lives. Those in their thirties report wishing they’d saved for a house, while those in their forties wish they’d saved for retirement.

To help ensure you do set and reach financial goals (rather than find yourself wishing you had), we put together a list of seven retirement and investment tips for young people.

Start Early

The most important thing for a young person to do, financially, is to start early. This might come as a surprise to you if you’re the type that tends to obsess over minutiae like whether Roth or Traditional IRAs or better, or what inflation might bring about, or whether you have the perfect asset allocation.

A surprising number of young people would rather debate about various aspects of personal finance than take meaningful action to get started. Don’t do that. Instead, resolve to get started today. Open a retirement account of some kind (more on which one later). If you don’t already have one, open a brokerage account and make a deposit.  Talk show host and TV personality Clark Howard has a chart on his website that shows how much (on average) you will retire with if you start saving at different ages, beginning at 15. As Clark concludes, “…the key to becoming a millionaire by age 65 is to start saving early!”

Have a Plan

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It might sound somewhat hypocritical to tell you to get started right away and then tell you to have a plan. By “plan,” however, we mean simply a set of financial goals.

You’re young, so it’s only natural that you’re hardly motivated to save or invest. To stay committed, it helps to save or invest with a specific, meaningful goal in mind. For instance, it will be far easier to continue putting money into your brokerage account if you know your goal is to put a down payment on your dream house five years from now, than if you were investing for some indefinite purpose.

Try to be as specific as you can, too. Establish a dollar amount target and crunch some numbers on what kind of investment return would help get you there within several different timeframes. Defining in advance why it matters to start and continue investing (and saving for retirement) will go a long way toward ensuring you follow through.

Take Advantage of Employer-Sponsored 401(k) Accounts

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If you have a full-time job, your employer likely offers a 401(k) or similar retirement plan. With these plans typically comes some form of matching: the employer will contribute a certain amount for every dollar you contribute. (Many employers suspended their matching programs during the recession, but have begun to reinstitute them now that the economy is picking up.)

If you have a 401(k) plan with an employer match, take advantage of it. It is literally free money – and tax-deferred free money at that, since you will generally not pay taxes until you withdraw the money after you retire.

Start an IRA, Too

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Already participate in a 401(k)? Good for you. Now, think about opening an IRA. Not only will you further reduce your taxable income, but just like with a 401(k), your IRA investments will grow tax-free. What about Roth IRAs vs. Traditional? Here’s the difference – with Roth IRAs, you pay taxes on your contributions now but not when you withdraw. That means the accumulation and growth that occurs within the account does not get taxed. A Traditional IRA lets you save without contributions being taxed today. Instead, they are taxed when you withdraw. It’s a good deal either way, but Roth IRAs are arguably smarter. And Traditional IRAs come with stricter income limitations for those who qualify for participating in a 401(k) or another type of employer-sponsored retirement plan.

Invest Passively

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There is a great deal of evidence that picking stocks (that is, trying to “beat the market”) is ineffective when it comes to pure investing performance. The reasons are many. For one, most people have no consistent skill at stock picking, according to A Random Walk Down Wall Street by Burton Malkiel.

It has been said (and supported) that a bunch of monkeys throwing wet paper towels at lists of stocks on a wall produce roughly the same returns on an investment as professionals armed with reams of statistics and formulas. Plus, actively managed mutual funds typically charge higher fees that further erode your return.

Don’t go down this road. Instead, be “boring” by investing in index funds, or even go with a life-cycle fund which attempts to keep you well-diversified without having to manually balance your portfolio each year. You wont raise as many eyebrows as people who brag about the hot new stocks they’re buying, but when all is said and done, history shows you will probably retire richer.

Automate It

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Contrary to what you may think, the key to successful savings and investing is not discipline. In fact, it’s the opposite — automation.

The idea is to set up your accounts — whether it’s an IRA, brokerage account or bank savings account — to be automatically funded when you get paid each week or month. (This is how 401(k) plans work by default.) Productivity guru Timothy Ferris features a guide to automating your finances on his Four Hour Work Week blog. Properly set up, it will actually become more difficult to stop the automatic flow of money to where it serves your goals than to let it continue. This, after all, is the point. Ideally, you should strive to remove the elements of volition and willpower from the savings and investing process as much as possible. (And it’s yet another reason to invest passively instead of actively.)

Cut Spending to Free up More Investment & Savings Capital

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Finally, there’s something to be said for taking an ambitious approach to saving and investing. If you’re going to put specific goals and make up a plan to make sure you commit, it only makes sense to put some real force behind your efforts.

In that vein, Mint advises analyzing your overall spending habits to get ideas for where you might be able to cut wasteful spending. When you think about it, this is a win on two levels. One, you will stop wasting money on things that do not advance your goals. And two, the money you saved is re-allocated to your retirement or brokerage account, where it most certainly will advance your goals.

Most of us, if we’re being honest, can probably identify at least a few areas in which we could spend less without a noticeable drop in our lifestyle. Make an honest effort to do that, and put the amount saved towards retirement savings and investment.