Six 401k Tips for People in Their 20’s
Starting a new job can be intimidating enough, and figuring out how to navigate the company 401k program seems like an easy thing to put off until another time. But here’s the thing – people usually don’t start getting serious about saving for retirement until their 40s or 50s when it’s too late. So do your future self a solid and get started now, while you are in your twenties.
And here are 6 tips that can help you get started:
1. Take free money
You’ve undoubtedly heard your parents, or some other old people, say the phrase, “There’s no such thing as a free lunch.” And that may be quite true (for those of us who don’t work for a fancy tech company) but there is such thing as free money.
Many employers offer a match to all or a percentage of your 401k contributions. Figure out if your company provides a match and what the requirements are to qualify and take your boss up on her offer to give you free money. With the magic of compounding, that free money from your employer will mean big things for your retirement nest egg.
2. Increase your contributions every year
Financial advisors say that you should save between 10% and 15% of your income for retirement starting in your 20s. If you are like most of us you’re probably thinking, there is no way I can put 10% or 15% of my income into my 401k and still have enough money for all of life’s necessities like rent, food, transportation and $15 cocktails.
It may be hard to start out with 10% or 15%, but it is important to start. So start where you can and increase your contribution each year by a percentage point or two until you get to the optimal savings rate. It’s more important to start now with a lower savings rate than to try and wait for the optimal time.
3. Save your bonus
It’s tempting to use a bonus to treat yourself with something fun like a vacation or dinners out with friends, and those things are important but so is not eating cat food when you are older. So take that unexpected bonus and put it in your 401k.
4. Buy stocks
Your 20s and 30s are the years where you do risky things like partying on a weeknight before a big meeting and sleeping with people you met on your cell phone. And it’s also when you should be taking on risk from an investment standpoint. When you are young, you can afford the short-term risk of stocks, because over the long term they provide far better returns. You’ve got the time to ride out a few recessions before you are going to need to access that money in your 60s, 70s and beyond. In fact, those recessions can be good buying opportunities.
5. And if possible don’t buy mutual funds
The problem with mutual funds is they are expensive. They charge significantly higher fees than an index fund that merely tracks the market as a whole. But don’t worry it gets better, not only are mutual funds more expensive than index funds, studies show that over time mutual funds underperform the market.
By now you are probably asking yourself, “so mutual funds are expensive and they don’t even return as much as a the stock market as whole – then why would anyone chose a mutual fund over an index fund?” Well there can be a few reasons.
First, people assuming because a mutual fund has an active management team picking select stocks that there is safety or the prospect of higher returns – not true. Second, with a 401k your investment options can sometimes be limited to select number of mutual funds from large financial institutions. It all depends on what your employer and the company that manages your 401k program decide should be available.
More and more 401k programs are offering low cost index fund and ETF investment options. If your 401k allows you to invest in index funds instead of mutual funds, you should do it. It will save you tens of thousands or even hundreds of thousands of dollars in fees and higher returns. However, if investing in mutual funds is the only option, that’s still better than investing in nothing.
6. Have an emergency fund
We’ve covered the importance of having an emergency fund here on the Starving Graduate several times before. The reason having an emergency fund is important to your 401k and retirement savings success is that when shit happens, as shit is wanton to do, rather than pulling money out of your 401k, which can cost you tremendously in fees, taxes and lost investment returns – you can simply access your emergency fund to get you through a rough patch like job loss or having your car break down. So do your future, old self a favor and start yourself an emergency fund.
