It seems the younger people are, the less inclined that they are to save for retirement. After all, younger people seem to not think about their retirement, and there may be some very valid reasons as to why they do not. If you are 20 or 25 years old, you have a difficult time thinking about an event that will happen almost four decades down the road. What is important to people in this age range are how will I pay for my college education?
College expenses are something that people in their twenties can relate to and definitely understand after all this age group pays more for education than any other in our nation’s history. Consider that in the 1985/1986 school year the average public four-year university cost $3,571 a school year and a four-year private university cost $8,885 a school year. Then we can fast forward three decades and see that the same four-year public university costs $16,757 a school year or an annualized increase of 5.29%. A private university costs $39,011 annually for an annualized increase of 5.06%. The cost of education outpaced inflation by over 2% a year means that for a parent to save enough for their children’s education they would have to achieve some amazing after-inflation returns to afford a basic education. That is because the cost increase for all universities over that thirty-year period was an increase of nearly 360%.
So now we have a point and topic that younger people can relate to with some general ease, the rising costs of higher education. But what if we use that same type of example to explain saving for something four decades away, retirement? Well, like many people I have student loans that have a fairly low-interest rate being charged to them, and unlike many, I work for the government and am taking advantage of the loan forgiveness program. But even if you are not eligible for that program, it is still wise to get at least a bachelor’s degree as you will earn more than if you did not have such a degree. Is a master’s degree required? That depends on the opportunity costs that you will have to look at when deciding if you want to pay that much more for an advanced degree. But while many states simply stay away from student loans, I say use them but wisely and only take out in loans what you need to pay for the cost of tuition and nothing more. Work while in college and keep the level of debt at a manageable level.
Now you have graduated from college and are working in your field of study hopefully making a decent salary that allows you to live, pay your bills, pay any student loan debt you may have and most importantly save for your retirement in a ROTH IRA. So why are you wanting to save for retirement when you are nowhere near retiring? Simple, the power of compound interest works in your favor over several decades. If you invest $5,500 a year from age 20 to 25 and it earns a modest 8% a year, and inflation is 3% your real return would be 5%, and that account would be worth $167,637 when you are age 59. If you can and what I would recommend is to invest $5,500 a year from age 20 to 59 and use the same return rate of 5% you would accumulate almost $659,000.
Now, most people can and should invest as much as they can as early as they can to take full advantage of the power of compound interest. If you work somewhere that has a 401(k)-plan put the money in that account especially if the company you work for matches all or a portion of your contributions. After all, never turn down free money in any form. But if you do not work somewhere with such a plan you need to establish a ROTH IRA to invest in. And when investing, I would recommend a low-cost index fund that tracks something like the S&P 500.
I know many people do not think that they can afford to save when they have just finished college and have so many new expenses and debts to pay. But ask yourself this, “Can you afford not to save at least $5,500 that compounds for four decades for your retirement?” I hope that you see that if it is important to you that you will find a way to cover your living expenses and debts while saving as much as you can. No one knows what the future holds but one thing is abundantly clear, the more you can save for retirement the better off you will be when you do decide to retire. And no one knows what the state of Social Security will be. I think it will survive in some form, but it may not look like what it does today.
If you have any questions or have any comments on this post, please leave a message here or reach out to me directly.
