High school and college students have the thing retirement aged people wish they had: time. One of the most frequent regrets of older adults is “I wish I had started saving for retirement sooner.” Even among those baby boomers with pensions coming to them, they still wished they could have started earlier.
This article is going to cover just the basics of retirement investing that a 16-20 year old needs to know to get started. However, this information will be useful for anyone looking to get a start on saving.
If you have a job, you have options
The first thing you should do is to maximize contributions to any 401k if the employer matches all the contributions you make. If your job offers this, its free money! Unfortunately, most students don’t work full-time in jobs that have these opportunities, so I will not cover this benefit in detail. It’s worth knowing about for when students move into careers that may offer this option.
For students earning wages from a summer job or work-study program, you have the opportunity to invest in what is known as a Roth IRA. A Roth IRA is funded by the money you take home from the job. It does not come out of paychecks before taxes. The money is put into stocks or mutual funds of your choice to grow.
Benefits of a Roth IRA
The Roth IRA is a fantastic vessel to save money. First, its funded by money that has already been taxed. So you put it in the account, and when you pull it out during retirement, you don’t get taxed again on those contributions. The money is put into the stock market, so it has the opportunity to grow a lot. Over time, the dividends get reinvested (if you choose this option, which you absolutely should) and the funds can grow even more.
Another benefit is that your contributions (you can put in your wages or up to $5,500 during 2013, whatever is less), can be withdrawn any time, tax-free. Your earnings can be withdrawn without penalty for only a few reasons, including buying your first home. Otherwise, those earnings need to stay in the account or you will have to pay a 10% tax penalty on them.
Types of Investments
The further from retirement, the more risks you can take. Any financial planner will tell you to adjust your risk levels as you get older. You don’t want to have all your money in stocks and risk another crash the year before you’re set to retire.
Lifestyle funds are easy to set up and leave alone. These are mutual funds, made up of other mutual funds and stocks chosen to allocate appropriate risk levels for your targeted retirement age. For example, if you plan to retire in 5 years, you’d choose the account that expects you to retire then. That fund will be structured to produce reliable income, rather than risk it on stocks. It would likely invest most of the money in bonds and high interest money market accounts to keep as much of your money as possible. A fund with a target retirement date 40 years from now will likely invest mostly in stocks, because you have plenty of time to recover from any down markets. The best part of lifestyle funds is the maintenance-free aspect. If you invest in a fund for retirement in 2050, the fund manager will automatically adjust the fund’s structure as you get closer to the retirement date. If you look at the account in 2049, the fund allocations will look completely different from when you started investing.
Index funds are mutual funds that are picked to mirror the performance of popular stock indexes like the S&P 500 and Dow Jones. The benefit to these sort of funds is that they typically cost a lot less to invest in. Historically, stock indexes have out performed managed portfolios, and Warren Buffet loves them.
Of course, you can choose individual stocks and mutual funds that you like. However, these require more hands-on monitoring of the account. You will need to do a lot of research to ensure you’re making wise choices with your investments. Personally for my retirement fund, I’d leave this to the professionals who are paid to do this sort of research. If you’re interested in the stock market just for spending money and fun, look into a low cost brokerage such as TradeKing. You can trade stocks and funds for a low fee per trade, and you aren’t dealing with a retirement account when you do it.
Low Cost to Start Investing
Students can choose whatever brokerage they want to manage their Roth IRA. Its important to look at the cost of the funds you’re interested in. The fund’s expense ratio is the cost of investing in that fund. It doesn’t seem like much, but the difference between .1% and 1% is staggering over time. The lower the expense ratio, the more money you get to keep in your account.
Load funds are also to be avoided. A load fund means that there is a fee for you to buy, sell, or both. There can be front-end load and back-end loads, the main difference being when you get charged a fee.
There are plenty of brokerages with no loads and low expense ratios. Vanguard is known for its index funds, and T. Rowe Price is another leading low cost brokerage. You can open a Roth IRA with as little as $1,000 at either brokerage.
Set it and forget it
Most brokerages also offer an automatic investing service. This will automatically withdraw a set amount at a set time to invest in the account you choose. You can schedule multiple withdrawals in a month, spread out however you choose. The reason to do this is because, as you know, prices for stocks and funds changes every day. If you put all your money in at once, you’d be buying everything at one price. If the price drops, you’d lose a lot of money. However, doing a little each week or month spreads your risk and helps balance out any losses. This allows you to buy into your stock or fund at various amounts over the course of time, and overall will help mitigate any losses.
Retirement investing requires wages
An important thing to realize is that you must have wages from a job in order to invest. Scholarships and loans do not count as income for purposes of investing for retirement. Don’t invest money you’re not permitted to invest. You can only invest money from wages that you have reported or will be reporting to the IRS.
So what are you waiting for? Figure out what brokerages and investments will work best for you. Your older self will thank you!