Eight months ago, I didn’t understand the first detail about retirement accounts. I knew that adults started them at some point, but I was only 26. I figured most people started saving in earnest when they were 35 or so: that it wasn’t something that I needed to worry about right now. While I don’t expect to be able to rely on social security by the time I reach retirement age, it’s one of those things that I just sort of figured would work itself out. “It’s not like I’m making an impressive amount of money right now, anyway,” I would tell myself; “the amount that I could manage to sock away this year would be trivial. Better to wait until I can make more significant contributions in five or ten years.”
Then, sometime last fall, some family friends invited me over. One friend works as an investor, and he agreed to give a short presentation about retirement strategies after dinner. His presentation was brief but informative, and by the time he finished, he had managed to invert all of my preconceived notions about retirement saving strategies.
Over the next few months, I researched retirements accounts until I felt confident enough to start one. It’s performed well so far, (Brexit aside) and I’ve compiled the principles I acquired during the process into a brief, straightforward guide that should enable you to start investing for retirement quickly and competently.
Principle #1: Start saving yesterday to take advantage of compound interest
I was under the mistaken impression that the small amount I could contribute to a retirement account wouldn’t make a difference in the long run, because I didn’t understand the concept of compound interest. Check out this video for a more thorough explanation, but basically, you can think of compound interest as “interest on interest.”
The earlier you start saving, the more time you give the interest you’re earning to compound and grow. Because of this, money invested early in your career grows significantly more by the time you retire than money invested later. I cannot overstate the importance of this principal. As this graph demonstrates, if you invest $5000 a year from the ages of 25 to 35 (10 years, $50k total) and then totally stop investing you will end up with a significantly larger retirement nest egg than if you had invested $5000 a year from ages 35-65 (30 years and 150k total!). (As you can see from the chart, consistent investing that also starts early is the most profitable strategy.)
Principle #2: Advantages of a Roth IRA
You have multiple options when choosing which type of retirement account is best for you; if you’re a millennial in a low tax bracket like I am, consider putting at least some retirement savings in a Roth IRA. Roths makes sense for those in a low tax bracket because they require that you pay income tax now on the money that you’re investing (at your current, low tax rate). Then, when you retire, you can take the money out tax free. Traditional IRAs, on the other hand, allow you to write off contributions now, but pay tax on them when you take the money out of the account during retirement (at the tax rate you’re paying then- probably an equal or higher one).
Additionally, when you invest your money in a Roth, you can take out the “principal” (money you invested) at any time without penalty (unlike a traditional IRA, where the money you invest must remain in the account until you turn 59 ½, or you’re forced to pay a 10% penalty). Because of this, money invested in a Roth can serve as an emergency account if need be (one that’s making you significantly more money than a traditional savings account, at that).
Principle #3: Index Funds are your friend
Forget the idea of trying to pick individual stocks that you think will perform well. It’s unlikely that you’ll manage to beat the market, so instead, just try to tie the market by purchasing index funds. (Index funds are bundles of stocks designed to track a particular market index like the Nasdaq.)
I recommend signing up for a online account with Vanguard and purchasing their index funds. Their management fees are very low and they don’t charge fees to purchase their index funds (I initially made the mistake of signing up for a TD Ameritrade account before realizing that I would have to pay a $50 fee to purchase Vanguard index funds, while I could it do with a Vanguard account for free.) I picked VFINX, an index fund that follows the S&P 500, on the recommendation of Warren Buffett and my favorite money blogger Mr. Money Mustache. VFINX requires an initial investment of $3000; if you want to start investing with a smaller initial contribution, purchase VOO to begin with and then transfer your money over to VFINX when you hit the $3000 mark.
That’s really all there is to it. Check on your retirement account infrequently, don’t worry about day to day fluctuations since you’re in this for the long haul, and add money as often as you’re able to.
If you’re interested to learn more before you begin investing, John Oliver recently produced an entire episode that’s both funny and entertaining about retirement accounts on his show Last Week Tonight.