A newly minted class of college graduates enters the work world this summer in what remains a tough environment for young job seekers. Half of last year’s graduates remain underemployed, according to an Accenture report. Yet hiring is up this year, and as young people land their first real job they might keep in mind a critical advantage they possess: time, which they have more of than virtually everyone else and can use to build financial security.
Saving early is a powerful force. But it loses impact with each year that passes without getting started. You don’t need to be sophisticated. You don’t need to pick stocks. You don’t need to understand diversification or the economy. You just need to begin putting away 10% of everything you make, right away. And 15% would be even better.
Consider a worker who saves $5,000 a year from age 25 to 65 and earns 7% a year. Not allowing for expenses and taxes, this person would have $1.1 million at age 65. Compare that to a worker who starts saving at the same pace at age 35. This worker would amass half that total, just $511,000. And now for the clincher: If the worker that started at age 25 suddenly stopped saving at age 35, but left her savings alone to grow through age 65, she would enjoy a nest egg of $589,000—more than the procrastinator who started at age 35 and saved for 30 more years.
That is the power of compounding, and it is the most important thing about money that a young worker must understand. Those first 10 years of a career fly by quickly and soon you will have lost the precious early years of saving opportunity and squandered your advantage. That’s why, if possible, I advise parents to get their children started even before college.
Once you start working, your employer will almost certainly offer a 401(k) plan. More than 80% of full-time workers have access to one. This is the easiest and most effective way to get started saving immediately. Here are some thoughts on how to proceed:
- Enroll ASAP Some companies will allow you to enroll on your first day while others require you to be employed for six months or a year. Find out and get started as soon as possible. Most people barely feel the payroll deductions; they quickly get used to making ends meet on what is left.
- Have you been auto enrolled? Increasingly, employers automatically sign you up for a 401(k) as soon as you are eligible. Some also automatically increase your contributions each year. Do not opt out of these programs. But look at how much of your pay is being deferred and where it is invested. Many plans defer just 3% and put it in a super safe, low-yielding money market fund. You likely are eligible to save much more than that and want to be invested in a fund that holds stocks for long-term growth.
- Make the most of your match A big advantage of saving in a 401(k) is the company match. Many plans will match your contributions dollar for dollar or 50 cents on the dollar up to 6% of your salary. This is free money. Make sure you are contributing enough to get the full match.
- Keep it simple Choosing investment options are where a lot of young workers get hung up. But it’s really simple. Forget the noise around large-cap and small-cap stocks, international diversification, and asset allocation. Most plans today offer a target-date fund that is the only investment you’ll ever need in your 401(k) plan. Choose the fund dated the year you will turn 65 or 70. The fund manager will handle everything else, keeping you appropriately invested for your age for the next 40 years. In many plans, such a target-date fund is the default option if you have been automatically enrolled.
- Take advantage of a Roth Some plans offer a Roth 401(k) in addition to a regular 401(k). Divide your contributions between both. They are treated differently for tax purposes and having both will give you added flexibility in retirement. With a Roth, you make after-tax contributions but pay no tax upon withdrawal. With a regular 401(k), you make pre-tax contributions but pay tax when you take money out. The Roth is most effective if your taxes go up in retirement; the regular 401(k), if your taxes go down. Since it's hard to know in advance, the smart move is to split your savings between the two.
- Get help An increasing number of 401(k) plans include unbiased, professional third-party advice. This may be via online tools, printed material, group seminars, or one-on-one sessions. These resources can give you the confidence to make decisions, and according to Charles Schwab young workers that seek guidance tend to have higher savings rates and better ability to stay invested for the long haul in tough times.
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