People in their 20s and early 30s have many competing financial goals:
• They’d like to buy a house, or a bigger house.
• They want to plan for college for their children.
• They may be looking at a new car or a nice vacation.
• And way off in the distance, they are thinking about retirement.
The problem is that retirement saving should be their number-one goal. Most young people today will not have a pension, and they will likely have reduced Social Security benefits. That means they are the only ones saving for their retirement.
Case in Point
I have two daughters now in their 20s, so I have experienced this firsthand. One of my daughters has recently graduated from college and has a good job. We are now discussing how much she should be putting in her 401(k). I told her she should target 20 percent of her gross. She told her friends at work this percentage and they all said, “Your dad is crazy.”
I knew I would get pushback on this number; my real goal was to get her started at 15 percent, so we are in the process of working out a compromise.
Savings Priority #1: Retirement
Here’s a key tip to saving wisely: Early savings discipline can pay huge dividends later. By saving well early on in your career, you will have much more flexibility in your 40s and 50s if you want to switch career paths, or if you are laid off or disabled for a period of time.
A lot of 401(k) plans currently have automatic increase options built into them. If 15 percent seems too much when you’re getting started, take advantage of this option. It will automatically increase the amount you are putting into your 401(k) annually by 1 percent per year until you hit a maximum of 15 percent or the IRS dollar limit, whichever is less.
I told my daughter that my compromise position is for her to contribute 15 percent to her 401(k), with a 1 percent annual increase until she hits 20 percent. All other savings goals, with the exception of paying off high credit card debt, should be delayed until you are on track for retirement. The average 20something will need between $5 million and $8 million to have a comfortable lifestyle in retirement.
Savings Priority #2: Buying a House
Anyone who wants to purchase a house should already have a cash reserve of three to six months of expenses saved for emergencies. What really makes a plan work is having no mortgage in retirement. The sooner you build up home equity, the closer you are to that goal. Mortgage interest rates are currently at record lows, but they won’t be there forever. I’m not suggesting you go out of your way to pay off your house sooner, but if you are in a position to have no mortgage in retirement, you won’t need as much in retirement savings.
Savings Priority #3: Saving for Your Children’s College Education
Too many people make the mistake of making this the number-two priority, behind the purchase of a home. You should only be saving for college once you are on track for retirement. In my opinion, the best gift you can give your children, outside of a good safe home in which to grow up, is ensuring that you and your spouse are financially secure in your retirement.
If you are not, you are likely to be on your children’s payroll for many years. Many of my older clients have experienced this firsthand. Their parents needed financial support at the same time as they were sending their children to college.
I am not suggesting that your children not go to college, just that you don’t have to pay for it.
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