Simple retirement investing for 20-somethings

So, you are a twenty-something who doesn’t want to think too much about saving for retirement.

Welcome to the club! Here are the basics:

  1. Find out if your employer has a matching program. Meaning, if you contribute $100, they put in $75 or something like that. The $75 is free money that you wouldn’t get if you weren’t in their program. Stop reading this now, and join their program… now!
  2. If your employer doesn’t have a match program, again welcome to the club! What you will need is an “IRA”. This is often referred to as the whole savings plan, but for our purposes when I say IRA I mean the mechanism we are using to transfer money. The “fund” is the place where the money resides. This two-part deal is more complicated than a savings account, because the different types of IRA (the mechanism you are using to save money) have different taxation rules, which I’ll get into in a second.
  3. The fund you buy is basically what kind of stocks you want to buy. You can buy really safe things that will never lose money (but never make money), or you can buy riskier funds which have higher returns.
  4. Just remember: the fund holds your money (and hopefully grows it), and IRA is how you are transferring money into your fund.

Roth IRA, the mechanism

The Roth IRA is great for young people. This is what I use to do all my investing right now. You pay all your taxes on money that you put into an IRA now, but you don’t pay taxes on the money when you withdraw it in retirement. If you are young and not making a lot, you will probably be taxed more when you are old and want to “make” more money (by withdrawing it from investments you make now). When you look at your account balance you know that you will actually have that money when you retire!

With the Traditional IRA (sometimes just called an IRA) your contributions are tax-deductible. This sounds nice–ooooo I can pay less taxes now! However when you withdraw money from the account in retirement you pay taxes on it then. So your account actually has less money in it than it looks like there is! You can save the same amount of money with the Traditional IRA as you would with a Roth IRA, but you’d have to take your tax savings and put that money into your IRA. No one has that kind of financial discipline! It’s probably not a bad idea to have both, but personally I’m going to wait until I’m able to comfortably max out my Roth (currently the limit is $5,000 a year) before I open a traditional IRA to put money into as well.

How much should you put in your IRA? As much as you can afford, every single paycheck. If you put the same amount of money in your IRA at a set interval (every paycheck is best) you will benefit from something called dollar-cost averaging. Just ignore how your chosen fund is performing, and always put the same amount of money in it. Easy, right? This will protect you from market fluctuation and mistakes you might make as an investor. If you don’t believe me, I gave you the term so you can look it up. Yes, yes but how many $$$ each paycheck? Financial advisers say you should save at least 10% of your salary, so divide it out: If you make $50k/year and get paid twice a month: $50,000 divided by 10 to get 10%, then divided by 24 is: $208 you should put in every paycheck. ($30k would be $128/paycheck.)

Choosing a fund

Some people get snooty and choose a fund managed by a well known investor who chooses stocks he thinks are going to perform well. The problem with this is two-fold. One, you have to pay the guy who chooses the stocks. This is called simply ‘fees’. Any fee’s that get levied against your money is obviously less money for you, but also less interest accrued, and this ends up being a lot. The second is that investors and fund managers who outperform the market are just lucky, and no one is lucky forever. You want a long-term solution that you don’t have to think about, that won’t cost a lot in fee’s, and performs the same as the stock market in general (which is considered to average 10% over large amounts of time, by the way). So just buy the whole stock market. I have an account at Vanguard that allows me to do just this: when I buy shares in my fund, Vanguard is just buying equal shares of stock in whatever companies are listed in the S&P 500. The fees are low because it takes no brainpower to do this (a computer probably does it). And this is a long term investment, so I’m not even worried about temporary downs like we are experiencing right now.

So, before we get into the specifics of how to set up this system, lets take a look at how I’ve been doing. I bought into this account with $3,000 right before the stock market crashed. I want to show you that I made a terrible mistake, and it’s fine. Long-term investing is easy and fool proof, and you should start right now. Not when the economy is better, start right now!

I opened my account in 2007, before the crash, spending $3,000 to open the account. I’ve done my best to put in the same amount every month and utilize dollar-cost averaging, though there are times when I’ve had to change the amount I’ve paid in slightly due to some other budget priority. Here’s what my balance looks like over time:

My account balance goes up pretty steadily, because I am always feeding money into it. It feels good to have a growing amount of savings. However, notice that the line goes up higher recently. That’s because in the early days of my investment, the S&P Index was going down, so I was pumping in money, and the money I put in was actually losing it’s value! Look at this:

If my investment were making money, the line would be over the zero dollar mark. Even to this day, I would have more money if I had just made all my deposit’s directly into a savings account. But I invested “at the worst possible time”, and I’m currently only down about $500, whereas at my worst, it looked like I had lost $3,200. You have the benefit of time and dollar cost averaging, you can’t lose!

How to Get Started

  1. First, figure out how much money you can afford to “give away” every paycheck. This is money you will “never” see again (until you retire). Try to put away at least 10% of your salary, but put in whatever you can.
  2. Second, do you have $3,000 sitting around? My guess is you don’t. So the first step is to open an Orange Checking Account, which has no minimum balance, and set up a transfer to automatically put the amount you put away in step one into the account. Using an Orange Account is better than using the savings account at your bank because you won’t see the money every time you check your balance.
  3. Once you have $3,000, then you can open your RothIRA at Vanguard. Go to Vanguard.com, and open a Roth IRA, selecting the S&P 500 fund. I’m not posting instructions because their site has changed since I’ve done this, and will likely change again, but you can do the whole thing online without ever talking to a person if you like!
    • Note, I think you select the fund first, then click buy. Try this link to the S&P 500 fund.
  4. Now set up your automatic transfer. At time of writing, you have to log in to your Vanguard account, click “Accounts and Activity”, then click on your fund–probably: “Vanguard 500 Index Fund Investor Shares”. Then scroll to the bottom, and find “Automatic Investment.” This is also where you can change the amount you invest.

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