A new batch of high school and college graduates is about to be set loose on the world and like virtually every class that came before, this one will leave campus with little practical knowledge about personal financial issues. Perhaps most glaring will be the kids’ lack of understanding of how and why they should begin to save for retirement right away.
Most schools don’t teach money basics, even though there is a crying need. Today, financial security is entirely in the hands of individuals; the government safety net has eroded and private pension income is fast disappearing. Yet long-term security remains within easy reach. You simply must start early and give your savings decades to grow.
Too often retirement planning addresses only those who are nearing the date. Advisers make a ton of money off these people, who may be wracked with anxiety. But there isn’t a lot they can do for them. Saving even large chunks of money late in life is no substitute for saving in small doses over 40 years. If you save $10 a day starting at age 25 you’ll have more than $1 million by age 65, assuming an 8% rate of return. If you start at age 45, you’ll only have $180,000.
Yet surveys show that young people are not starting early; in fact, they are starting later than ever. The wealth gap between young and old has never been wider. In 1984, the median net worth (adjusted for inflation) of households headed by people 35 and younger was $11,521 vs. $120,457 for households headed by people 65 and older, Pew Research Center found. By 2009, that gap had grown to $3,662 for young households vs. $170,494 for older households. Ten times greater wealth for older households has become 47 times greater wealth, in large part because young people are not saving.
There are good reasons for this trend. The average college grad has about $25,000 in student loans and another $4,000 in credit card debt. In the tough economy, many move back home for a while and get a later start on their career. They’ve also not had the best role models in their parents, says John Pelletier, director of the Center for Financial Literacy at Champlain College. He notes that just one in 10 boomers are confident about their retirement plan and that 40% expect to have to scale back their lifestyles when they quit work.
Indeed, boomers started saving during the bull market of the 1980s and their strategies were built around having most of their money chasing big returns in the stock market, says Katie Libbe, vice president of consumer insights at Allianz Life. Today, she says, asset allocation and diversification within each asset class are paramount.
What can new grads do now to prepare for retirement in 40 years? Here are some simple steps:
- Pay yourself first Make saving a routine on day one by automatically setting aside a specific amount from every paycheck. One way to do that is enroll in your employer’s 401(k) plan on your first day of work and contribute as much as you need to get the full company match.
- Invest for growth With four decades to retirement you can afford to invest mainly in stocks. But keep it simple with low-cost mutual funds that provide ready-made diversification. Consider index funds or a target-date fund, which will slowly shift your holdings into low-risk investments as you age.
- Manage your debt Avoid consumer debt for anything that is not essential and make sure you have a plan to pay off those student loans. Do not defer student debt unless it is a last resort. Pay down your highest-rate debt first.
- Save found money When you get a raise, bump your retirement savings by half the amount of your increased income. Do it right away and you’ll never miss the money.
- Never take a check When you switch jobs, roll your tax-favored savings plan into the one at your new company. Don’t ever take cash out as part of the rollover.
- Understand risk The way we save for retirement has changed. It’s on you to get it right. Young workers need to understand the new realities, which include many forms of risk—from the costs of living until age 100, to the bite that inflation takes out of a fixed income, to the escalating expense of retiree health care. It’s all perfectly manageable. But starting your first day out of school is the key.