By Albert Lalonde
When starting a retirement savings and investment plan, the rule of thumb is the earlier, the better.
For young professionals, that can be easier said than done. High rent, student loan payments, and modest junior-level salaries make saving a challenge. And now in this unprecedented year come the dynamics adding economic uncertainty – the coronavirus, a global recession, and the recent presidential election. Those young people whose 401(k) values were rising steadily before 2020 now are nervous and wondering how to plan for a retirement that’s a long way away.
But while the seas are stormy, there are proven principles they can use to navigate and stay on a steady course toward retirement – no matter how distant it appears on their map. As many of us know, it gets here soon enough.
These are some key points young savers should consider as they develop a financial plan for retirement.
Become a disciplined saver. The optimal savings rate toward retirement is at least 20% of gross income. That may be too high for young savers, given their other financial obligations, but the important thing is to make savings a priority. Save at a consistent rate and increase it as soon as possible.
The best way to stick with your savings plan is to develop automated savings strategies, such as to have contributions made directly to a 401(k). Another option that’s popular is splitting up direct deposits, with one going into a dedicated savings account.
Keep contributing to your 401(k) – even if your employer stopped matching. Due to the pandemic, many companies suspended or reduced their 401(k) matching contributions to save cash and avoid layoffs. While such a move slows one’s accumulation of retirement funds, the bigger long-term damage is done when an employee stops contributing to the 401(k) at the same time that the employer stops matching. At minimum, maintain your current retirement contributions or, if you can afford to, increase them to compensate for the temporary loss of your employer’s 401(k) match.
Another alternative is redirecting a portion of your retirement contributions to a Roth Individual Retirement Account. Contributions to a Roth IRA are made with funds on which you’ve already paid income tax, and in many cases offer more flexibility when it comes to investment choices. But whatever you do, keep contributing. By staying the course, either in your 401(k) or Roth IRA, you can continue to grow your nest egg and take advantage of a market recovery when it arrives. And if you can afford to increase your contributions, you’ll keep your retirement plan on track. While these are all positives, it’s important to save elsewhere. Remember, qualified retirement funds are functionally locked away until age 59 1/2, so they aren’t available in the event that a cash need arises. Moreover, 401(k) savings are taxed at the time of withdrawal.
Young investors should consider balancing traditional 401(k)s with a Roth IRA – or Roth 401(k) if it’s offered – or a normal brokerage account. Roth contributions are made after tax, but they allow tax-free growth and withdrawals in retirement. They also typically allow penalty-free withdrawals up to the amount contributed. This provides some liquidity as well as an excellent tax benefit for accounts that appreciate substantially. Regular brokerage accounts provide no tax advantages, but they are liquid and still offer growth.
Having a growth mindset is central to building a good retirement plan while young. With many years until retirement, a young investor’s accounts should be weighted toward stocks, with enough diversification to protect against poor performing stocks or industries. Success in the stock market comes over the long haul, and young people have time to ride out cycles and downturns.
With a long time horizon and relatively low income relative to their later career earnings, young investors are in a unique position to realize the benefits of these vehicles. Using a mixture of these different account types will diversify tax exposure and balance savings and earnings with accessibility.
For young investors, it cannot be emphasized more: start saving early, be consistent, be diligent, be growth-minded. Start saving in a systematic way and diversify as you can. Whatever 2020 is throwing at you, it doesn’t have to stop you from having a good, disciplined plan that will pay off many years from now.
Albert Lalonde, a financial planner and investment advisor representative, is the founder of Kaizen Financial Group.