Planning for the Future: A penny saved could make you a millionaire
As young adults, we tend to operate on a pretty tight budget. Whether we are working full-time in an entry-level career or a student working part-time, money is definitely hard earned and easily spent. With monthly expenses sucking up most of our income, it is difficult to think about investing in the future. Besides, we have plenty of time to think about things like retirement when we're older, right?
Wrong. As young adults we have a highly enviable advantage - time. Time is the greatest asset when it comes to investing, more so than the amount of money actually invested. What little we put away now will prove to be far more valuable than the larger sums we might be able to afford in our 30s and beyond.
Pressure to start thinking about the future may be overwhelming but it has tremendous merit. Social Security was established to provide a supplemental income to citizens when they reach retirement age. However, with the big debate over Social Security and whether it will even be around when we retire, we need to begin planning for the future.
Additionally compelling is the reality that just last year one in every 73 households filed for bankruptcy, and roughly nine million consumers sought credit counseling or other debt-management services. Combine that with a high unemployment rate and the growing number of jobs being outsourced overseas and we have much to be concerned about when it comes to our financial stability in the future.
Where to start, what to invest in, and how to manage your investments - all mind numbing issues to send you into a spending fit. However, there are three simple steps to put you in the right direction:
- Assess your current financial situation and spending.
- Identify short and long term goals.
- Establish a budget and pay off credit card debt.
The first step is acknowledging the need to start planning your future. Then establish your goals and pay off high-interest credit card debt. Now you are ready to invest. When it comes to deciding the amount of money to invest, a good rule of thumb is allocating a percentage of your monthly income to specific investments. For example, you may want to set aside 10% for retirement, 10% to long-term savings, and 10% to short-term savings. While this may seem difficult, living on 70% of your salary will provide excellent financial footing for the rest of your life.
Money put away for an emergency fund, college tuition or a down payment on your first house should be as liquid as possible, meaning that at any time an asset can be easily and cheaply turned into cash. Avoid high, variable interest rates. If you are enduring a rocky year with the stock market and an unexpected house or car expense emerges, you don't want to pull your money from a lagging market. Therefore, place emergency fund savings in accounts that are easily accessible and don't have maturity dates or early withdrawal penalties. Short-term goals like a down payment for a first house or a trip to Europe are likely timed goals in your life. You will have lead time before you need to withdraw that money. Keeping funds for these short- term goals in volatile investments is very risky. If the stock market performs poorly for several years, that new house for your family may be further away than you expected.
Establishing a retirement fund should be a priority for every investor. Conscientious investing can provide a comfortable lifestyle after you quit working and may even allow you to retire early. Ask yourself what kind of lifestyle you will want. Do you want to leave an inheritance for your children? While many of these questions are difficult to answer today, the most important thing you can do is start now. You can narrow the focus of these goals as you get older.
Do you need more than a retirement fund? Most retirement funds have an annual contribution limit. In 2005, IRAs are at $4,000 and 401(k)s at $14,000. Over time these accounts will certainly grow, but may not yield enough to provide the lifestyle you desire in your retirement years.
When choosing investment vehicles beyond a retirement fund, consider your comfort level with risk and how actively you want to manage your portfolio. Higher yield investments always entail risk but some more than others. Bonds prove to be a pretty safe investment but with considerably lower returns. A key to determining your comfort level is your investment savvy. It doesn't require a PhD in investing to understand what strategies are right for you.
Diversification of investments is extremely important as it will reduce overall risk. To really diversify your investments, it doesn't hurt to turn to the pros. Professionals manage mutual and index funds for you, freeing up much of your time and energy. However, always remain active in investment decisions and be knowledgeable about where your money is being invested and how it is performing.
Editor's Note: Various conditions apply to different investment and savings vehicles, and retirement accounts. Please consult a qualified professional advisor for assistance in determining which vehicles and accounts you qualify for and which best suit your individual needs.