The last thing budding adventurers like yourself want to do is get bogged down with is a bunch of mumbo-jumbo about retirement planning for young adults.
Here's the thing though... one day, you're going to retire. And if you truly succeed in creating for yourself the unconventional life of your dreams, you're not going to have some 9 am - 5 pm job helping you arrange everything for that day. You're going to have to figure out how to get prepared by yourself.
A few years back when I was 18, I didn't know what retirement planning was. I was 100% focused on making a better "now" for myself and not thinking about simultaneously securing my future.
Then I read The Motley Fool Investment Guide for Teens. It rocked my world. It taught me how rich people get rich and how with a little discipline I could predictably become a millionaire.
In this blog post, I'm going to paraphrase some of the wisdom in that book and hopefully ignite a life-changing spark between you and your relationship with money.
WTF Is Retirement?
If the number of times I mentioned the word "retirement" in this article's intro didn't put you to sleep already, we're gonna kick things off by putting a definition to "retirement" (zzZZzzZZZ).
Simply put, retirement is the age that you want to stop worrying about how to get money and start focusing 100% on how you can live the most incredible life possible (kind of like what we teach you to do on this blog at a young age!).
When you retire, you want to have so much money saved that you don't need to work anymore. You certainly can work if you love doing whatever rewarding thing it is you do but you'll be financially set enough that if you want to spend the next 10 years napping in a hammock you can go for it.
When Do People Retire?
There's no age you have to wait for until you retire. The goal is to retire when you have enough money saved to last you for the remainder of your life.
The situation does get a little more complicated than that given certain withdrawal rules around retirement accounts (more on that later). For your reference though, the average American retires between 57 and 66 years old.
How Do You Save for Retirement?
Here comes the fun part.
Some people think that saving for retirement planning is as easy as taking a percentage of your paycheck each month and putting it under your mattress or into a savings account that you'll withdraw from later.
That could work... if you sock away a tremendous amount of money.
For most people though, it would be near impossible to create a comfortable retirement doing that.
Why? Because savings accounts and mattresses have horrible "interest rates".
Interest is this incredible thing that allows your money to grow while it's sitting. If where you put your money has a high-interest rate, $1000.00 in that account could double in a few years! If the place you put your money has a horrific interest rate, in a few years $1000.00 could grow by only $10.00.
That's why, when retirement planning, it's important that you invest your money in places that are going to give you the highest returns. Below are 3 of the most popular places you can put your money that will make your retirement savings grow incredibly fast.
A 401K Account
A 401K is an account offered by a lot of 9 am - 5 pm jobs as a benefit. The way it works is that money is automatically scraped off of your paycheck and is deposited into your 401K account. Then, a really good investor (a person who knows where to park your money so it will get the most interest/returns) takes your money and on your behalf, invests it in places where it'll see the most growth.
Over your career you'll continue putting money into your 401K, that really good investor will continue parking your money in great places, and you'll continue to see your money balloon. Then, when you reach retirement age, you can withdraw that now huge sum of money on a monthly basis and live off of it until your children bury you! (...that's a depressing image.)
An IRA Account
401K's are great but you need to have a conventional job to have one (booooo). For a very similar alternative that's open to anybody (including you right this second), you'll want to invest your retirement planning money in an IRA.
Again, an IRA account is very similar to a 401K in that you deposit money into it and can then A) Manually choose places to park your money within the account you think will give you the best returns or B) Put your IRA money into a "mutual fund" which allows a really good investor to manage your money for you.
At the bottom of this article I'll talk a little bit about what I recommend you do specifically.
A ROTH IRA Account
A ROTH IRA is the same as a regular IRA with one key difference. Taxes! (Woohoo, another word that puts people to sleep!).
Here's the rub... Say you make $1000.00. If you deposited that money into an IRA, you wouldn't need to pay taxes on those $1000.00 at the end of the year.
You would, however, have to pay taxes on that money when you withdraw it in retirement.
With a ROTH IRA, if you make $1000.00, you'll need to report it and pay any taxes you owe at the end of the year. When you withdraw that $1000.00 in retirement though, you'll get your money back 100% tax-free!
I always recommend ROTH IRAs over regular IRAs because with the way taxes and interest work, you'll end up walking away with a lot more money when you opt to pay your taxes up front.
The Magic of Compound Interest
Why is it that the returns you see putting your money into a 401K an IRA or ROTH IRA are so much better than just sticking your money into a measly savings account?
A) In one of the above retirement accounts, a savvy investor will place your money into investment opportunities that can earn you enormous returns. With a savings account, your interest rate is flat and low.
B) Compound Interest
Compound interest is god's gift to becoming a millionaire. It means that you can earn interest on top of interest.
Let's break this down with a comparison...
Let's say you have an account that earns "simple interest" (not compound interest). Let's pretend the interest rate on that account is 1% and pays once per year. If you deposited $100.00 into that account, you'd have $101.00 at the end of the year (your original $100.00 + $1.00 in simple interest). At the end of two years, you'd have $102.00. Three years, $103, etc.
In that example, you're only earning interest on the original amount of money you deposited into the account. Boring.
Now let's look at an example with compound interest.
With a similar account that earns compound interest, after 1 year you'd still have $101.00. At two years though, you'd have $102.01. That's because this year, you earned 1% on $101.00, not on just the original $100.00.
One penny difference. Not impressive, right?
I totally get that.
These low numbers were just for example purposes. Let's see how simple vs compound interest performs against one another with larger numbers over a longer period of time.
You read that chart right. With compound interest you'll make $144,202 more than with simple interest over the same time frame.
Bottom line, when you're retirement planning, you want your money invested in places that have a high-interest rate and offer compound interest. A 401K, IRA and ROTH IRA offer both of those things.
Can You Just Tell Me What to Do?
Sure! Now that you know all of the basics of saving for retirement and are hopefully moved by that fact that you can turn $10,000 into $184,202 without lifting a finger through investing, it's time for me to give you my simple recommendation on what you should do for retirement planning!
1) Save up $1000.00
Most retirement accounts require a minimum deposit to open. Some are as low as $1000.00 others are much higher. The place I'm going to recommend you open up your retirement account with only asks for $1000.00
2) Open up a ROTH IRA with Vanguard
Vanguard is a world-class investment firm that charges very low fees for managing your money. I trust Vanguard with all of my retirement accounts. Open your IRA by clicking here.
3) Deposit your $1000.00 into your ROTH IRA
Vanguard may make you do this during your account setup process. If they don't you can do it once your account has been established.
4) Invest your $1000.00 in one of Vanguard's "Targeted Retirement Funds"
Vanguard has specific targeted retirement funds (mutual funds) for every retirement year. So, for example, if I was going to turn 60 and retire in 2025, I'd deposit my $1000.00 into the "2025 Targeted Retirement Fund". If I was retiring in 2050, I'd put my $1000.00 into the "2050 Targeted Retirement Fund. Figure out what year you'll be turning 60, find the closest targeted retirement fund to that year and stick your money in it.
5) Continue to contribute a small percentage of what you make to your targeted retirement fund
People contribute anywhere from 8% - 20% of what they make into their retirement planning fund until they retire. I contribute 10%.
6) Retire a Millionaire!
Results may vary but if you're good about contributing to your retirement consistently, through the power on compound interest, you have a very good chance of having well over a million dollars by the time you're 60 years old.
Wrapping Up Retirement Planning and Some Things to Watch Out For
Whew! You made it through. Congratulations!
Hopefully this quick chat on retirement planning has inspired you to be proactive in not only creating an unconventional life for yourself today but also in creating a secure life for yourself tomorrow.
To wrap things up, here are some things to be mindful of.
- Investing your money in retirement accounts is riskier than sticking it in a savings account. When your retirement money is in a savings account, it's federally insured and basically bulletproof. That being said, it will grow at a meager rate. When your money is in an investment account it can grow exponentially but can also shrink as the economy ebbs and flows. This is natural and short term gains and losses should never concern you. You're in it for the long run and over the last 100 years, the stock market, on average, has given people a 7% return. That's way bigger than the sub 1% you'll get from a savings account.
- You can't withdraw your money from a 401K or IRA until you're 59.5 years old. If you do, you'll incur a penalty. This prevents you from stealing from your future self to buy a sexy pair of pants.
- You can only put "earned money" into an IRA account. That means your parents technically can't pass you $1000.00 under the table for you to stick in your IRA. You technically have to mow their lawn and do other chores to earn that taxable income before you can invest it.
- I am not a financial expert. Saving and growing my net worth is my passion and sharing my experiences with you makes me happy! That being said, I'm just a kid who has built a "work from home"," travel when he wants to" life for himself. I'm not uniquely talented or smart so take or leave my advice.
Finally, to give you more perspective on everything I've said about saving and retirement planning, check out The Motley Fool Investment Guide for Teens and this incredible video on how to automate your finances. Both have changed the course of my life forever.
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