Investing for retirement can be difficult at the beginning of your career. You don't make much money, and probably have no idea what to invest in. In your 20s retirement seems so far off that it feels absurd to invest in retirement accounts. While the stock market has been growing recently, who wants to take a chance on losing hard-earned money during the next downturn?
Many young people put off saving for retirement because they are struggling to get on their feet, and investing can be confusing. But delaying retirement investing is a mistake. When you're young, there is plenty of time for compounding to work in your favor. And while it can be difficult to pick among the myriad of funds in your 401(k), if you go with low-cost index funds there's a high probability that it will work out fine in 40 years.
Your saving rate is more important than your rate of return. When you're starting out, the amount you save is much more important than the return on your investment. This is because your nest egg isn't very large yet, and market swings have only a minimal impact on the total valuation. For example, if you have $5,000 in your 401(k) and the market declines 10 percent, your portfolio value will decrease by $500. However, if your monthly contribution is $1,000, then your balance would still be higher at the end of the month.
Usually the stock market doesn't fluctuate that much and your monthly contribution will be more than any swing in the market. It will take years to build up your portfolio enough that market swings will outpace your new contributions. When you're starting out, it's more crucial to track your expenses and find ways to save more.
Stock market corrections are good for young people. The stock market is at an all-time high, and it can be unnerving to jump in. The thing many young people don't realize is that a big stock market correction is good for them. By contributing to your retirement plan every month, you are dollar-cost averaging in. When the market declines, you're getting a great deal by picking up more shares. Historically, the stock market does very well over the long term, so picking up shares at a discount is a great thing.
Some people stop investing when the stock market crashes, and that's a mistake. When you're young, you need to keep investing through thick and thin. And stock market crashes can actually be great buying opportunities for young folks. If your stomach can handle it, stay invested through a few of these crashes and you will see your portfolio grow after the market recovers.
Start off with simple investments. The wide array of investment choices can be particularly difficult for young people to figure out. Some retirement plans have 30 or more funds to choose from and it's puzzling. The easiest thing for young folks to do is figure out their ideal asset allocation and invest in index funds accordingly. Asset allocation is important because it takes your risk tolerance into account and will help you stay invested during the down years. Investing in index funds is an easy way to start investing because you'll be diversified and usually the fees are lower. As you learn more about investing and build up a portfolio, you can diversify into individual stocks and other kind of funds.
While it's difficult to save for retirement when you're in your 20s, that's the best time to get started. The earlier you invest, the better off you'll be in the future. Compound interest has plenty of time to accumulate when you're young, so you should take advantage of it while you can.
Joe Udo blogs at Retire By 40 where he writes about passive income, frugal living, retirement investing and the challenges of early retirement. He recently left his corporate job to be a stay at home dad and blogger and is having the time of his life.
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