Many college age students like to live in the here and now. Wondering more about where the next party is and what tests are approaching, than what type of lifestyle they will have when they call it a retirement in 40 years.
The fact of the matter is, during college and just after graduation is when you have the greatest weapon at your disposal to be sure to live the retirement that you want: time.
Investing your money will have a compounding effect over time, this is where the money grows upon itself. The more time invested the longer your money has to grow and multiply.
For example: there are two individuals saving for retirement, both age 20. The first saves $500 a month for 20 years until age 40, and stops saving. The second individual saves twice the amount but puts off saving. He saves $1,000 a month for 20 years, but waits until age 40 to start. Who will end up with the better retirement? The saver with more time on their side.
It turns out, with an annual return of 10 percent, the average annual return of the market, the first saver who put his money in initially will end up with $2,782,352, while the saver who waited, but contributed double, will still only end up with $759,368. This is an abstract example, but clearly shows the power of time on money.
Conversely just for reference, had the first saver been ambitious and saved for all 40 years and contributed the same $6,000 per year, which for many may only end up being 5-10 percent of their annual salary, the saver would end up with $3,162,039.
Clearly saving a little money over time can add mountains of cash to your retirement fund. But now the question is, how do you save your money?
There are two good options available, and a solid mix of the two can provide savers the highest returns, and the cushiest retirement.
The 401kThe 401k is a retirement account that many working individuals take advantage of. The basic premise is the saver will agree to withhold a certain percentage of every paycheck (usually 5-10 percent) to contribute to the account, and some employers will match the contribution up to a certain point. The money also enters and grows tax-free until you take it out at retirement.
This is an attractive option due to the free money the employer will also contribute to the account; this will help the money grow at a much quicker rate when twice the contributions are made monthly. The only drawback to the account is the money flows into investments known as mutual funds. Basically paying a money manager to invest your money for you through their fund. This is good for novice investors, however the fees associated with the funds can sap returns.
The Roth IRAAnother option is the Roth IRA. The individual starts this account, and money is contributed after tax but is tax free upon removal. Also, any gains made from trades within the account are not taxed.
This is an attractive option due to its tax advantages when removing the money, and much more freedom for investment choices, such as stocks, bonds and options within the account.
Mixing these two options will ultimately provide the best returns. Both accounts offer attractive tax advantages, however, mixing the accounts can negate some of the drawbacks. For example, contributing to the 401k up to where the employer stops matching is a good idea to get the free money, but contributing after that will ultimately cost you in the fees you will lose out on by investing in mutual funds.
After contributing to the match level in your 401k, diverting the rest of your savings funds into a Roth will allow for investment flexibility, and tax free trades and withdrawals
