Student loans are the herpes of the millennial generation. We can’t get them to stop spreading. If you made it out of college without those sores on your financial record don’t get too comfortable, you’ll probably end up marrying someone who has them. Even with the disease of student loans running rampant through our generation, it’s imperative we begin preparing now for the end. The end of our careers, that is.
Recent college graduates received their diplomas with an average of $27,000 in student loans, a 58% hike since 2005. Not surprisingly, 54% of “Generation Me” claims debt as their biggest financial concern, according to a report by Wells Fargo. To compound financial issues, plenty of those recent graduates are having trouble becoming gainfully employed. So if you’re drowning in debt, working for minimum wage, and living in your parent’s basement, it seems certifiably insane to worry about retirement.
Unfortunately, now is the time to start preparing. Paying down debt is important, but so is amassing enough money to survive from retirement until your death; or to even be able to retire in the first place. The reason to start now comes in the form of a great financial gift to us all, compound interest. Even Albert Einstein noted compound interest as the 8th wonder of the world.
With compound interest, your money will earn interest on the interest already accumulated. For example, you invest $4,000 with an 8% interest rate. In the first year, you’ll earn the same amount you would using simple interest, $4,000 x 8% = 320. However, in the second year instead of just accruing interest on the original $4,000 you’ll get to use $4,320. The formula will then be $4,320 x 8% instead of $4,000 x 8%. With simple interest you’d only get $4,640, but compound interest yields $4,665. Just think, that’s a difference of about five beers during happy hour!
Compound interest is important to understand because it drastically impacts how much you can save for retirement. If Millennial Mary opens a Roth IRA at 22 years old by investing the maximum $5,500 at an 8% interest rate and never touches it again, she’ll have $150,517 by 65. If Millennial Mary waited until she was 35 because she wanted to put that $5,500 towards loans, she would only accrue $55,344 by 65.
If Millennial Mary opened the Roth IRA at 22 and contributed $5,500 at 8% annually for 43 years, she’d have $1,961,904 by 65. If she procrastinated until 35, and contributed annually, she’d barely get passed half-a-million with $677,949. Time is everything when it comes to investing.
A variety of accounts exist to start preparing for retirement. The main two are a 401(k) or an IRA. Traditional 401(k) or IRA means a person will not pay tax on the money going into the account, but when it comes time to cash out, the government will get to tax the total sum. With a Roth option, the government taxes the money going in now and the money is all yours when you begin making withdraws. A 401(k) makes sense over, or in addition to, an IRA if your company matches your contributions.
The experts at Charles Schwab suggest inquiring about a company’s 401(k) policy in job interviews, being aware of fees when opening a 401(k), and of course enrolling as soon as you’re eligible.
Starting a retirement account you regularly contribute to in your early 20s is one of the almost foolproof ways to become a millionaire by your mid-60s. You don’t even need to start with $5,500. Charles Schwab offers a Roth IRA with a $1,000 minimum. Fidelity doesn’t set a minimum requirement, but cautions investors certain mutual funds may impose minimums. Other major financial institutions to investigate are The Vanguard Group and T. Rowe Price.
If you’re interested in setting up an IRA or Roth IRA, begin by comparing options with different financial institutions such as banks, mutual fund companies, and brokerage firms. You’ll need to consider the minimums amount to open an account, annual fees, and the type of investments available. With an IRA or a 401(k) you’ll need to create a portfolio of investments, so get advice on how to select investments.
Paying off your student loans is important, especially because interest rates are working against you. However, it is possible to begin saving for your retirement while paying down debt. If you don’t have an option for an employer matched 401(k) open an IRA. Try putting aside a small portion of your income for six months to a year, using your tax return, or working some odd jobs for extra cash to open in order to open an IRA. Ultimately, stop making excuses and make an investment in the most important thing you can: yourself.