Millennials and Retirement: The Importance of Investing
The uncertainty around the COVID-19 pandemic has highlighted the importance of saving. In fact, building up savings can be the safest way to protect yourself from unexpected events such as economic downturns. Currently, Americans are saving at unprecedented rates. According to the Bureau of Economic Analysis, the average saving rate of 7%-8% (of income) jumped to 33.7% in April of 2020. Saving is a great habit that will contribute to an individual’s long-term financial health and reduce anxiety around uncertain events. Unfortunately, accounts such as bank savings are not a good way to build wealth in today’s environment. Interest rates were historically low prior to the start of the pandemic, have subsequently fallen further, and projected to remain low for the foreseeable future. For savings that are not needed for a year or more, millennials can utilize a brokerage account and investment vehicles, which is arguably the best way to grow your earnings and financially prepare for future events.
Millennials, unlike older investors, can generally take more risk since they have a much longer time frame to recover from any losses before they retire. Before investing, it is important to pay off any high-cost debt. For example, if you were to earn a hypothetical 10% return in the stock market but be paying a 15% interest rate on a credit card, it makes more sense to pay off the credit card first. Certain lower-cost debts, however, can be paid off while you start investing. Student loans, for example, have average rates of 2.75% for undergraduate borrowers and 4.3% for graduate borrowers, so it might make sense to invest while simultaneously paying off these loans (businessinsider.com).
Once you begin investing, it can be extremely valuable to diversify your investments. There are more attractive opportunities for entry-level investors than ever before. Employer-sponsored retirement plans such as 401(k)s and 403(b)s are a good way to begin saving for retirement. The investments are selected by the sponsor of the plan, and employers often match your contributions up to a certain limit. It is important to be aware of fees and expenses. If you see several investment options within the plan that are charging more than 1% a year, that may be a red flag. If you are in a high-cost plan, you should consider contributing enough to get a match, but should also consider putting your money elsewhere. Individual Retirement Accounts (IRAs) can be useful vehicles for saving for retirement, but the annual contribution limits are fairly low. Roth IRAs are typically more attractive to younger people because your contributions have already been taxed, and most people are in a lower tax bracket now than they will be at the time of retirement. There are, however, income ceilings on who can contribute to a Roth. Starting your own business? A SEP IRA may be a great vehicle for you to save for retirement in a tax advantaged way and allows for greater savings beyond an IRA. Most people believe tax rates will be higher in the future and utilize other retirement savings strategies to pay taxes up front. Permanent life insurance is a tool that has fewer limitations on your savings relative to more traditional retirement vehicles and is funded with after-tax dollars, allowing you to draw a large portion of the funds tax free in the future**.
Another dimension of investing is the “active/passive” decision. Active investment funds are managed by professionals and seek to outperform the broad market. Index funds, which replicate the broad market, is a passive approach. While you don’t have the opportunity to outperform the market, passive funds tend to have lower fees and expenses. Both approaches allow you to invest in a greater number of stocks vs. purchasing them individually, which allows for greater diversification. The volatility of stocks can be offset by complementing your stock investments with bonds investments, which are far more stable. According to a study by Vanguard, an investment portfolio evenly divided with stocks and bonds would have lost nearly 29% of its value during The Great Recession but would have bounced back a year later. A portfolio that was entirely in stocks would have lost 55% of its value and taken three years to recover. It is important to find the right stock-bond investment mix that aligns with your goals. Target-date funds*** can be a great choice for deciding your stock-bond allocation because they are designed based on the year you want to retire. As the date approaches, the investment allocation automatically shifts to become more conservative. Investing as early and as often as possible allows you to maximize potential growth, as well as prepare the future.
It is important to start saving for retirement as early as possible and as much as possible due to the power of compounding interest. It essentially means you earn interest on the interest you receive. The earlier you begin saving, the more time you have to build wealth as a result of compounding interest. As an example provided by Business Insider, Chris and Jennifer are two workers looking to save for retirement. They both save $100 a month which earns 5% compounded annually. The only difference is Chris started saving at 25 while Jennifer began at 35. At their respective age of retirement, 65, Chris had accumulated $162,000 while Jennifer had accumulated $89,000. Even though Chris only contributed $12,000 more than Jennifer, his savings were nearly double hers at the age of retirement. Millennials should begin preparing for retirement now, as it can greatly benefit their financial health in the future.
For Educational Purposes Only – Not to be relied upon as financial, tax, or legal advice. All examples are hypothetical and designed to illustrate mathematical principles. Investing involves risk, including loss of value, and diversification cannot assure a profit or protect against loss in a down market.
**Life insurance is subject to terms and conditions not outlined here. Accessing policy cash values through loans and withdrawals may be subject to costs and limitations, and may lower benefit values.
*** The principal value of “Target” funds is not guaranteed at any time, including at or after the target date.