Financial planning advice can come in many forms, even the songs of Rod Stewart. The chorus of “Ooh La La,” by The Faces (Stewart’s band with future Rolling Stones’ Guitarist Ronnie Wood) wisely declares: “I wish that I knew what I know now, when I was younger.”
We would agree. And while Ronnie & Rod may not have had their investment returns in mind when they wrote this song, below are what we consider to be some of the best pieces of financial advice you’d do well to know now, before your too much older.
Invest in Yourself
Investing in yourself, especially when you’re young, is the most important investment you can make. Any professional skills and knowledge you can acquire is your “Human Capital;” this investment is linked directly to future earning potential and your ability to meet financial goals. So: read, learn, and acquire skills that can increase your income. Without human capital, you will be limiting your ability to create investment capital.
Financial Planning magazine recently created a “Retirement Planning Pyramid,” as seen in the link. The idea was to imagine if individuals had a retirement pyramid they could follow, much like the food pyramid, which might lead to financial health. Not surprisingly, investing in yourself is the foundation.
Take Advantage Of Compound Interest
Next up in the retirement pyramid is compound interest. When people think of interest, they often think of debt. But interest can work in your favor when you’re earning it on money you have saved and invested. Compound
interest helps the money you put away grow faster due to interest building upon
itself. For every year you delay in saving, you will have to contribute more to reach your savings goals because of lost compound interest.
If you start saving $400 per month at age 25, you would have $1 million saved by age 65 (assuming a hypothetical 7% annual investment return). If you don’t start until age 35, you’ll have to save twice as much to reach $1 million by age 65. With compound interest, the simple fact is that when you start outweighs how much you save.
To truly accumulate wealth and take advantage of compound interest, it’s important to start early and be consistent. Even small investments matter: you can get started now by contributing to your 401(k) or making regular investments in a Roth IRA.
In the words of IRA expert and financial industry speaker Ed Slot, “Roth IRAs are the best motivation to save for retirement that we’ve seen in America. Everybody should be in the Roth game if they can.”
Unlike the tax-deferred traditional IRA, with a Roth IRA you pay all taxes up front (your contributions are made with after-tax dollars). The perk is that you receive tax-free withdrawals in retirement (after the age of 59½). When you decide to withdraw the money, you don’t have to pay taxes on any of the growth.
If you have one million dollars saved in a Roth account at retirement, you will have one million dollars. If you have one million dollars in a traditional IRA… well, you will have a lot less after paying taxes.
Another significant advantage of Roth IRAs is that there are no required minimum distributions. You can leave your money in the account to grow forever, instead of being required to start taking withdrawals (and stop contributions) at age 70½ as you would with a traditional IRA account. This allows you to use a Roth IRA as an estate planning tool to provide tax-free income for grandchildren and future generations.
The one caveat to a Roth IRA is that to fully contribute, you must make less than $120,000 ($189,000 for joint filers). Contributing to a Roth early in your career is especially smart considering as your experience and income increase, you may no longer be eligible. There are more complex strategies to get around these limits, although working with an advisor is recommended.
All investments come at a cost, but how much each has is a different story. Unfortunately, you can’t line up all the investment products on a shelf so you can compare them. It’s up to you to research on your own and figure out if you are paying premium, retail, or discounted costs on your investments.
It’s essential to know this because over the course of your working career all the way through to your retirement, fees can add up and make a substantial dent in your savings. Try to avoid high-cost funds, which can eat away at your savings. The higher the fees you pay, the longer it will take for your investments to grow. Many people don’t realize how much they’re paying in fees (or assume they aren’t paying any), but the average 401(k) plan cost in 2014 was 0.97%. Check with your plan provider’s required annual disclosures (ask for the 404a5 form) to make sure your plan is competitive.
Are there money lessons you your team members wish you’d learned earlier? What financial lessons are you still learning? Whatever questions you have, we can help.
You can reach us by calling (844) 377-4963 or emailing Fifirstname.lastname@example.org. You can also book an appointment online here. We would love to sit down to discuss you & your company’s situation and how we can help you tackle your greatest questions and goals.
Investment Company Institute/Brightscope Defined Contribution Plan Profile: A Close Look at 401(k) Plans, 2014 (December, 2016)