We spend countless hours on our study grind so we can graduate and land our dream job (or just any job with a steady paycheck, if we’re being honest).
But what’s the point of all the stress if you don’t have the ultimate goal in mind while you slave away at Club West?
Retirement.
It’s a distant, yet vastly important goal that all twenty-somethings should have on their mind. It’s a way to ensure that all the time we put in cramming for finals isn’t time wasted and by the time fortune stops smiling on us, we can start smiling on our fortune.
Why Does it Matter?
I know what you’re thinking. You are young, carefree and you don’t give a fuck about retirement right now. You have plenty of time to think about “adult” things when your time in college has long passed. It’s a completely natural mentality because being an “adult” is scary shit. But what if I could tell you that getting your retirement started today is possibly the most important thing you could do, and your actions now could result in a seven figure bank account years down the road? What if I also told you that retirement isn’t as complicated or scary as it seems?
Honestly, that’s the truth. Before I can give you secret formula to financial independence you’re going to need to be familiar with some very important terms that will allow you to navigate these murky waters and also enable you to have a conversation with your parents that might actually impress them.
Terms To Know
Individual Retirement Account
An Individual Retirement Account is essentially a long terms savings account with huge tax benefits down the road. There are many different varieties of IRA, but you don’t need to worry about those for a while. All you need is a plain ol’ traditional IRA. The main benefit of an IRA is that you don’t have to pay taxes on your money until you withdraw funds at retirement age.
Compound Interest
Essentially compound interest is interest on your interest. When you put money in a savings account, you earn interest. It’s like the bank saying “thank you” for keeping your money in their bank. Now imagine you put $100 in a savings account that the bank is paying 5 percent interest on. After a year, that same $100 will have grown to $105. After your second year, you will have earned 5 percent on the original $100 AND 5 percent on the additional $5. Repeat for decades for best results. Compound interest baby, interest on your interest.
Exchange Traded Fund
Commonly referred to as ETF’s because Exchange Traded Fund is a mouthful. It is treated like a common stock, but instead of being tied to a single company, an ETF is tied to a basket of companies. For example, AAPL is the stock symbol that is tied to Apple. If you were to buy a share of AAPL you would have bought a share of Apple. A common traded ETF is SPDR. It is tied to the S&P 500 Index, which is the 500 largest stocks in the United States. By buying one share of SPDR, you get ownership in all of the stocks SPDR follows. Rather than individually buying all 500 stocks in the S&P 500, you can simply buy a share of SPDR. (One share of SPDR currently trades at $190.16, so buy before it goes up!)
Stock Index
Indices are ways to group stocks together. You can think of stocks in the same index as being in the same basket. They are often grouped depending on size, industry, region of the world, etc. Common indices you may have heard of are the NASDAQ, which is comprised of technology stocks, the Dow Jones Industrial Average, which is comprised of 30 of the largest and most influential companies in the United States, and the S&P 500, which is comprised of 500 of the most widely traded stocks in the United States.
Tax Deferred
This simply means you put off paying taxes until a later date. Imagine you go to 3 Natives and the price of an acai bowl is $10.00. When you pay, the total charge is $10.60, because you paid 6 percent sales tax. In this case you did not defer the tax, rather you paid it right then. If you could somehow put off paying that $.60 until you retired, that would be an example of tax deferral.
Now that you learned some swanky new words, you’re ready to start growing those sweet sweet savings.
Steps to Take Now
1. Open an Individual Retirement Account
As stated above, this is the vehicle for your savings growth. Reliable and well known brokers (the middle men in the investing world that connect buyers and sellers) that offer IRAs (and $0 account minimums) include: Scottrade, E-Trade, and TD Ameritrade.
2. Fund your IRA with a deposit of $1,000
There is a saying that capital is attracted to the source of highest risk adjusted return, and that is exactly what your $1,000 deposit will be doing.
3. Invest your initial $1,000 in SPDR
With the help of your broker, you will want to invest that initial $1,000 in the ETF SPDR. The benefit of investing in SPDR is that diversification hedges risk at minimal cost you. Rather than individually buying shares of the 500 largest companies in the United States, buying shares of SPDR does it for you. A single share of SPDR holds a proportion of all the 500 companies on the S&P 500 stock index. This way your retirement savings aren’t at the mercy of movements of a single stock, rather the average of the 500 largest companies in the United States. Feels pretty safe, doesn’t it?
4. Each year until you reach retirement age, deposit and invest an additional $1,000 in your IRA
The benefit of investing in SPDR is that your savings are basically tied to gains in the overall stock market. This might freak some people out, thinking that stocks are dangerous investments. In reality, the stock market is a safe place to invest money, contingent on the amount of time you allow the investment to grow. Historically, an investor can expect to return 7 percent per year when owning stocks, because historically, it’s true. The caveat is that the money must sit there for a long time to ensure the historical return.
In order for this strategy to work (and it really will!), your savings need maximum amount of time to compound (remember compound interest?) and sweat out normal market boom and busts. Your savings aren’t excited by inevitable periods of hyper growth (like from 2009 to 2015) or major contractions (like 2007-2008) Your savings are relishing in the average 7 percent return over the long time horizon of 40+ years. I know it doesn’t sound very sexy, but trust me, it will be incredibly sexy when you retire with six figures in the bank.
5. Don’t touch the money until you reach retirement age
Seriously. Don’t do it. Don’t touch your savings until you reach retirement age. You want to adhere to this for two major reasons. 1) There are hefty penalties you will incur if you withdraw capital from an IRA before you turn 59.5 years old. And 2) you want to allow maximum amount of time for your principal to grow. You are contradicting the phenomenon of compound interest, and opening up your savings to the inherent risk in the stock market by not allowing it to smooth out periods of stagnation by pulling out your money before you reach retirement age.
This is the most simple and yet probably hardest part of the strategy, and if you do it, you’ll thank me a later. Just don’t touch it. This is where the benefit of a tax deferred IRA comes into play. You want to have the biggest base for your savings to grow, right? Then why take out a portion every year for taxes meaning less principal to be compounded, when you could just take out a lump sum for taxes at the end when you retire? You don’t care anymore at that point, you’re already rich from deferring taxes until you’re ready to pull out your money.
Don’t believe this strategy is fool-proof? Don’t believe me, just watch:
Imagine you invest $1,000 in your newly formed IRA at the beginning of the year and buy shares of SPDR. At the end of the year, SPDR has returned you 7 percent, so your $1,000 has grown to $1,070. You deposit and invest another $1,000 in year two and so on and so forth. After ten years of this strategy, your savings have grown to a value of $16,750.75. After twenty years, the value is $47,734.86. After forty-five years, right about the time you would be retiring, the value of this strategy would have grown your savings to $326,754.21! This is the the case if you stuck to the original $1,000 deposit each year. If you were to deposit more than $1,000 as you advance in your career and your earning power grows, the compounding effect would be hella more than $326,754.21 at the end of 45 years.
I guarantee that when you’re fat, old and tan, you won’t regret following this advice. See you at the country club.
Trending Now
Midweek Melodies with Michigan Rattlers
You may also like
