2016 Grads: Invest Now for Your Future
July 26, 2016 | Your Finances
If you recently graduated from college, hopefully you ended the semester on a high note, landed a job at one of your top five employers and even enjoyed a few weeks of summer before entering the working world. And now it’s time to get ready for retirement. Seriously. Sure, it may be decades away, and you’re probably saddled with student loan debt. But today, pretty much everyone is on his or her own to pay for retirement. So the sooner you start saving, the better off you’ll be.
With that in mind, I thought it would be helpful to run down five things to know when you sign up for a retirement account like a 401(k).
1. Maximize your contributions: Starting early and contributing the maximum amount you can afford means you put the power of tax-free compounding to work for what may arguably be the most important financial goal possible—your retirement. In addition, most companies offer a matching contribution. At a minimum, contribute enough of your salary to get the match; otherwise you are leaving free money on the table.
Compound returns and interest are on your side when you hit the ground running with savings. As Albert Einstein is rumored to have said, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
Here’s an example: Begin investing $3,000 a year into your 401(k) when you are 22 and continue that investment for 40 years, until you are 62. If your investments return 7 percent a year on average, you will, at the end of 40 years, have saved $598,905. However, if you wait even 10 years to start investing, that amount will be $283,382, less than half of what you could have saved by starting immediately at the beginning of your career.
From this perspective, there is a lot to gain by saving early and figuring out a way to balance repaying your student loans and saving for retirement on an entry-level paycheck. There are a number of strategies you can employ to manage your debt and save for your future.
2. Don’t be afraid to take risks. When you start saving for retirement immediately, you may want to consider investing in stocks, also known as equities. Although we cannot always predict the future based on the past, stocks historically have outperformed bonds and cash. Stocks are more volatile than bonds and cash, so their performance will zig-zag more in the short term. But because your time horizon is so long, if a stock does go down in value early on, there is time to potentially recoup the loss.
Your lengthy time horizon is something to consider when the news of the day—whether that is the Fed raising rates or the U.K.’s European Union referendum—causes the market to drop. Because you won’t retire for decades, you can take the news in stride. In fact, since 1927, a period inclusive of wars, depressions and recessions, U.S. Large Cap stocks haven’t produced one negative annual return. In fact, the lowest annual return for U.S. Large Cap was 6.63 percent, just before the market crash of 1929. In other words, the odds appear to be in the investor’s favor.
3. Diversify. Within your 401(k) or other retirement plan, you can choose how to invest your savings. When you diversify, or include a wide variety of investments in your portfolio, you typically reduce risk and may even increase returns.
Please remember that past performance is no guarantee of future results and that all investments carry risk, including potential loss of principal. Also, no investment strategy can guarantee a profit or protect against loss.
While a heavy allocation to equities may be appropriate given your long-term time horizon, there’s still room for diversification. Most important is that you consider diversifying across broad equity asset classes. This means that while your portfolio might be heavily allocated to U.S. stocks, consider international and emerging-market equities as well.
Different investments perform well during different periods of time. By putting your retirement dollars in a variety of different types of stocks, you may benefit from the market cycling in and out of various sectors while protecting your portfolio when one sector goes down.
4. Simplify your retirement planning. You can simplify the whole asset allocation decision by choosing a target-date fund, a type of mutual fund that will allocate assets for you between different types of stocks and bonds. The target date is the approximate date when investors plan to start withdrawing their money. These funds are set up for diversification based on when you plan to retire. So, for example, if you plan to retire in 2055, the concept is to pick a fund with that date. Then, as you move closer to retirement, typically the target-date fund is designed to move to a more conservative asset allocation with a lower allocation to stocks and a higher allocation to less volatile assets, such as bonds and cash/cash alternatives.
While target-date funds are designed to appear simple, some are quite complex with many variables that should be considered prior to investing. Target-date funds make the assumption that everyone retiring at the same time should follow the same investing strategy, which in reality may not be true. And, while time horizon is an important consideration, other factors to consider include your risk tolerance, expected life span and your specific retirement and financial planning goals and objectives. One more thing to consider: the principal value of a target-date fund is not guaranteed at any time, including at the target date.
Target-date funds are just one way to simplify, but you may find that you prefer a more individualized approach. If you’re considering a target-date fund, take the time to do research and determine if this one-size-fits all approach is right for you.
Working with a financial professional is another way to simplify your retirement planning. A professional can help you decide what type of asset allocation and diversification is best for your individual situation. Professional assistance also has the benefit of offering an objective perspective that can be useful in retirement planning.
5. Stay disciplined. Many investors lose money from their retirement accounts by chasing “hot” performing sectors. It can be very tempting to abandon your diversified portfolio in favor of sectors that are on a hot performance streak. However, when that bubble bursts, it can leave you with a big loss—maybe less than you initially saved.
Sticking to diversification is part of a disciplined investment process that individual investors would do well to adopt from institutional investors. Institutional investors typically don’t let the movements of the market or their emotions get in the way of their investing decisions. Many individual investors have the tendency to chase hot sectors or bail out of the market when it is going down. Understanding those tendencies can help you stay disciplined and avoid those common investing pitfalls.
Hopefully, these thoughts on retirement will help you as you begin your career. As you progress in your career, you can make an important contribution to your future by increasing your 401(k) plan contribution. Avoid borrowing from those funds and cashing out when you change jobs. Steadily contributing to your retirement plan over time will position you for a financially secure future.
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee WI (NM) (life and disability insurance, annuities and life insurance with long-term care benefits), and its subsidiaries. Northwestern Mutual Wealth Management Company®, Milwaukee, WI (NMWMC) (fiduciary and fee-based financial planning services), subsidiary of NM, federal savings bank. Northwestern Mutual Investment Services, LLC (securities), broker-dealer, registered investment adviser and member FINRA and SIPC.
This material does not constitute investment advice, is not intended as an endorsement of any specific investment or security and is not a prediction of what will happen in the markets.
Costs of target-date funds can vary significantly, and the principal value of target date fund(s) is not guaranteed at any time, including at the target date.
You should carefully consider the investment objectives, risks, expenses and charges of the investment company before you invest. Your Northwestern Mutual Investment Services Registered Representative can provide you with a prospectus that will contain the information noted above and other important information that you should read carefully before you invest or send money.