Between 401(k)s, compound interest and ETFs, there’s enough investing jargon to make your head spin. Can young professionals with fixed budgets be savvy investors? Absolutely.
Here’s one of the investment world’s best-kept secrets: You don’t need that much money to start. The earlier you start investing, the longer your money has to grow by the time you retire. To set yourself up for a strong financial future, here’s what you need to know about investing — and why you should start now.
Student loans. Credit card debt. Rent and groceries. You might feel like your financial plate is plenty full.
Consider this: The earlier you start investing for retirement, the larger returns you’ll see over time. Thanks to compound interest, a 25-year-old who consistently contributes to her retirement will be well ahead of someone who doesn’t start saving until age 35.
Let’s say you put 3% of your $30,000 salary a year in your 401(k). Your employer matches 3%. The returns will vary depending on the mix of investments, but for example, consider a 10% return.
- Year 1: 6% of your salary = $1,800
- Year 2: $1,800 + 10% return + additional 6% of your salary = $3,780
- Year 3: $3,780 + 10% return + additional 6% of your salary = $6,158
That’s only after three years, not considering pay increases. As you begin to earn more, you could also increase the percentage you contribute, leading to even greater returns.
Types of retirement accounts
These are the most common retirement accounts available to early-career professionals.
A 401(k) is a retirement savings plan sponsored by your employer. Some employers also offer a 401(k) match: If employees contribute to their retirement funds, the employer will also put in a certain amount. If your employer offers this perk, take advantage of it. 401(k) matching policies vary by company, so speak with your HR department to understand how yours works. Aim to contribute the maximum amount that qualifies for your employer match—if your employer matches up to 4%, put in at least 4%.
Individual Retirement Accounts (IRAs)
IRAs are an option if you don’t have employer-sponsored retirement accounts.
Contributions to a Traditional IRA maybe tax-deductible, meaning you can deduct the amount you put in during the course of the year from your taxes. If you withdraw funds before you retire, you’ll have to pay penalties. The maximum amount people 50 and younger can contribute to a Traditional IRA in 2018 is $5,500.
A Roth IRA is a post-retirement account, meaning you will not receive any tax benefits from your contributions.However, you maybe able to withdraw contributions without paying a penalty, if the fund were held for five years. For 2018, Roth IRAs also have a $5,500 limit for people under age 50.
Types of investments
Investing can be risky, but all investments are not created equal. This is why most financial advisors recommend people building up their retirement savings. These can include (but not limited) mutual funds and ETF's.
- Mutual Funds: A professionally managed investment portfolio. Instead of having to pick the investments yourself, you invest in a portfolio of stocks, bonds and securities. The mix of investments is selected by professional investors.
- Target-Date Funds: A type of mutual fund that is a combination of stocks and bonds that are selected based on your anticipated retirement age. The mix of funds will likely be slightly riskier when you’re young because you have more time to bounce back if the market dips. As you get older, TDFs alter the mix of funds to reduce their risk.
- Exchange-Traded Funds: Exchange-traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange.
Consider meeting with a financial advisor or investment advisor to better understand your options and which investments might be the best fit.
Investing do’s and don’ts
Putting money into lower-risk investments is not a get rich quick scheme—your money will grow over time.
The stock market goes through peaks and valleys, so if the market dips, stay calm. While you might feel compelled to pull your money out during a dip, most financial advisors recommend against this. Inevitably, the market will rise again.
Set up automatic contributions to your retirement account from your paycheck. If you have to manually transfer money over, you might forget.
Ramp up as your income grows. Every time you get a 3% raise, bump up your retirement contribution by 1%.
Brush up on your investing knowledge. It takes time to wrap your head around investing. Meet with a professional financial advisor and sign up for the Fifth Third newsletter to guide guidance on meeting your financial goals.
Investing involves risk, including the possible loss of principal invested.
This information is intended for educational purposes only and does not constitute the rendering of investment advice or specific recommendations on investment activities and trading