Although your salary may be relatively small when you are younger, investing in retirement sooner can pay major dividends later in life due to compound interest. The sooner you can start investing in retirement, you should. Even if you have student loans, you should still consider investing towards retirement now.
Note: If you are saving money to buy a house, you may consider waiting to invest in retirement. However, the more you invest towards retirement early, the less that you will need to save each year towards retirement (Financial planners recommend investing between 10-20% of your income each your towards retirement)
Where to invest in retirement
If you have a job, there are two tax-sheltered accounts where you can place your dollars: an IRA or your employer’s retirement plan (for non-profits, these are 403b’s). If your salary is low, then you should consider first investing in a Roth IRA. This retirement account lets you invest $6000 post-tax each year (as of 2019). There are two types of IRAs: tradiational and Roth IRAs. In traditional IRAs, you invest pre-tax dollars, which is useful if you think that your tax rate is greater now than when you retire. With a traditional IRA, you will have to pay taxes on the money when you take it out during retirement. Roth IRAs use post-tax dollars, and is recommended for many young investors. In the account your investments will compound, and when you withdraw the money, you won’t pay taxes on your earnings. This is a great deal for young workers because your tax bracket now is probably quite low, so the overall taxes on your investments will simply be the low taxes you pay now.
When opening a Roth IRA, look for low fees. Two companies with Roth IRA options and low fees are Vanguard and Fidelity. My Roth is with Vanguard. When you open an account, you can link your IRA with your bank account, and make a yearly $6000 contribution online.
If your employer offers a 403b and you want to maximize Roth contributions when you are young, consider opening a CalSTRS Pension 2 Roth 403b. Although the investment options are more typically limited than an IRA and the fees are higher, you can contribute up to $19,000 post tax each year (as of 2019). Just like a Roth IRA, when you withdraw this money during retirement, you don’t have to pay taxes on it. If you work in California, you can research 403b options through this lovely 403b Compare website. If you do decide to open a 403b account, you will need to both follow the instructions on the 403b Compare website linked above and submit a salary modification form to your payroll administrator at your employer. Contact your human resource representative to find this form. It should look something like this.
Note: You can open up both a Roth IRA and Roth 403b to contribute up to $25,000 post-tax each year. Most young teachers don’t earn enough to contribute this amount, especially if you are saving to buy a home. If you can contribute this amount, though, your future self will thank you.
Before you contribute money to your retirement accounts, you will need to know what to invest in.
Investment Strategies When You Are Young
Once you open an IRA or 403b, the number of investment options can be overwhelming: US stocks, international stocks, bonds, money market funds, index funds, etc. Each of which has their own pros and cons. Riskier investments tend to produce higher returns long-term, but can drop dramatically short term (stocks fell 50% during the financial crisis in 2007 and 2008). Of course, you should begin your search with low-cost index funds.
Younger investors should be more aggressive in than older investors. This means take risks. If you are young and the market does drop significantly, you have significant time to recoup that money before retirement. Stock index funds are more risky than bonds.
However, you can minimize risks by diversifying your investments. Rather than just investing in a single company’s stock, spread the risk around by investing in a large number of companies by using low-cost index funds. In addition to investing in stocks, keep a certain amount of your funds in bonds. You can use this tool provided by Vanguard (select your age at the bottom) to figure out roughly what percentage of your funds should go where. If your retirement account has access to them, consider purchasing Vanguard’s Target Retirement Funds. Not only are they quite inexpensive (expense ratios of less than 0.15%), but they come automatically diversified and rebalanced. This is a great fund for investors that have little free time on their hands like me.