The Class of 2015 will usher more than 1.8 million college graduates into the workforce with newly minted bachelor’s degrees. For most of these graduates, getting a job is priority number one. A first job provides a new kind of independence: the ability to move into one’s own space, pay for expenses and budget. It also opens the opportunity to create financial independence for the rest of your life.
If you’re among those who will be entering “the real world,” thinking 40 years ahead may seem like a tall order – but it’s never too early to start planning. Ask yourself these few critical questions to get you on your way to financial freedom in your golden years:
What is my 401k Initial Percentage?
When you sign up for a 401k account, you’ll need to determine the percentage of your compensation to automatically divert from your paycheck into your 401k (or other retirement savings instrument offered to you.) This number should be set prior to making decisions about two other big expense categories: housing and transportation. Too often, people make this decision backwards and feel they don’t have enough money left over to invest in the future. But there’s a big advantage to start investing in your 20s: compound interest. If your employer offers a ‘match’, put aside at least the maximum percentage the company will match. If there is no matching, begin with a minimum of 3 – 6%.
What is my 401k Goal Percentage?
Now is a good time to also set the Goal Percentage to eventually divert to your 401k. Financial experts such as Dave Ramsey suggest you invest 15% of your compensation. Other financial experts suggest numbers from 10 – 15%. Too often, people sign up for a 401k with a flurry of new-hire documents with little thought and no strategy. Years later, they look at their balance and wish they had been bolder. Having a predetermined goal for your eventual percentage is smart – be sure to review and revise your withholding annually.
Am I willing to keep my lifestyle flat until I reach my Goal Percentage?
The most efficient way to achieve your goal percentage is to apply ALL annual pay raises to your 401k at the early moments of your career. After that, 15% of every raise should be diverted from your paycheck.
The biggest decision is to start and have a plan. Let’s take a look at the math – you will see the massive advantage of time when growing your future nest egg.
As an example, I’ve picked a state school from the salary report at PayScale.com that will project average early career salary and mid-career salary (age 42.) I am using Ohio University in Athens, Ohio, but you can pick any college.
- Early career salary: $43,600
- Mid career salary: $77,000
- Begin with your Initial-Percentage of 6% into your 401k (in this example your employer does not match)
- Set your Goal Percentage at 15%
- The 401k is in equities and yield (on average), a conservative 7.5% return
- If you apply 100% of your 2.88% annual raise, you will be at your 15% goal in 4 years
At 65, you will have just over $2.9 million dollars in your account!
Once at retirement age:
- Ratchet down the risk of your portfolio to a 5% annual return during your golden years (less volatility)
- Withdraw 4.5% annually
- At retirement you are making more money (nearly 20%) than your last year of working
- As you pay yourself, your investment portfolio grows annually
Yeah, I know what you’re thinking: “I just graduated and now you’re asking me to think about retirement?” Remember, a bit of strategy and early sacrifice assures that your golden years will truly be golden. You now have enough discretionary time and discretionary money to follow your heart’s desire. So have fun and be good with your money!
Alan J. McMillan is the founder of LearnEarnRetire, an organization that coaches 18-24 year olds by assisting them in the transitions from Campus to Career to Financial Independence over time. He speaks annually to thousands of students at campuses like MIT, Howard, Syracuse, Spelman, Ohio State and Virginia Tech. He also sits on the faculty at Ohio University in Athens, Ohio.