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Don’t procrastinate: Investing in your 20s

No matter one’s age, people can have trouble motivating to save for retirement. The most common mistakes that investors make often depend on their life stage and they frequently relate to human behavior. Simply put, certain behaviors can impede good choices, and our human tendencies can derail even the best intentions. That makes it vital for all investors to try to understand the human mind when it comes to retirement readiness.  

 

The Person:

She is a millennial, recently out of college, in her mid-20s and working her first—and not particularly well-paying—job.  

 

The Behavior:

When there are fun things to buy and college loans to pay off, it’s only natural to want to put off saving. But spending a little money on the occasional extravagance and saving for retirement do not have to be mutually exclusive.

 

The Expert Advice:

Those prone to procrastination should take note: Thanks to the exponential growth of compound interest, saving in the early years can make a huge difference in the long run, and can potentially add thousands of dollars of annual income in retirement.  

“The hardest thing for people when they first start saving is that they don’t see results right away,” says Ben Carlson, Director of Institutional Management at Ritholtz Wealth Management, author of the book A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan and founder of the website A Wealth of Common Sense.

Earn 10 percent on $1,000, Carlson notes, and you have an extra $100—not a life-altering amount of money. Or is it? “The usual line people use is, ‘I’ll just wait to save until I’m ready later,’ but you can save a much smaller amount if you start earlier and let it build on itself,” he says. Like a snowball that gets larger and faster as it rolls downhill, the real gains come as compound interest builds momentum. Or, as Carlson puts it, “It stacks up over time, but it does take time.”  

Over a decades-long time horizon, the results are powerful. While future performance can never be guaranteed, historic data bears this out. Since 1926, the S&P 5001 has been in positive territory over the course of every 20-year span. And even in its worst 30-year stretch (1955-1984), its annualized return came out to 7.8 percent. But thanks to compound interest, that initial investment would have grown by just shy of 240 percent after inflation.  

 

The Data:

The results are so powerful that an early investor who saves for 10 years can actually out-earn someone who saves for four times as long. How? It all depends on when the savings occur.  

Consider the example of a person who invests $5,000 a year from age 21 through 30, and never saves again. Her friend saves nothing in his early years, but invests $5,000 a year from age 31 through 70. Both earn 8 percent annual returns. Believe it or not, the early saver will have 22 percent more money when she retires at age 70 than her procrastinating friend.  

Source: Bloomberg Data.

The Change:

Clearly, failing to begin immediately saving for retirement can result in a drastic negative output over a lifetime of employment. To combat this at an age when assets are lacking, young investors should learn to view the one thing they have in excess—time—as a tangible asset that they can leverage.  

“When you’re young, you have little financial capital, but you have huge human capital, and that is your biggest advantage,” says Carlson, who notes that this time horizon allows 20-somethings to withstand even the most bearish markets. “They have the time to ride those out because they have future earnings power, which is a huge advantage.”  

One surefire way to put savings to good use—no matter how humble the amount—is through target date funds (TDFs) for retirement. This naturally gives investors a level of diversification, as such a fund will slowly change the allocation mix as an investor’s life stages change. Basically, it’s all about having the discipline to continue to save a little bit of your paycheck.  

Because of the Pension Protection Act of 2006 (PPA), TDFs are now a qualified default investment alternative (QDIA) for any plan participants being automatically enrolled into defined contribution plans like 401(k)s—something that Carlson sees as a key to putting younger investors on the right financial track. “You try to help people make good decisions ahead of time, and then automate those decisions,” he explains. “That’s what target date funds do.”

 

Footnote

1The S&P 500 Index is an unmanaged index of 500 stocks of large U.S. companies. It provides a broad indicator of stock price movements.
 
 

 

Prudential's suite of target date funds was designed to help offset today's longer retirements and counteract behaviors that keep us from making good choices. Learn how Prudential's Day One® Funds can help participants get more retirement ready at DayOneFunds.comopens in a new window.

RISKS: Investing involves risk. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost, and it is possible to lose money. Past performance does not guarantee future results. Asset allocation and diversification do not assure a profit or protect against loss in declining markets.

The target date is the approximate date when investors plan to retire and may begin withdrawing their money. The asset allocation of the target date funds will become more conservative as the target date approaches by lessening the equity exposure and increasing the exposure in fixed income type investments. The principal value of an investment in a target date fund is not guaranteed at any time, including the target date. There is no guarantee that the fund will provide adequate retirement income. A target date fund should not be selected based solely on age or retirement date. Participants should carefully consider the investment objectives, risks, charges, and expenses of any fund before investing. Funds are not guaranteed investments, and the stated asset allocation may be subject to change. It is possible to lose money by investing in securities, including losses near and following retirement.

© 2016 Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions worldwide.    

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