It is the season for college graduations. Many are planning parties and wondering what they can give as the perfect graduation gift. Excitement permeates the air as invitations are sent, photos are taken, and job offers are accepted. However, we cannot ignore the fact that as our young adults enter their careers, our greatest gift should be to talk to them about saving early for retirement and the importance of preparing for financial emergencies.
I am sure that many of us can agree that if someone had shared with us about investing early for retirement as we entered the job market, our financial picture would be much rosier. The principle of compound interest is not taught in most classrooms. I consider it to be the Eighth Wonder of the World. Let us assume your graduate is 22 years old and begins saving $200.00 per month at 8% interest compounded annually for 45 years, it would grow to $933,977.57 by the age of 67. Look at what happens if your graduate waits 10 years and begins at age 32 saving $200.00 per month at 8% interest compounded annually for 35 years, it would compound to only $416,517.40 by age 67. That is a difference of over $500,000 in a short 10 years!! Imagine that!! This is the reason why we should encourage our graduates to start investing early for retirement.
Compound interest is magical because it is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest. Have your graduate to experiment with different amounts of savings and interest rates using the compound interest calculator at www.investor.gov.
I know that talking about money is not easy for some, but it is a conversation that we should have with our graduates. How do we start the conversation? Let’s begin the conversation immediately after graduation day with the following game changers:
- Explain to your Graduate(s) that once they start a job, their employer may offer an account called a 401(k) or other similar accounts known as a 403(b), 457, Thrift Savings Plan (TSP) depending on the type of organization that they work for. They are to enroll as soon as they qualify and deposit pre-tax dollars through a payroll deduction (direct deposit). Their employers may even provide matching contributions, so they should contribute at the least the minimum amount equal to the match. For example, if the employer matches six percent (6%), then they should save six percent of their paycheck. This is free additional money that would add to their bottom line.
The benefits of starting early are the years of compound interest growth and having the ability to bounce back from any market downturns. The good news is that the contributions could reduce taxable income and will grow tax deferred until retirement.
- Talk with our Graduates about an individual retirement account (IRA) and encourage them to open a Roth IRA after they meet their employer’s match or if their employer does not offer a retirement plan. The deadline to contribute to an IRA account is the same as the last day to file an income tax return in the following year. The smart money move is that your graduate can open a ROTH IRA account in 2021 as soon as they are employed and begin making contributions with after-tax dollars until the tax deadline date in the year 2022. They will watch their interest grow tax-free for life. Yes, a Roth IRA account balance can grow to hundreds of thousands of dollars, even millions, and every cent would be tax free to its owner!! Who does not LOVE tax-free money??
- Prepare them to save for emergencies, unexpected expenses. We all have seen the devastation of the 2020 Pandemic and the financial destruction that it has caused millions of individuals. Some of these people had plans in place, but they did not have layers of financial resiliency through what is known as an Emergency Fund. Savings and retirement accounts were both depleted for the lack of an emergency account. Financial emergencies will happen, and preparation is the key for survival. That preparation begins with a savings account solely for what I call “suddenly”: job loss, medical crisis, car repair, etc. These things usually happen suddenly. If you do not believe me, think of the last time that you had an emergency. Did it come with a warning?
Some experts suggest saving three to six months’ worth of expenses. Today’s economic environment has shown that it should be at least 9-12 months of your expenses. If this seems too difficult, set a savings goal you think will meet your urgent needs. When you reach that goal, aim higher. A smart money move is to open an emergency account with an online bank with a higher interest yield than having your account at a local bank or credit union earning minimal interest. My emergency account is currently 16 months of my expenses. It took me a few years to get there but I saved consistently whatever amount I could from every paycheck in a high yield online account that consisted of Certificates of Deposit and cash.
- Help your graduates begin their career with a written budget to understand their cash flow. It is the only way that they will know how to manage their expenses and minimize the usage of debt. A budget is your graduate’s spending plan that would enable them to set and meet their financial goals.
I understand that talking about money can be difficult and graduation time may not be considered the best moment to begin the discussion. Let us think about it for a moment. There is never a good time to talk about money but what better gift may someone give their Graduate than preparing them to know how money works and how to make their money work for them. Money is the only thing that we have that can work 365, 24/7. Therefore, teach your graduate how to make their money work harder for them than they work for it.
Finally, an important smart money move is that you and your graduate talk with a financial professional to understand the underlying securities in their retirement accounts and how to determine the proper allocation for the greatest return during your working years. Putting all your eggs in one basket can be a risky way to invest or not putting your money in the right basket can diminish your rate of return. Feel free to contact CAN Financial Services, LLC for a complimentary review of your retirement plan by scheduling an appointment at www.canfinancial.biz or call 832-496-0886. We would love to assist you!