When you think about your 20s, it is common to think about getting a career off the ground, figuring out a city that you want to live in, or potentially finding a partner to spend your life with. Personal finances can be an after-thought beyond getting bills paid and digging out from under student loans.
However, I have sensed there is a growing understanding and appreciation for the power of the time value of money driving compound interest. There seems to be a greater awareness among people in their twenties that time in the market is the greatest asset of all.
This time in the market is more valuable for long-term goals, like retirement, but retirement is far from the only financial goal for many young professionals. Other common goals include paying off student debt, replacing an old car that has been driven since high school, saving for an engagement ring and wedding, and purchasing a first home.
Like retirement, these goals aren’t cheap, either! In fact, the current landscape is rather daunting. Student loan debt has grown to an average of over $30,000 following a 4-year degree, the average brand-new car now costs $48,000, national home affordability is hovering near all-time low levels, and I can tell you first hand that a wedding in Northern Virginia is not the cheapest expense I just listed.
Any savings directed towards these other goals ultimately reduces a young investor’s time value because these other goals are shorter-term goals. Said another way, the opportunity cost of not investing for retirement is huge. But again, retirement is not the only financial goal.
So, how do you navigate your 20s financially?
In other words, how much do you save? How do you balance saving for retirement and intermediate goals? Which investment accounts will serve to achieve those goals? These are the questions we can help you answer. As you approach this complex equation with very large implications, you must remember - Contrary to what Instagram influencers might have you believe, in your twenties, your savings rate is more important than your investment returns. Here’s why.
Consider somebody one year removed from college with $10,000 invested in an account. If the balance was invested entirely in diversified equity investments and global equity markets had a banner year returning 20%, then the investor just earned $2,000. That will not move the needle much. On the other hand, saving 20% of an $80,000 salary, or $16,000, will be impactful and allow the account to reach higher levels where market returns are also more impactful. A higher account balance does not mean you should let your foot off the gas with your savings rate. As generally illustrated below, savings is fuel to the fire in regards to compound interest (this return rate is used purely for illustration and does not reflect a specific investment strategy).
How should you allocate your savings in your twenties?
Resources online will commonly proclaim that before you put even a single dollar away for intermediate goals (car, wedding, home), you must max-out your employee retirement account, and fully fund an IRA and Health Savings Account. To keep things simple, if a 20-something year old made $100,000, then following online advice involves saving $32,850 before saving and investing $1 in a taxable account for liquidity and intermediate goals! A 33% savings rate is certainly something to strive for but is often unrealistic in today’s world with higher levels of student debt and rising prices - currently, the average savings rate among the general population is 5%. And, keep in mind, liquidity is critical no matter how old you are and there are penalties associated with withdrawing early from the three accounts above. [Translation—you don’t want every dollar wrapped up in an investment vehicle that penalizes you for removing funds. You’ll need emergency cash on hand.]
Ultimately, there needs to be a balance between saving for intermediate goals and long-term goals like retirement. Target a healthy savings percentage and divide across goals. As income grows, maintaining the same healthy savings rate will enable more dollars invested across your goals. In this process, absolutely prioritize achieving a matching contribution in a retirement plan or health savings account with your employer. Also, ensure you have enough cash on hand for an emergency. Finding this balance is challenging, but beginning a financial plan early will lay out the achievable stepping stones to get you from today to your intermediate financial goals while still taking enough advantage of the time us 20-something year olds have for the longer-term financial goals.