I’m not a millennial, but a number of my Vanguard colleagues currently fit this demographic. And they often seek counsel from the one with a few flecks of grey in her hair―about work, life, and investing.
When it comes to investing, my message really comes down to “Get your investment priorities straight.” In short, here’s what matters:
- Invest 12‒15% of your income for retirement.
- Create an emergency reserve.
- Balance investing and debt reduction.
Let me elaborate.
Max your retirement savings, and consider using a Roth
If you work for an employer who offers a tax-qualified retirement plan, contribute at least up to the company match. If your employer doesn’t offer a match, then consider the investment options and costs within your plan. You may have more investment flexibility and control by investing in an IRA.
A Roth IRA account can be a millennial’s best financial friend, giving new meaning to BFF. At this stage of your career, your income is likely much lower than it will be later in life, so the relatively small tax deduction you would get from a traditional deductible 401(k)/IRA today is likely to be far outweighed by the benefits of the tax-free withdrawals from a Roth account in the future.
Use a 12‒15% savings rate as your target. Does this number make you cringe? Keep in mind this goal includes both your contributions and your company match. If you’re not there, start small and increase your savings rate 1% every year. For example, if you’re 25 and save 5% in your 401(k) with a 3% match, you’re already at an 8% contribution rate. Set up an auto-increase deferral rate of 1% and by age 30, you’ll be well on your way at a 13% savings rate. And this way, you probably won’t even feel the increase pinch along the way.
The good news is that more millennials are opening IRAs, and at a faster rate than their older counterparts. According to our research, they represent 19% of new accounts today versus 7% in 2006.
Earmark part of your savings for emergency reserves
An emergency reserve is a must. This typically means keeping at least 3‒6 months of living expenses in cash reserves, such as a money market fund. Another alternative is to consider your Roth IRA, which allows you to tap your contributions (but not necessarily any earnings) tax- and penalty-free. While I don’t necessarily advocate this for everyone, realize that a Roth IRA offers flexibility and, while the account should be prioritized for retirement, the options it provides make it an especially attractive vehicle for most young investors. While you build up your cash emergency reserve, you might think of your Roth IRA contributions as a supplement―a backstop against a really big emergency that you’ll hopefully never experience.
Balance investing and paying down debt, focusing first on non-tax-deductible debt
If left unchecked, consumer debt, such as credit card debt, can be a recipe for financial disaster. It usually comes with high interest rates and, in most cases, there are no tax advantages. That said, some debt can be considered a good thing because it provides proof that you’re a good credit risk when you’re looking later to finance big ticket items like your first home. The key is to manage the debt so that you don’t accrue large balances and become strapped with the tyranny of compounded interest.
For millennials, the elephant in the room is mostly likely student loans. You may choose to focus on one goal at a time or “hedge your bets” by balancing savings and debt reduction. See this article for more information. I’m fortunate that I learned the keys to financial independence at an early age from my parents and my mentors. Even though I didn’t make much money at the outset of my career, I participated in my 401(k) and invested in an IRA whenever I could afford to. I jumped at the chance to take advantage of a Roth IRA when it was introduced in 1998. At that time, I converted my small traditional IRA to a Roth IRA. And I still contribute to my Roth IRA.
I share my financial life lessons with my millennial friends every chance I get. Some of them listen to me. And sometimes I hear them sharing their own financial decisions with each other and witness firsthand the confidence this gives them. In fact, many of them now tell me how they’re educating their own millennial friends (and in some cases, their own parents!).
Special thanks to my fellow Gen X colleague, Stephen Weber, for his contributions to this blog.
All investing is subject to risk, including the possible loss of the money you invest.