I recently received a delightful letter from a college student who wanted my advice about investing for retirement. I say delightful because I simply don’t get many money management for college students requests, especially about retirement planning.
In formulating my response, I made a couple of assumptions:
1. He either has debt (college or car) or needs his income to avoid such debt.
2. He does not have an emergency fund in place.
Read on for his letter and my response.
Letter from Chris
Hi,
My name is Chris _____________. I am getting in touch because I have read a couple of your articles and I thought it would be a good idea to see if you would be able to offer me any financial advice. I am currently 21 and will be entering my fourth year in college. However I transferred into the program that I am in so I still have about two more years to complete. I have been talking with my mother about what I can be doing now to start saving money for retirement. I recently had the opportunity to invest in a 401k with my work, however it is only a part time job and I don’t know how much longer I will be here. I was also thinking about investing in an IRA. It is difficult because I don’t know what I want to do after I graduate or where I want to be geographically. If possible I would greatly appreciate it if you could give me any information or help. Thank You.
My Reply
Dear Chris,
I am very excited to hear from a college student who is thinking about how to invest for retirement. You are a rarity in today’s world! You may be surprised at my answer, but I would rather see you save your money right now instead of investing for retirement. The reason is simple: you will probably need the money, and if you have it tied up in retirement investments, you may be forced to borrow money for such things as:
· Making it through college.
· Buying or repairing a car.
· Paying for a place to live while you are looking for work after college.
Avoiding debt and paying cash as you go is a lifetime habit that will serve you well for years to come. It wouldn’t make sense today to be borrowing money while investing for retirement…sort of like taking out a loan so you can invest…not smart.
Once you finish college and get situated, I recommend paying off any outstanding debt and building up a good emergency fund before investing for retirement. You will be more relaxed, and, with no debt, you will have a lot more money to invest at that time.
Once you start investing for retirement, I like taking advantage of your 401k up to the point your employer matches. If he matches 3%, for example, I would invest 3% in order to get that “free money”. Investments above that 3% should be in Roth IRAs. You will have to pay your taxes on those investments now, but all growth in the Roth IRA is tax free. That is a good thing when you get ready to retire! Your goal should be to invest 15% of your income for retirement. If you do that, you will be fine.
If you want some good reading, you can go to my blog and read my posts on Dave Ramsey’s 7 Baby Steps. They will explain in more detail exactly when and why you do what you should with your finances. There are 7 articles in the series; the first is Dave Ramsey’s Baby Step 1: Baby Emergency Fund and there is a link at the end of each to the next in the series.
You may also want to read Dave Ramsey’s book, “The Total Money Makeover”. It is the best selling book on personal finance on the market, and a great read. In fact, I would be glad to give you a copy if you promise to read it. Just let me know.
Again, I am very impressed to hear from you. Please write back with any Roth IRA questions — or any other questions you have about my response…and about getting a free copy of The Total Money Makeover.
If you keep asking these great questions, you are going to do well in life.
Joe Plemon
Like I said, this was a delightful letter. It made my day and once again affirmed that at least some of our current generation is thinking about the future. I wish I could be around when Chris is ready to retire…my guess is that he will be well prepared.
Readers: What did you think of my advice? What would you have said differently? How old were you when you first started thinking about your own retirement?
Hello Joeplemon,
I am completely agreed whatever you have advised to that student,i don’t want to manipulate your thoughts and experiences at all…your every phrase is very much valuable and meaningful and even easy to understand also.I have liked your this post very much.I know few college students who are searching for some retirement plans,i think i should refer them to your blog,so they can learn something better for their future.
THANK YOU and GOD BLESS
It is a good letter and a well thought out response. Hopefully Chris will head your advice but will begin investing toward retirement soon after graduating from college. I would love to hear how this all turns out. Maybe he will read this post and update us in a few years.
It my seems convoluted, but I’d suggest he put what he can into a Roth IRA.
The rules allow penalty-free withdrawal of deposits, so for someone who can’t fund both a decent emergency fund and retirement account, this can serve dual purpose for a time. It also has the ‘locked away’ feel that discourages tapping it for routine expenses while a regular emergency account might not.
I think you can never start saving for retirement too early. You never know when your situation might change and if you might want to retire earlier which will require more money.
I am keen to see how this story finishes. Like Cashflowmantra said, I hope he heeds the advice.
@cashflow,
I too would like to see how it turns out. I received Chris’ permission to use his letter, and I have tipped him off that his letter is featured in today’s post. I think he will heed the advice.
@JoeTaxpayer,
Although I don’t use my Roth as an emergency fund — yet :), I wouldn’t quibble with those who do. Your point makes sense for those who aren’t in a position to fully fund their emergency fund before beginning their retirement investing.
@Miss T,
Theoretically, one should start retirement investing ASAP, but practically speaking, I don’t think one should accumulate debt while, or because of, retirement investing. This is why I advise Chris to delay… he probably will have other expenses during his college years that need to be met before he is in a position to start investing. At that time, he can hit it hard.
In an ideal world, everyone should begin investing or saving for retirement as early as possible. The real advantage to starting early is you have more time for growth. The bottom line is start early no matter how small a start.
Great advice in general Joe. BUT if this person is responsible (it sounds like he is), I would def. encourage him to open an IRA. His income will never be as low as it is now. And he might not need all the money. If he needs it, he can always withdraw the principal from the ROTH IRA as easy as a savings account. And if he doesn’t need it, it is there for his golden years. Just an option…
I think your advice is great, cordial and convincing. It is definitely right that everyone should begin investing or saving for retirement as early as possible but the premise is NO DEBT and enough emergency money.
@krantcents,
Agreed that the earlier you start, the bigger the nest egg will grow to. I want Chris to start as early as he can as long as he can avoid debt.
@Suba,
I like your logic and will pass it along to Chris. I admit I hadn’t considered taking advantage of the Roth flexibility. However, this is an option he should use only if he can do so while remaining debt free.
@Amenda,
You said it better than I did! I am not backing off my “no debt” premise, but, after reading some of these comments, I would have little issue for Chris to build his emergency fund and Roth simultaneously.
@Maegan,
Agreed. Part of my “no debt” advice was to help Chris develop a “no debt” mindset, which will serve him well for his entire life. Conversely, creating debt while investing for retirement could be a recipe for a lifetime of debt.
At first, I was thinking he should go ahead and invest for retirement since he was already thinking ahead.
But your advice about paying off debts and staying out of debt first makes more sense.
Then he’d be on a clean financial slate, and can begin investing with gusto.
@Darren,
I am glad my advice makes sense, and I really like the phrase “begin investing with gusto”. 🙂
It seems there is always an ongoing debate on whether you should start saving before you get out of debt, or pay off your debt before you start saving. Honestly, I think it’s okay to mix the two. I started thinking about retirement the first time I was offered a 401k by my employer, when I was about Chris’s age. I think a lot of younger people start considering retirement when they are provided with that sort of opportunity. You offered some excellent advice, and I especially like that you make mention of emergency funds – so important! However, paying off student debt can take as long as 20 years, or more, and I really don’t think anyone should wait that long to begin saving for retirement. How much of a loan should someone pay off before starting a retirement fund?
@Penny Pincher,
You ask a great question: “How much of a loan should someone pay off before starting a retirement fund?”
Of course, my advice to Chris was an effort to get him to avoid school loans altogether (and subsequent conversations have given me good reason to believe he will). I suppose, as you say, that some student loans may take 20 years to pay off, but wouldn’t that be if they make minimum payments? I am such an anti-debt guy that I would like to see that debt tackled by working and extra job (or two). Maybe 20 years of payments could be paid off in two years if one gets focused enough. If that could be accomplished, I would first get the student loan debt out of my life forever and then invest with gusto (see Darren’s comment) for retirement.
I might, however, soften my stance a bit if offered a match on a 401k. Investing just enough to get the full match (while still attacking the debt with a vengeance) isn’t a bad idea.
I think that i have to agree with you. I also think that before you go for retirement, you must be financially stable enough so that you won’t worry about your future. Pay your debts and make sure that you have emergency funds.
It is good to see a student looking so far ahead. I think your advice is appropriate given his current situation. It is very difficult to plan so far ahead before you even know for sure what career you will have and what sort of earning potential you will have.
Joe,
As a naive, inexperienced, and poor recent college grad, I would have to respectfully disagree with some of your advice in your original post. I think it better to save for retirement while going through college with all of its expenses. I hold to this because of the IRS’s limit of $5,000 per year in the IRA. When you are older and have more money, you can’t just pump tons of money into an IRA because of this limit. Starting early also gives you the benefit of being in the market over a longer period of time and you take advantage of compounding interest. Check out this link:
http://www.mindyourfinances.com/money-management/savings/081104-04
Granted, you should definitely not tap out your cash to invest in an IRA that is not liquid at all. This should all be done assuming you have at least some moderate cash reserves.
Also, if you send money to pay off a student loan at 5% interest instead of sending it to an investment at 7.5% interest (the market since 1920 has averaged around 9.5% annually), you are both losing out on that 2.5% and you are losing out on any compounding interest.
@Ben,
You are another of these delightful young men. I congratulate you for thinking about retirement at such a young age, and taking the time to put those thoughts into writing.
My hunch is that, with your mindset, you will do fine. However, I stick with my advice to Chris, which is more about lifestyle than math. Because I want him to develop a lifetime of avoiding debt, working his way through college without accumulating any debt will set a foundation to continue to do so throughout his life. Yes, he could borrow money to get through college and begin his retirement investing now. But borrowing money creates, for many, an “easy access” to money which is then spent with little frugality. Working his way through college will teach Chris to watch every penny.
I don’t like the concept of leveraging…borrowing money in order to invest, as you recommend. As I said, borrowed money comes too easy and can bring about poor money management. That factor varies from individual to individual, but is a very real, and often overlooked, one. Also, risk must be figured into this equation as well.
You are absolutely right that the earlier one can start investing, the more years one has for those investments to work. Starting early is very, very important. However, even if Chris doesn’t get started until age 25, and invests 15% (as I recommended), and only earns $48,000 annually for 40 years, without ever getting a pay raise, he will still have $3.2 Million at retirement (at 9.5% return) while staying out of debt his entire life. I like that plan.