When it comes to investing, my message to Millennials is simple: get your investment priorities straight.
My parents told me that when I started investing, and it’s served me well. Even though the markets and economy were quite different 25 years ago when I started my career, the message is enduring.
Here are my three top tips:
1. Set a target of 12% to 15% of your monthly income toward retirement, preferably in a Roth account
Does a 12% to 15% savings rate target make you cringe? It might sound like a lot, but this goal includes both your contributions and your company match. I get it. 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, building up to that 12-15% target.
Start with your tax-qualified retirement plan. Many employers offer them. Contribute at least up to the company match. If your employer doesn’t offer a match, then weigh the investment options and cost within your plan. You may have more investment flexibility and control by investing outside of your workplace plan in an Individual Retirement Account (IRA).
A Roth IRA 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 get from your traditional 401(k) plan or IRA contributions are far outweighed by the tax-free Roth growth.
Personally, I jumped at the chance to take advantage of a Roth in 1998. At that time, I converted my small traditional IRA to a Roth IRA. And I still contribute to my Roth IRA today.
If you’re 25 and save 5% in your 401(k) with a 3% company 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 you probably won’t feel pinched along the way.
2. Create an emergency reserve. An emergency rainy day fund is a must, typically keeping at least 3 to 6 months of living expenses in cash reserves. Consider an interest-bearing checking account or a money market fund.
This is a safety net in the event of an unexpected expense or job loss.
Another alternative is to consider your Roth IRA, which enables you to tap your contributions tax- and penalty-free to meet an emergency. I don’t necessarily advocate this for everyone (I believe a Roth IRA should be prioritized for retirement), but the account’s flexibility makes it an especially attractive vehicle for most young investors.
3. Balance investing and reducing debt. Consumer debt, such as your credit card balance, can be a recipe for financial disaster. Unpaid credit card bills usually come with high interest rates and, in most cases, there are no tax advantages.
That said, some debt can be considered a good thing, as it provides proof that you’ve a good credit rating later when you’re looking 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 most likely student loans. You may choose to focus on one goal at a time, or better yet, “hedge your bets” by balancing savings and debt reduction. Pay down debt with the largest interest rates first. As with much in life, investing comes down to balance and discipline.
Maria Bruno is a senior investment analyst in Vanguard’s Investment Counseling & Research Group.
