The first few years in the workforce are a time when many young adults are still trying to find their footing. Even if you're fortunate enough to be gainfully employed, the cost of living on your own — and perhaps paying back student loans — can feel a bit daunting.
But knowing how to save money in college and at the start of your career can have a positive impact on your future finances.
So, how much money should you have saved by 25? While the answer depends on your exact circumstances, anything you put away now can help make it substantially easier to weather unforeseen setbacks and reach your goals later in life. Here's what to know about saving for the future, both near and far.
Why Saving Matters
At minimum, adults are generally advised to have enough money to cover three to six months' worth of living expenses. That includes everything from rent and utilities to car payments and grocery bills. An emergency fund calculator can help you figure out what you need to set aside, either as a lump sum or through monthly savings, in order to hit your target.
If at all possible, your early 20s are also a great time to start growing your retirement fund. A typical American will need to replace 80% of their pre-retirement income when they leave the workforce. In most cases, Social Security only replaces a portion of that amount, making it imperative to build a retirement fund of your own.
The Time Value of Money
Because of the compounded nature of investment returns — that is, earnings from one year that are reinvested have the potential to generate additional earnings in the next — each dollar invested now is likely to be worth more than those invested later in your career. This effect, known as the "time value of money," means even small contributions to an employer's 401(k) plan or other investment vehicle can make a big difference by the time you reach retirement age.
And the earlier you start saving, the smaller the percentage of income you may need to put into an investment account in order to reach your retirement goal. The impact of creating a "head start" is evident when running several scenarios through the Western & Southern retirement calculator.
For example: A single 25-year-old who earns $40,000 a year and already has $10,000 socked away will only need to save 9% each year in order to replace 85% of his or her pre-retirement income by age 65. But if that same individual is just getting started on their savings journey at age 25, they'll need a target savings rate of 10.5% to reach that same long-term goal (assuming an 8% rate of return prior to retirement and a 5% return thereafter, as well as income from Social Security).
5 Ways to Get off to a Good Start
Even putting aside a modest amount may seem like a big hurdle when you're young and not yet bringing in a hefty paycheck. Here are five ways you can make room for your savings:
- Learn how to save money in college. Because of compound earnings, even putting away small amounts early on can help make a big difference. So, if you're working a part-time job at school, consider putting as much as you can in a brokerage account or a tax-efficient IRA (though your parents will need to open a custodial account if you're still a minor).
- Stick to a budget. Saving can be much easier when you learn to limit your discretionary spending. One way to do that is by loading a fixed amount each month onto a debit card that you use exclusively for non-essential outlays such as eating out. You can also download one of the many budgeting apps available to help prevent overspending.
- Use tax-friendly investments. Each dollar you invest goes a lot further when it's placed in a tax-advantaged vehicle such as an IRA or employer-sponsored 401(k). These accounts allow you to make tax-deductible contributions in exchange for paying your ordinary income tax rate on withdrawals in retirement. Roth IRA accounts are also popular among younger workers; the difference is that contributions are made after tax and withdrawals made during retirement are typically tax-free as long as specific requirements are met. For those in a lower tax bracket, paying the IRS now allows you to maximize your tax break as a retiree.
- Take advantage of your employer's match. Many employers offer a match on funds that employees contribute to their retirement plan. Whether it's 25 percent of what you kick in, up to a certain limit, or a full dollar-for-dollar match, it all helps get you closer to your goal. Those dollars can help your investment account grow at a faster rate. If you're not putting in enough to maximize those matching funds, it's like leaving money on the table.
- Team up with a pro. Developing good money habits now makes it easier to reach your financial milestones later on in life. That's why meeting with a financial representative as a young adult can make a big difference. A professional can provide an unbiased look at your financial patterns and educate you on the financial products and strategies that best fit your needs.