As members of Generation Y, we have watched everyone older than us lose their shirt on their personal home and in the stock market. Yet, when we go to the bank and sit down with the investment banker, they tell us to save our money, buy a home, and invest in stocks though an IRA and 401(k). This doesn’t make sense to our generation and we ultimately sit there and scratch our heads.
Then, we ask the question: “Why?”
That is when we get a long-winded answer that begins with — “Well, based on historical calculations …” or “If you will please refer to my chart that shows a 10% return …”
So, if you’re like me you been left feeling frustrated and lost. Even sitting down at the computer and doing the Google search leaves you feeling empty. Google “investment vehicles” and see how many articles tell you about the wonders of a 401(k). Just in case you’re not sure, let’s talk numbers. Let’s figure a 5% return for this. How much money do we need to have saved by the time we are 65 years old? The answer: $1,000,000 in cash will get us $50,000 a year and $2,000,000 will get us $100,000 a year. With most of us starting out in life at or around $50,000, does that seem like a lot? Can we live in a nice home and in a nice neighborhood? For that matter, can you live how you live now? This is without throwing in the inflation that lurks in the corner.
With that being said, what happens if you have $2,000,000 saved and the market brings in 1% like it is doing to our parents? Your $200,000 goes to $20,000 and that is what happened to the Baby Boomers. That’s a good amount of savings, but they bet on a return that wasn’t guaranteed. How would you feel if you worked for 40 years to wake up making less than you did when you were 20? Go ask your parents. I am sure they can tell you just how it feels. The reality is, for most of them, they even had that old thing called a pension. True, it isn’t as big as their parents was, but it is still more guaranteed than the market’s and bank’s returns.
Now that you see the problem, let’s talk about savings. As you know, its hard to start really saving until you paid off all of your debt. Let’s assume you’ve done that and your 25 years old. If you save $20,000 a year for 40 years that means you are putting away $1,667 per month for 40 years. Assuming a 5% return, at the end of 40 years you will have $2,543,875.60 to your name. What happens if you do the same thing and the rate of return is 1%? You will have $983,349.07. That is the difference between living nicely and having to keep working. That is the reality of interest. Our parents knew all about that and they believed 5% to be a low amount and were willing to bet on it. The question is — are we?
Remember that the above all assumes you save for 40 years and save the amount listed. What if you save less or start late? The numbers go down. Of course, if you can save more and start early you are going to be in better shape. Just remember at some point you have to buy a house, have kids, pay off loans, and the list continues.
Whether you have started or not, here are some of the investment vehicles available to you:
401(k). Hopefully, your employer matches up to the amount that you invest. This money is invested for you in the market and over time it will grow. This plan allows you to take pre-tax money and place it in your savings. This is good because you can defer your taxes.
403(b). These are plans for public employees that are meant to mimic 401(k) plans. Typically, the employer (who is the state) does not match.
IRA. These are accounts set up by yourself at a bank. They take money directly from your paycheck either post- or pre-tax depending on your decision. Traditionally, you will choose for it to be a percentage of your pay. Thus, with pay raises, your contribution will increase without you having to notice. Everything that you earn on these accounts will be untaxed until you withdraw it. Depending on your tax status, this may be helpful. One nice thing about an IRA is you can decide how the money is invested. You can use your account to hold Real Estate, Stocks, Bonds, and Mutual Funds.
Theses are the traditional forms of savings. As I have said before though, Generation Y and X are going to have to look into other options for security. When I look at the world and see successful people, I see those who own real estate, their own business, franchises, and have diversified themselves. Generation Y and X are going to need to do more of the same. Frankly, at 1% interest rates, I am not sure I am willing to rely on just saving my pennies.