Retirement may seem far off if you are a young professional, but there's no better time than your 20s to start planning your post-work life. Many people get automatically defaulted into their employer's retirement plan without thinking about what exactly they're investing in. Here are seven tips for 20-somethings to start evaluating their retirement portfolios now.
1. Determine your risk tolerance
Before getting started, reflect on your personal comfort level with risk and reward.
Anika Hedstrom, a financial advisor from Medford, Oregon, suggests asking yourself: "How would you feel if your portfolio lost 5%? 20%? Would you sell everything or ride the wave?"
Honor these feelings when choosing what type of assets to invest in, but be open to a bit of risk while you're young.
"Remember that this money will possibly be invested for more than 30 years," says Dana Twight, a certified financial planner from Seattle, Washington. "You can take some risk with these funds."
2. Evaluate your package
If your employer offers a retirement plan such as a 401(k), make sure you understand how it works. Here are some things to consider:
• Employer matching: Some companies offer matching up to a certain percentage of what you contribute to your account.
• Contribution limit: For 2014, the cap is $17,500.
• Vesting schedule: "All contributions you make are 100% vested, but it could take up to five years to be 100% vested in your employer's contributions," Hedstrom says. "If you leave the company prior to this date, you will also leave a percentage of their contributions.
• Investment options: Your employer may offer anywhere from three to hundreds of choices for investing in mutual funds, target-date funds, indexes, company stocks and more.
• Fees: Many 401(k) plans have operating expenses, trading costs and other fees. Minimize the fees you pay by comparing plans and funds to get the best deal.
"If the plan is loaded with high cost, I would limit contributions to the amount needed to qualify for any employer matching," says Joe Alfonso, a certified financial planner from Lake Oswego, Oregon.
3. Start early
You may feel like a broke 20-something, but now is the best time to start contributing to your retirement, before other life costs get in the way.
"Do the heavy lifting upfront before your life gets complicated with houses, kids, aging parents, and other life stressors," Hedstrom says.
Compounding makes every penny saved early pay off in the long run, because the interest you earn on your retirement fund each year is added to the original amount you invest. Calculate your compound interest here.
"I have never had a client tell me they regretted saving money when they were in their 20s," says Johanna Turner, a certified financial planner from Mayfield, Kentucky. "I've had many clients who have come to me with the opposite sentiment."
You may be overwhelmed with the number of places you can invest your money, but don't let that stop you from contributing money at all.
"What you invest in is far less important than getting money into the account in the first place," says Brian Frederick, a certified financial planner from Scottsdale, Arizona. "Cash flows into the account are going to be more important than the growth of money that's already in the account."
Always contribute enough to your 401(k) to max out your employer's contribution; it' practically free money for you.
"This is a must," Turner says. "You will never be able to go back and make it up and you will never be offered a legitimate 100% automatic return on your money."
One way to ensure that you're routinely contributing is to automate the process. You can set up automatic escalation, which will increase the amount you contribute each year.
"For example, if you begin to contribute at 2% at the age of 23, increasing each year, you would be at 8%," Twight says. "If you made $50,000 at age 30, that would be $4,000."
You've heard the saying, "Don't put all your eggs in one basket." The same principle is true for investing your cash.
Turner suggests splitting about 97% of your portfolio between both small and large companies as well as growth funds, which are risky but expected to yield high earnings, and value funds, which are cheap and grow slowly. You can also invest in international funds and real estate, but save about 3% in cash.
Once you've maxed out your employer's 401(k) match, consider opening other accounts to further diversify your retirement fund.
Roth IRAs are a great option. You'll pay taxes upfront, but you'll enjoy tax-free withdrawals when you take cash out during retirement. People in their 20s are typically in a low tax bracket, so it makes sense to pay taxes now rather than later.
"To be able to grow your investments for 30 or 40 years and then have a pile of tax-free money is a wonderful thing," Turner says. "Start your Roth early and fund it faithfully."
You should rebalance your retirement portfolio annually to make sure you're investing your money as efficiently as possible.
"Would you be comfortable with one trip to the doctor at age 5 and never returning? Even if you feel healthy, you still want that peace of mind of an annual checkup. Same goes for your portfolio." Hedstrom says.
To rebalance, start by re-examining your tolerance for risk and reward. If your answer has changed, adjust your investments accordingly. Additionally, depending on how your assets fared throughout the year, you may need to buy and sell securities to bring your portfolio back in balance.
These seven guidelines will help you optimize your retirement savings, but don't feel like you have to have the perfect portfolio right away.
"They key is to start," Hedstrom says. "You will make mistakes. It's best to make them now while you are young and have time to learn and refine your approach."