Financial planning is best done by focusing on the big picture and then hammering down the details required to make it a reality. Your financial plan is more of a mosaic than a big canvas painting; a combination of diverse elements forming a coherent whole.
So, let’s start by thinking about where you want to be when you’re 50 or 60 and work backward from these goals (the big picture).
What do you want to be doing and where do you want to be? For most people, this exercise is difficult. They don’t even know what they are having for lunch tomorrow. How are they supposed to know what they will be doing decades from now? If one of your goals is to be retired or working less than full time, you’re going to need money in the bank to allow you that kind of lifestyle. How do you think your role models got there? Perhaps your parents are retired now or that rich uncle you’ve always envied who spends most of his time traveling and golfing can clue you in on the secret. How is it that your future self will accumulate enough money to be able to meet your life goals? More times than not, this is where consistently saving to a retirement account, such as a 401(k), comes into play.
The older, hopefully wiser, version of you will be looking to wind down work and increase leisure time around age 60.
The future you will begin to look at your accounts and ask your financial advisor if your funds can sustain your current lifestyle through retirement. What answer would your “future self” like to hear? Probably a “yes!”, with a big smile. If so, your mental picture of the future will most likely include a significant accumulation of savings in a retirement account, such as a 401(k). You’ll be happy to see that over the past 20-25 years of your career, your properly diversified portfolio has weathered more than one market downturn, accumulated investment earnings through tax-deferred compounding, and now given you the option to work less and enjoy life more.
Your almost retired self will probably think that it was a wise choice to begin saving early and often.
You started with 5% of your paycheck at age 25; glad you bumped it up to 8% at age 27 after your first big raise; and then began maxing out your 401(k) contributions at some point in your late 30s. You’ll probably think back at those times you would have preferred to have the extra $300 per month that was going into your 401(k) to spend on frivolous things and think that you made the right choice. You will see the benefit of years of discipline through forced savings. Lastly, you’ll be grateful that you took full advantage of your various employers’ 401(k) match programs and didn’t leave any free money on the table. That 401(k) plan is now a huge asset.
So, is saving to a 401(k)-plan needed in your late 20s or early 30s?
The answer is no. Other than not paying income taxes on what you save, there is no immediate benefit to saving to any pre-tax retirement account when you’re young. That said, the fact that there is no instant gratification does not make saving to a 401(k) something unimportant. Like your health or career choices, financial ones cannot be made just thinking about the now. You must think about the future implications of your choices. Make it a habit to save to a retirement account, such as a 401(k), early on in your career. Use consistent savings, time, and tax-deferral to your advantage. Your older self will thank you later.