I recently sent a letter (yes, a real letter) to my 20-year old nephew encouraging him to start saving for his retirement today. With time and compound interest on his side, his options are endless. To reach financial independence, he’ll need to invest and adopt some crucial money-smart habits early on in his life.
Cross your fingers for me that the message resonates with him!
Hey buddy. I hope your summer was a blast!
You’re back for your junior year this fall. That’s such an exciting time for you. I absolutely loved my time at college. Enjoy every minute of it.
I know the last thing you're thinking about right now is investing for retirement, but humor your Uncle and hear me out.
You’ve probably heard of the typical person retiring when they’re 60 or 70, right? Well, I want to share with you how you could retire at 40 years old.
Since you haven’t entered the full-time working world quite yet, the idea of early retirement might not sound appealing to you. If it doesn’t, you can put this letter away and maybe open it again if you have a rough year at work in the future.
If the idea of only working 20 years of your life instead of 40 sounds intriguing, read on.
7 Steps to Early Retirement for a 20-Year Old
The steps to early retirement are quite simple, but not everyone will do it. You know why? Because it takes patience and willpower. As you graduate and enter the work world, you may find that a lot of your colleagues lack these two traits. Hell, I lack these traits most days, but I’m at least aware that they’re crucial when you want to do something incredible in your life.
Whether it’s running a marathon, negotiating with your 3-year old to eat their breakfast or reaching financial independence … these major feats all take time and a whole lot of determination.
So at 20 years old, you have something that a lot of people don’t have: TIME! Let’s take advantage of it and set yourself up for early retirement.
1. Invest Now for the Long Term
I put this first because I want to express the urgency of investing. If you have an earned income this year, you can take advantage of a Roth IRA. This type of investment vehicle currently allows you to contribute up to $5,500 per year. That may seem like a lot of money for you now, but you can steadily increase your contributions year-over-year until you’re able to completely max it out.
Roth IRA contributions are considered “after-tax money” which means that taxes have already been taken out of your paycheck. A major benefit of the Roth IRA is that your earnings will grow tax-free. You can’t withdraw the earnings until you’re 59 ½ without a penalty but you can withdraw your contributions at any time. There are ways to get around this, but don’t worry about that for now … just let it grow and grow and grow.
Let’s say you put $3,000 in a Roth IRA making 8% interest compounded annually and you didn’t contribute anything for the next 40 years. When you turn 60, you’d have $65,173.56.
What if you stayed consistent with that $3,000 contribution each year for the next 40 years? That would give you $904,516.69.
And how about the maximum contribution of $5,500 each year starting from age 20 to 60? $1,658,280.59!! Talk about a cushy retirement.
What about if you waited until you were 40 to start investing? Your ability to take advantage of compound interest gets slashed significantly!
Look at the difference between starting at age 20 versus starting at the age 40. In the final example, you would be missing out on $1,250,819.26 in interest not including your contributions. My point is the earlier you start, the more compound interest works in your favor.
Where do you invest your money you might ask? I’d recommend you keep it simple. Get hooked up with Vanguard and buy VTI to start. This will allow you to pretty much own a small slice of every major company in the US. Call your Uncle and I’ll help you out.
2. Avoid Consumer Debt
You’re gonna run into a lot of temptation to take on debt in many forms and fashions over the next 20 years of your life. Do your best to steer clear of it. Live by the mantra of “If I don’t have the money, then I can’t buy it.”
Short-term loans, payday loans and credit cards can all be slippery slopes in college and in the years following. These are fast and easy ways to get cash, but they have crippling interest rates that will leave you paying on them for years. Don’t have the money? Don’t buy it. This goes for cars, clothes, boats, fancy dinners, vacations, etc.
Right now, 78% of Americans are living paycheck to paycheck. The continual reliance on consumer debt is a big reason why people can’t seem to get ahead.
Don’t get me wrong. There’s nothing wrong with having a credit card as long as you use it responsibly. You don’t want to abuse it. Only buy things with your credit card if you have the money in your bank account to pay for it.
3. Find a Career with Upward Mobility
Okay, you’re going to be at least working for the next 20 years of your life. Let’s find something that excites you, engages your brain and provides you with a solid income. In addition, you want to make sure you have the ability to increase your income steadily over your years working.
In your early 20’s, you probably won’t make a ton of cash right away. No worries. Always show your interest in learning more, give your best effort and continually find ways to demonstrate your value to your upper management. By doing these actions, your salary, benefits, and position at the company will most definitely increase.
This solid and consistent income you’ll be earning will help fuel your early retirement machine.
4. Save 50% of Your Income
If you can save 50% of your income when you get your first job at 22, you’ll be able to retire in 17 years at age 39. Now, since you’re 20, 17 years may still sound like a long time. I can assure you since I’ve already been working for 13 years that it sure beats 40 years of working!
Now, your question might be … “What do I do with this 50% each year?” The absolute first thing you need is 3 months of your monthly expenses in a savings account for an emergency fund. This may take some time to build up, but it’ll keep you from turning to debt to solve your financial problems (remember step 2?).
After that 3 months of expenses is saved up, now it’s time to take advantage of the magical, mystical, all-powerful COMPOUND INTEREST!
5. Max Out Tax-Advantaged Investments
With your new awesome job, your employer will more than likely have a 401k available for you. This is a pre-tax investment option that allows you to save for retirement. Now, you won’t be able to draw from your 401k until you’re 59 ½ without a penalty, but the benefits of not paying any tax now are completely worth it. And like the Roth IRA, there are sneaky yet legal ways to get around the early withdrawal penalty.
Now, max this baby out! Contribute the maximum of $18,500 (this may go up in the next couple of years) per year and let it grow. While you’re at it, max out the Roth IRA described in step 1.
Your employer may not have Vanguard options like we discussed earlier. If they don’t, try to find something called an “Index Fund”. These are simple, low-cost solutions that track a market index. A “Total Stock Market Index Fund” or an “S&P 500 Index Fund” are great options to consider.
You’ll eventually want to incorporate a bond index fund to create a balance of stocks and bonds in your portfolio, but in the beginning, just focus on starting. The longer you wait, the less compound interest will be working in your favor.
6. Build Passive Income Early
After you’ve maxed out the tax-advantaged options, here are some thoughts on creating money in your sleep in your 20’s and 30’s:
House Hacking
Buy a house when you have at least 20% to put down, and rent out rooms to your friends. With the income from your roommates and the right math, you’ll be living in your house for free. This strategy could work with a single family home or a multi-family home. I did it for the majority of my 20’s. I made lots of friends and money.
Buy-and-Hold Rental Real Estate
If you dig making money through your primary home, consider adding rental properties to your portfolio as well. 90% of the world’s millionaires have used real estate to amass their wealth, but they educated themselves first. If you’re considering this route, check out BiggerPockets or Paula Pant. They have been excellent “real estate 101” resources for me.
Taxable Brokerage Account
Once you’ve exhausted your tax-advantaged investment options, you can look into a taxable brokerage account to continue investing in the stock market. Stay away from individual stocks. They’re too risky and pretty much like going to the casino in my opinion.
Small Business
If you have extra time and you want to follow your passion, try flexing your entrepreneurial muscle a bit. Think about what drives you and then figure out how you can sell it as a product or a service. Start small. You don’t want to stress yourself or your wallet too much.
Starting a blog can be an easy way to hold yourself accountable to your goals and make you some extra cash too.
7. Realize What Early Retirement Actually Means
I’m actually not a fan of the term “early retirement”. That sounds odd given that I’ve just written this whole letter about the topic, but hear me out.
I prefer the term “financial independence” instead. This set of words infers warm fuzzy feelings of freedom and the ability to choose the course for your life. Once you’ve amassed enough wealth to cover your annual expenses consistently without working, you’re financially independent. You’re free to do what you want when you want and with whom you want.
For most people, early retirement doesn’t mean sitting back on a beach and doing nothing. Many people are still working in some way (part-time, flex between leisure and work) in retirement. That number really surprised me the first time I heard it, but it really makes sense. After a few months of lying on the beach, we’d probably get bored. We wouldn’t be challenged, we wouldn’t be growing and we wouldn’t be pursuing our passion.
That 68% of folks are more than likely doing “work” that gives them purpose. They are working when and where they want to. I believe that’s what financial independence is all about … Designing your best life.
Crazy Uncle Out
This real world stuff can seem difficult and confusing, but it’s really not. Invest early, spend less than you earn and pursue your passions.
I wish someone would have given me this type of advice when I was 20. I hope you find it helpful in your life journey buddy.
I’ve included some gift cards to the finest late night eateries available (Chipotle, Domino's) … because no mail to a college guy is complete without providing access to delicious food.
The burrito you’ll buy tomorrow will taste good, but I’m willing to bet your future financial independence will taste a lot better.
I love you and wish you the happiest life possible.
Best wishes,
Uncle Andy
Are you pursuing Financial Independence or Early Retirement?
What would you add to this letter?
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