Start a Roth IRA ASAP
Unlike a traditional IRA and 401k which are income tax deferred, the Roth IRA features contributions that are taxed in the year they are made, while gains and withdrawals are never taxed. Therefore, the best time to contribute to a Roth IRA is when your income is low. When are our incomes typically at their lowest point? While we are young adults, of course. As long as you have earned income, an individual can contribute to a Roth IRA up to the amount of his/her earned income or $4,000 (increases to $5,000 in 2008), whichever is less. For a married couple, both spouses can each contribute up to $4,000 for a total of $8,000 (increases to $10,000 in 2008). Think of it this way, some part-time workers don’t even pay income tax, due to their low income coupled with qualifying deductions. In such a case you could actually make Roth IRA contributions which would not be taxed, and the account would never be taxed. Pretty sweet deal!
Gradually Ramp Up Your Lifestyle Over Time
Some people make the mistake after graduating from college of buying a really expensive car, I guess as a reward to themselves for all of the hard work they put forth to earn their diploma. This is absolutely one of the worst, albeit most common, mistakes young adults make. Why? Because after buying a BMW at 22 years old, do you think we’ll buy a Honda or a Mercedes at 25? Of course, we’ll buy the Mercedes because we don’t want to go backwards on the “perceived” quality scale. The point is, it’s a good idea to hold back a little on the quality we demand as young adults because our taste will probably only get more expensive as we grow older. In other words, making a less expensive purchase as a young adult translates into a lifetime of less expensive purchases, even while steadily moving forward on the “perceived” quality scale throughout.
Base-Load Your Investment Accounts
Another trick to take advantage of while still a young adult is to base-load your investment accounts. By base-loading, I mean contributing a larger than normal amount to your accounts at the beginning of your investment career and little to none the rest of the way. This advice works great if you take advantage of it before you are married with kids and have a mortgage. Before you walk down the aisle and start a family, your expenses are typically low, so you are able to put some of your excess cash to work. That way when you do take the plunge, you can cut back or even eliminate investment contributions altogether, and it won’t even matter. For example, say at 22 years old you start contributing the maximum of $4,000 per year to a Roth IRA and continue until you are 30, at which time you decide to get married and start a family. Because running a household and raising a family can get expensive, you halt all contributions to your Roth IRA from this point forward. However, you allow the contributions you have already made to continue compounding. If we assume the Roth IRA compounds at 10% per year, how much will your account be worth when you reach 65? Surprise, nearly $1.3 million dollars! Pretty amazing.
Young adults have a distinct advantage over the rest of us because they still have the most valuable resource of all on their side – time. Making wise financial decisions early in life sets the stage for financial success during your retirement years. Hopefully, my simplistic personal finance training offered here will inspire young adults to take action now so they will be able to reap the benefits in the future.