Two Reasons Not Save for Retirement in Your 20’s

by RJ

in Investing

I’m The Bull of Wall St. asked frequently about alternative options to investing in the stock market. To many surprises, I explain that not everyone in their 20’s is meant to invest in the stock market.

At first, this shocks most people. The usual response is, “Aren’t you a CERTIFIED FINANCIAL PLANNER®?  Don’t you know the power of compound interest?”

Of course I am and of course I do, but I still believe that everyone in their 20’s isn’t meant to save for retirement just yet. There are two scenarios that come to mind, where I believe someone should not be in such a hurry to invest.

# 1 – Risky Career (Entrepreneur, Start up Employee)

If you’re taking a career risk, such as being an employee for an unestablished start-up, delaying retirement savings may make sense. By choosing a non-traditional career path, you’re taking enough risk. To take another risk with your investments, such as putting your entire portfolio in stocks, could be too much.

The goal is to balance the risk of your human capital, which is your ability to earn money, with your financial capital, which are your assets and liabilities. In your 20’s, your human capital has the greatest risk.

For some, once they are able to increase the value of their human capital (by acquiring skills and experience) their career becomes less risky. This usually takes until late 20’s and early 30’s. However, once someone successfully increases their human capital, and therefore their career path becomes less risky, they can afford to take more risk with their financial capital.

# 2 – High Interest Debts

If you have high interest credit card debt, the optimal choice is generally to pay it off before saving for retirement.

The only situation where saving first would make sense, is if your employer matches your 401(k) contributions AND the interest rate on your debt isn’t considered too high.

Not Investing, Doesn’t Mean Not Saving

Not putting your money into the stock market, doesn’t give you an excuse to spend more than you earn. If you have a risky career or high interest debt, you should save even more than someone with a safe career or no debt. The only difference is that your extra cash is going towards building an emergency fund or paying off high interest debt.

What do you think? Do you agree or disagree? Are there any other situations where someone in their 20′s shouldn’t invest in the stock market? Let me know in the comments.

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{ 8 comments… read them below or add one }

tmgbooksNo Gravatar May 4, 2011 at 9:34 am

I agree with the basic premise of your post. But I of the opinion that no one should save for retirement. That does not mean that you cannot save or don’t need to save, it is just that the goal is financial independence not “retirement.”

If you think about it, you will realize that in order to retire, you will first need to achieve financial independence. Most who pursue the goal of saving for retirement, plan to meet their monthly costs with income from Social Security and income from “retirement” accounts, mostly 401k and IRA-type accounts.

You must meet certain age requirements to receive Social Security payments and make penalty-free retirement account withdrawals. But if those two income sources are not part of your planning and you are planning to retire before you are age-qualifed for those payments, it will be that much more costly and require that much more in savings to achieve the necessary level of passive income.

Most of those who claim they are planning to retire “early,” are, in fact, planning no such thing. Instead, all they are planning for is a change in employment construct; usually going from the typical five-day, forty-hour week construct to some mix of passive income and part-time self-employment. That is not “retirement,” early or otherwise.

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RJNo Gravatar May 4, 2011 at 11:23 am

I see what you saying. I know that retirement has been a bad word lately. I could have easily changed the title to “2 Reasons Not to Invest in the Stock Market.”

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JeffreyNo Gravatar May 4, 2011 at 12:17 pm

Whew, I feel much better now about saving for retirement, R.J.! I think you definitely have a good point that there are other circumstances to consider.

Something I think about a lot is whether I should be investing to fund my retirement or investing in my own business as an entrepreneur now. These are always tough decisions, but I think that sometimes the risk is worth it, as long as you have a good plan in place and there’s good potential upsides.

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RJNo Gravatar May 4, 2011 at 5:06 pm

Glad I could help. I face the same situation myself.

What works for me, is to never stop the actual habit of investing. Therefore, no matter what my income was last month, I dollar cost average into the market. Even if I could only afford to invest say $100, it’s important that I don’t stop.

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EricNo Gravatar May 6, 2011 at 6:28 pm

I agree with much of this. I personally pay off my credit card balance in full each month (not everyone is so lucky) before contributing anything to my IRA. Then I replenish what I spent to keep my checking balance what I prefer it to be. 20% of the remaining paycheck is then contributed to my Roth, and anything left over is thrown straight into savings (emergency fund and student expenses).

I definitely feel that there are important things to consider before committing cash to a retirement account in which it cannot be withdrawn (though of course, there are exceptions with withdrawing contributions from Roths). Still, it would take a serious financial ditch for me to touch my contributions. And for those in special circumstances like those above, it’s important to take care of a few hurdles before heavily funding retirement.

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ColeyNo Gravatar May 9, 2011 at 2:05 pm

I agree with the point about paying off high-interest debt before investing in the stock market (one caveat, of course, is to be certain that one is not keeping a running balance of $X in credit card debt indefinitely, saying “Oh, I’ll start investing as soon as that is paid off.”)

But I disagree with this idea that one’s stock investing in retirement vehicles ought to be postponed in his early working years based on the relative employment risks associated with his profession. I guess my question would be “Well, what’s your alternative?”

I’m not sure the correct statistical way to explain my objections, but I think you’ve essentially selected two unrelated items and compared them: “Risky job, better have safe investments; safe job, stocks are OK.” One could make an equally persuasive argument that a person in a more volatile career field ought to work on giving his retirement savings an even healthier boost in the beginning.

Generally, I thought stock investing is considered “risky” in the sense that it is subject to high volatility in the short term. Thus, goes the old saying, if you need the money in [whatever relatively small number of] years, keep it out of stocks. Long term, on the other hand, the volatility is smoothed out and performance tends to revert to the mean.

None of this has anything to do with the volatility of a 20-something’s earning potential,and, in fact, I think, suggests the opposite of your assertion.

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RJ WeissNo Gravatar May 10, 2011 at 9:53 am

I see you point. But I guess where I disagree is that your job and investment portfolio should be related.

I wrote this with the thought that eventually your career does stabilize. Once that does occur, you can start balancing out your overall risk between your human and financial capital. Hopefully, this happens by the time you’re in your 30′s.

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JeffNo Gravatar September 26, 2011 at 4:09 pm

I can give you one good reason to start saving for retirement early, in fact the earlier the better. That reason is compounding.

In a simple example: Ben saves $2,000 per year at 12% starting at age 19. He stops at age 26. At age 65, his $16,000 in contributions are worth $2.28 million.

Arthur waits and starts saving $2,000 per year at age 27. He invests this $2,000 per year all the way to age 65. Even so at 12% interest, his nestegg is only worth $1.53 million.

The earlier you start, even if it is smaller, is the best policy. Also note the rate of return must be greater than a .5% savings rate. The only way to get this is to invest in the equity markets. The younger you are, the more likely you hit one of the market periods which bring about great returns. Alternatively check out strategies, like StockSignal, that allow you to prosper in any market.

Paying off debt is noble and a great idea, but save something earlier, even if it is a small amount!

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