Legend has it that Albert Einstein once called compounding interest the most powerful force in the universe. Unfortunately, that concept has escaped many of those who would benefit most from it: the 20-somethings who have entered the work force but aren't saving up for retirement.
While it can be hard to justify saving for something that will occur decades into the future, financial advisors say its importance can't be understated.
One reason is that Social Security is far from guaranteed: Without reform, the program will not be able to pay out benefits at current levels, starting in 2041. People who are 22 years old now would typically still have at least 10 years to go until retirement at that point.
Another reason is that compounding interest makes saving early far more profitable than starting late.
As an example, Vincent Barbera, director of financial planning at TGS Financial Advisors, offers two different scenarios: Person X deposits $2,000 into an IRA each year from the ages of 22 to 31, then stops, while Person Y deposits $2,000 each year from the ages of 31 to 65. Both have the same interest rate and allow interest to accrue. Person X will earn nearly $50,000 more than Person Y by age 65, even though the latter contributed $50,000 more to the account over 25 additional years.
With that in mind, here are five helpful tips for 20-somethings who want to start preparing for the future:
• Put "surprise" cash into an IRA. Instead of spending that $100 birthday present or $600 rebate check, pretend you never received the money and stick it into your retirement savings account.
• If your company offers a 401K plan, enroll -- even if you put the minimum amount that will be matched. If not, start contributing to your own individual account.
Joseph Birkofer, a financial planner at Legacy Asset Management in Houston, suggests putting at least 7% of your gross pay into such an account to match your contribution to Social Security and Medicare.
• Use automatic deposits from your check or bank into your IRA. That way, you don't have to put in the effort of manually depositing funds and won't be tempted to use them toward another purchase.
• Put yourself in their shoes. Find it hard to justify saving money for something so far off in the future? Imagine yourself as a retiree and how it will affect your family and lifestyle. Birkofer suggests thinking about how your grandma, great-uncle or local retirees pay for lunch.
"There's only three places to get money besides stealing it or winning the lottery: the government, whatever you did yourself or from your family and your kids," he says.
If you don't want to rely on Social Security's shaky outlook or the unattractive option of burdening your family, being financially independent through your golden years can only come from the initiatives you take now.
• Don't get burned. When choosing a fund, make sure to balance risk.
Some want to chase higher returns with riskier funds, but starting out slow might make more sense -- especially for those who are hesitant to start saving in the first place.
Birkofer suggests young investors build up a core of $15,000 to $20,000 in a balanced retirement fund, then start exploring funds that are weighted in international or emerging-market investments.
"We lost almost a generation of investors because of the dot-com bomb and it's taken them years to come back to the market," he notes.
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