This month, thousands of newly minted college graduates will begin the annual migration from the protected confines of their college campuses to the corridors of corporate America. For me, this strikes particularly close to home as my son folds up his cap & gown and heads off to Boston to begin what I’m certain will be a promising professional career. Way to go honey, your mother and I are incredibly proud of what you’ve accomplished.
What follows here is more or less an open letter to my son and his friends. While I’ll eventually need to come to terms with the fact you’re already capable of exercising thoughtful decisions as an independent adult, I’m still a parent, I’m still going to give advice, and occasionally I’m probably going to embarrass you. Really, I can’t help myself.
Within days of landing in your new office cubicles, you (along with the best and brightest graduates the country has produced) are going to have a life-changing encounter that will unquestionably reverberate for the rest of your adult life. No, I’m not talking about an encounter arranged through Tinder or Bumble. What I’m talking about is the corporate intake encounter you and your peers are about to have with the representative from each of your respective human resource departments.
Along with your office key, ID badge, and (if you’re lucky) a company parking pass, the HR representative is going to hand you an enrollment form for the company’s retirement plan. Defined by specific chapters of the Internal Revenue Code, these plans come in a dizzying array of alphabet soup definitions with 401(k), 403(b), and 457 plans being the most common. For the sake of simplicity, we'll just refer to the whole lot as 401(k) plans. Whether you know it or not, the decisions you make on that form regarding salary deferral could very well spell the difference between a retirement spent greeting friends and family at your country home and a retirement spent greeting guests at Walmart.
For 2022, the IRS says you can contribute up to $20,500 of your pre-tax wages to a 401(k). OK, I get it…that’s not going to happen given the average $52,000 starting salary that awaits most recent college grads. Undoubtedly you’re all feeling a bit overwhelmed by the sudden reality of renting new apartments, purchasing cars, and maybe tackling that mountain of student debt. But rather than writing off the whole retirement savings thing as an exercise in futility and/or "something I'll get to later", why not try taking a smaller bite out of the apple? At the very least, scoop up the free cash your new employer is offering as a match to your contribution.
If you learned nothing else about finance these last four years, hopefully, you know enough by now not to walk away from free money. Here’s how it works: Most employers typically match pre-tax 401(k) contributions at 50 cents on the dollar up to 6% of base salary. So you’ll need to start by making a commitment to save at least that 6%. Assuming you earn the average wage, you’ll set aside $3,120 in the first year and your employer will chip in $1,560. Save an identical amount in each of your first 5 years of employment, earn a 6% rate of return, never contribute another nickel, and thanks to time and the magic of compound interest it will grow to $304,892 by the time you retire. Not a bad start.
Next, you are going to take another 4% of your base salary and use that to accelerate the scheduled payments on any outstanding student loans. If you are one of the fortunate few that got to walk away from campus without accumulating any debt, put that extra 4% towards your retirement plan as well. You are going to need it. After all, guys like me regularly counsel clients to accumulate somewhere between 8 and 12X their ending salary in order to be able to live comfortably once regular paychecks stop hitting the bank account every other week.
Finally, make an ironclad contract with yourself to take 1/2 of any bonus or salary bump and earmark those funds towards gradually increasing your periodic retirement contributions until you eventually reach the IRS maximum contribution limit. You can spend the other half on whatever your heart desires, but you’ll sleep better knowing the occasional splurge hasn’t come at the expense of your long-term financial health. Come to think of it, I’ll sleep better too.
In the last few weeks, you and your friends have been told countless times by a seemingly endless parade of speakers that you have the ability to rise above any obstacle preceding generations may have set in your path. I honestly believe that is true. Still, while you are out there making the world a better place for everyone else, don’t forget to help yourself along the way.
And oh by the way, on your way to the top…don’t forget to call your Mom.
Michael Reid, CFA is a Managing Director and Partner at Exchange Capital Management who doesn’t sleep well until all his kids are home safe in their beds. The opinions expressed in this article are his own.