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Chelsea walks us through how investing in retirement works and how anyone can reach their retirement goals, including a numbers-based example of what investing in retirement could look like.

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Hey, guys.

It's Chelsea from The Financial Diet. And this week's video is sponsored by M1.

And we talk a lot on this channel, and you hear a lot in the personal finance world generally, about how important it is to save for retirement. And most people by now, especially if you watch this channel frequently, know that the most effective way for most people to save for retirement is going to be through investing in the market, and that the most important thing when it comes to investing is to start early and be consistent. And now, that is not to say that if you're really basically any age that it's too late for you to get started investing.

But in general, it's better to start yesterday than today, and better to start today than tomorrow. But when it comes to the specifics, we get a ton of questions about what kind of accounts you should be opening, where you should be putting your money, how it actually works, and how much money you need. So today, we're going to walk through all of the nitty gritty math about saving for what many would consider to be a comfortable retirement.

And if you're looking for an app to take you to the next level of your investing journey, you should check out M1. M1 a.k.a. the finance super app is an all-in-one investing platform where both new and advanced investors alike can custom build the portfolio they want or use one of their pre-built diversified portfolios. By automating your contributions to either a traditional or a Roth IRA with M1, you can make investing in your retirement as painless as possible, and with zero hidden fees or confusing costs.

And with an M1 community portfolio like the M1 community pie, which focuses on groups of publicly traded companies led by executives from marginalized communities, you have the option to invest with both your values and your financial goals in mind. So click the link in our description to get started with M1 today and to begin building your wealth for tomorrow. So now to get into the actual nitty gritty of what you need to save for retirement and how to do it.

So you've probably heard of the general rule of thumb, which is to have one year of your annual salary saved by the time you're 30. Which, as we all know, is not feasible for most people. But stating rules like that so simply can also be misleading because it's not suggesting that you have to save that amount in cash, but rather that you have to have about that much in your retirement investment account in order to be on track towards retirement.

And that includes the amount that you have earned on top of your contributions. And as long as you're investing the contributions you make to your account, your money will grow exponentially over time. You'll often hear that the average rate of return on 401(k)s is between 5% to 8%, but it varies every year, according to data from retirement and financial services provider Mid Atlantic Capital Group.

And the average rate of returns on 401(k)s between 2015 and 2020 was 9.5%. Now, some years your portfolio might make amazing gains and others it might be net negative for the year, but the important thing is to stay the course so that you can benefit from those averages over time, which are positive. And, of course, benefit from the compound interest that comes along with it.

We'll link you to a video in the description from our resident investing expert Amanda Holden on how to invest through turbulent times and not get completely freaked out by it. But how much do you actually need to retire? So experts say that most people will want to depend on an annual retirement income of 80% of your final pre-retirement income.

Now, there are a lot of different schools of thought about how much you need in an investment account when you retire. But a popular one is the 4% rule. The 4% rule is an equation to help you figure out the total amount you need in your retirement account in order to withdraw your ideal retirement income.

So your retirement income divided by 4% equals the total retirement nest egg. Now, of course you can't predict the future. But do your best to try and predict based on your current salary, your age, your industry, et cetera, what you roughly estimate your ending salary to be.

For example, say you're 25 now and you're making $40,000 a year. If your salary increases 3% per year, and you want to retire at the average retirement age of 62, your last salary before retirement would be $119,409. We'll link to the calculator we use to get this number.

So in this example, your retirement income, which is 80% of your final pre-retirement salary, would be $95,527. Using the 4% rule, this means you'll want your retirement nest egg to be about $2.4 million total. Now, here's where we get to where I can already imagine is some people hooting and hollering down in the comments.

When we talk about retirement, we often talk about very large numbers. Now, not only are these numbers just point blank going to be out of reach of some Americans even using the savviest investment strategies and doing so as early as possible, but it's very important that when we think about retirement-- and more importantly, we understand why we need to prioritize it in the way we do and be so consistent with it-- these large numbers can be very misleading. We tend to think of millionaires as living in these mansions, and on yachts, and spending on caviar and champagne, and having very extravagant lives.

But if you're talking about possibly having 10 to 20 or even more years in retirement, you're not living on a million dollars every year. You're living on a million dollars over that period of time, meaning that the amount that you're taking out, even while compound interest continues to accrue, is going to be depleted over that time. So you might hear something like $2.4 million and say, well that's crazy as [BLEEP]..

I don't need to have this Monopoly man [BLEEP] retirement. But what we're actually talking about is a relatively normalized salary. But we also have to remember that it's not just a question of saving $1.00 2.4 million times.

The reason that leveraging investing is so important is because it makes these numbers more achievable. Again, not for everyone. And again, not easy.

But a lot easier than just saving it in cash. So these are some scenarios of how to actually get to a number like that. Scenario one is investing in a 401(k) without employer matching.

In this scenario, you have a 401(k) plan offered through your employer, but they don't offer employee matching. If you start contributing 50% of your retirement income on a $40,000 salary at age 25 and anticipate a 3% salary increase every year, by age 62, you will have $2,496,950 in your 401(k), assuming a 9.5% rate of return. However, just because that was the rate of return for 2015 to 2020 doesn't mean you should depend on it.

Contributing the same amount but only seeing a 7% rate of return would earn you $1,437,760 in your nest egg. In order to reach that goal of $2.4 million by retirement at that lower rate of return, you would either have to increase your contributions or push back your retirement age. But remember that you don't have to stick with the same contributions your entire working life.

We recommend increasing them as you can afford to until you are maxing out your contribution limit, which is currently $20,500 a year, or $27,000 if you're over 50. Scenario two is investing in a 401(k) with employer matching. So the previous example had a scenario in which your employer offers a 401(k) but doesn't offer a matching bonus.

So now let's look how your situation could be different if you did have an employer that matched. So an employer match is a benefit where your employer matches the amount you contribute to your retirement account up to a certain percentage. According to Vanguard, the median employer matches 4%.

So using that same salary number as before, starting at a $40,000 salary at age 25, say you contribute 15% of your annual salary to your 401(k), and assume a 9.5% rate of return and a 3% annual salary increase. And your employer offers a 100% contribution match up to 4% of your annual salary. In 37 years, your retirement nest egg will be $3,162,801, which is well over that $2.4 million goal.

And if you're able to take advantage of an employer match, the lower rate of return will have less of an impact, as long as you're still contributing consistently. In the same scenario outlined above but with a 7% rate of return, you'll end up with $1,821,161 in 37 years. So this is still a ways off of your goal, but it does put you much closer to it than if you weren't taking advantage of an employer matching program.

This is why it's important to remember that not taking advantage of programs like this if they're offered to you is literally leaving free money on the table. But it's also important to remember why considering benefits like this is extremely important when considering a job or negotiating. We tend to focus a lot on just the salary, and it can seem like a bigger difference in the short term.

But when we look at how much an employer match, which one employer may not have over another, can add up to over the course of saving for retirement, it could actually end up representing way more money than that initially higher salary another employer might offer. Scenario three is investing in a Roth IRA. So let's say you don't have a retirement program offered by an employer.

Your main option is going to be to open an individual retirement account, or an IRA. The downside of an IRA is that the contribution limit is currently much lower than 401(k) contribution limits. It's $6,000 a year versus $20,500.

And it's doubly unfair because people with a 401(k) plan can also open an IRA, but the only way to get access to a 401(k) is through an employer, which could be yourself if you're self-employed. If this is what is available to you, it should be a priority to max out your contributions as early as possible. Because say you start maxing out that account now at age 25 and continue contributing $6,000 a year until you want to retire at age 62.

Assuming a 9.5% rate of return, you'll end up with $1,917,688 in your IRA. In this scenario, you'd have to make up the difference by investing elsewhere, such as in brokerage accounts. Remember, though, that IRA contribution limits do occasionally increase, so to make sure you're always maxing them out.

Now just remember that these are all samples, with sample numbers, sample salaries, and sample goals. Yours are going to be different, and you have to do these calculations on your own, which is why we'll link you to them. But demystifying this whole concept of a seven figure retirement is incredibly important, because we must separate our mental image of what it means to have millions in the bank from what it means to actually live on that money over the course of a dignified longer retirement.

Many of us want to be able to retire earlier than the average. And that's a really noble pursuit. But it's also important to remember that that takes even more aggressive investing and savings up front.

Young people can tend to not think at all about retirement, and imagine that future self as basically nonexistent or someone who will just deal with that problem when they get to it. But unfair as it may be, that is the kind of thinking that leads to record numbers of seniors having to work all the way up until their death because they don't have enough money to live on. You want to do everything you can to avoid being in a retirement that does not allow you to live well or enjoy your golden years.

And as much as it sucks to think about yourself in that place at the age of 25, that is the best and most lucrative time to start thinking about it. Remember also that while we used 401(k)s and IRAs as examples here, there are different types of retirement accounts-- things for people who are self-employed, who work in the nonprofit or government sectors, et cetera. And if you ever quit your job, do make sure to roll over your 401(k) so that you don't lose all the contributions that you made.

We'll also link you in the description to a guide on that. Lastly, do not be discouraged or think that because you may never reach a specific number, you'll never be able to retire. Investing is all about being consistent and remembering that doing something is better than doing nothing.

And starting today is the best time to do it. And if you're looking for a great place to get started taking control of your finances, check out M1 at the link in our description. As always, guys, thank you for watching.

And don't forget to hit the subscribe and join buttons and to come back every Monday, Tuesday and Thursday for new and awesome videos. Goodbye.