An early start on good saving habits

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

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NEW YORK (Money) -- Question: My 21-year-old daughter makes $80,000 a year working at a large firm. She has very low expenses, so I'd like to see her sock away a huge amount of money. I told her that if you get used to spending a lot each month on "fun" stuff, it will be much harder to save down the road. I'd also like to see her bypass the high-end investment firms in favor of less expensive alternatives. What do you suggest? --Tom F., Chatham, Illinois

Answer: I'm with you, Dad. I think it's a great idea to encourage the habit of saving regularly early in one's career (or life, for that matter) so that it becomes almost second nature.

But let's not overdo it. As Cyndi Lauper once famously put it, girls just wanna have fun. (Boys too, I might add.) Nor does having a good time necessarily make you some sort of financial reprobate.

I'm not sure how much you have in mind when you say you want your daughter to sock away a "huge" amount of money, but you don't want her setting a goal that's so high that saving becomes a privation and unsustainable. She would be making the same mistake as people looking to control their weight who go on a crash diet.

Your aim here, therefore, should be to get your daughter to think of saving as a natural part of life, a regular expense you must budget for just like any other (which, in fact, it is, as I explained in a column about how to live within your means and lead a financially responsible life.

So, how can one inculcate the savings habit in a way that avoids dealing with firms that charge onerous commissions and fees?

Well, the first thing you can do is to encourage your daughter to sign up for her 401(k) plan, assuming her company offers one (as most large firms do). You might suggest that she contribute at least enough to get the full employer match. If doing that doesn't bring the combined contribution from her and her company to 10% of her salary, then she should kick in whatever it takes to hit that goal, which is a decent starting point for someone her age.

I can't guarantee that her 401(k) plan's expenses will be lower than those she'll encounter at outside investment firms. But unless your daughter finds that, after evaluating her 401(k) plan, it is truly horrendous, it's highly unlikely that she would be better off forgoing the tax savings, convenience and other benefits of a 401(k) to save outside the plan.

In addition to her retirement savings, your daughter should also have about three months' worth of living expenses in a bank money-market account or savings account that pays competitive yields.

The idea isn't to earn big bucks on this money; that's not going to happen in today's environment. Rather the aim is to have a safe stash that she can draw on in the event of a financial setback or emergency so she doesn't have to tap her 401(k) or other retirement savings and possibly incur taxes and penalties for early withdrawal. She should be able to build this emergency fund while contributing to her 401(k).

Once she's built up an emergency fund, your daughter can either divert the regular savings that was going to that fund to her 401(k), thus boosting her contribution rate there. Or she could put the money into a Roth IRA that would complement her 401(k). By funding her Roth with low-cost mutual funds like those on our Money 70 roster of recommended funds, your daughter can avoid bloated fees that act as a drag on growth.

One final note: What may seem straightforward to someone who's well versed in financial affairs may be daunting to a neophyte. The last thing you want to do is overwhelm your daughter with so much information and so many choices that you paralyze her into inaction.

So break this process down and, without being overbearing, help her put the pieces into place one at a time. Help her get signed up for the 401(k), then open the emergency account, then consider the Roth.

She can always fine-tune her choices later. The most important thing is to instill the habit of saving so that it becomes routine. If your daughter manages to do that, she'll improve her chances of having fun not just at 21 but for the rest of her life as well.