Saving For Retirement
Saving for retirement is no walk in the park. However, you will be much more likely to achieve your goals if you follow a few key retirement savings principles.
1. Start early
Time is your ally when it comes to saving for retirement. If you start early, you will spread your time horizon out. You will be able to put away less in savings each month and still meet your goals. This phenomenon is primarily due to the exponential effects of compounding growth or compound interest. We’ll talk more about compound interest later, but just know that Albert Einstein said it was “the most powerful force in the universe” and “the eighth wonder of the world.”
If you didn’t start saving early like so many Americans, that doesn’t mean you should give up now. The best time to start saving was years ago. The second best time to start saving is today.
2. Take advantage of retirement accounts
There are a number of savings accounts that are geared toward retirement. For example, many employers offer tax-advantaged retirement plans like a 401(k), 403(b), or 457(b). If you have access to a retirement plan through your employer, that is a smart place to start saving, especially if your employer provides a contribution match. Even if you can’t contribute the maximum amount, you should still find ways to take advantage of any employer incentives. Find out what is available to you and start taking advantage right away.
Individual Retirement Accounts (IRAs) can provide similar tax advantages, but you don’t have to access them through an employer. If you do not have access to a retirement plan through your employer or are already maxing out contributions to your employer plan, you might consider an IRA.
Nearly all employer plans and IRAs have you invest the money in those accounts, allowing you to multiply your returns over time.
Whether you use an employer plan or an IRA, using a retirement-specific account instead of a traditional bank account can provide substantial tax advantages and protections for your retirement nest egg.
3. Save as much as you can
Again, many experts recommend saving 10-15% of your salary towards retirement. If 10-15% of your salary seems unrealistic, review your monthly expenses to see if you can cut back anywhere to save more for retirement.
Most budgets have more wiggle room than you would expect. In a recent budget analysis, we found that reducing spending–not even eliminating it–in a few categories could save a family nearly $500 per month. Some common categories to cut back on include eating out, vacations, clothing, entertainment, and alcoholic or caffeinated beverages.
Take a look at your own budget. By simply making minor budget cuts in a few of these categories, you could increase your cash flow and save more for retirement.
Lastly, if you pay yourself first (i.e., put money in savings before spending it on other things), it is much easier to save enough.
4. Increase your contributions over time
Many retirement accounts, including 401(k) plans and IRAs, are tax-advantaged accounts that can help you save money on a tax-deferred basis. Using a pre-tax account allows you to save more from each check now without affecting your take-home pay as much.
In that same vein, you are likely to get raises or bonuses throughout your career. The average raise in America is about 3% every year. If you increase your retirement contribution by just 1-2%, you still end up with 1-2% in additional discretionary income. Likewise, you could contribute a portion of any bonus or tax refund you receive to your retirement savings. These saving habits are a win-win for your wallet and your retirement
Make the decision now to increase your contributions over time by saving a portion of your money before it ever hits your bank account. Doing this will improve your chances of retiring comfortably.
5. Bonus Tip: Don’t forget to account for inflation
It is easy to forget that future expenses come with a higher price tag. If your current income is $50,000, that income will have much less buying power when you retire due to inflation. You can mitigate this by thinking of your target retirement income in terms of buying power. So, say you plan to retire in 2050. According to current estimates, if you want $50,000 of buying power in 2050, you’ll need around $100,000 and then more each subsequent year to account for inflation in retirement. Something to keep in mind as you plan.
Investing For Retirement
We’ve already touched on the power of investing your retirement savings and the effects of compound interest. Many retirement accounts allow you to invest your savings, and some will even manage your investments for you. However, it is vital that you are familiar with some best practices so you can feel confident as you make investment decisions for retirement.
Invest in the Market
Investing in the market means putting your money to work for you by purchasing stocks and bonds intended to increase in value or appreciate over time.
The stock market has an overall track record of success, with average annual returns ranging from 8-11%. That doesn’t mean that every year produces high returns, but over time, the stock market has consistently trended in a positive direction that has outpaced inflation.
With the average length of a working career at about 40 years, investments can have a significant amount of time to appreciate.
For example, an investor who started investing in the S&P 500 in 1980 would have experienced an annual 8.8% return over 40 years. That puts their overall re A one-time investment of $10,000 at that time would be worth nearly $240,000 in 2020, and an investor who contributed $10,000 per year starting in 1980 would have over $3 million after 40 years, despite having contributed only $400,000 during that period.
With that in mind, investing in the market is key to improving your retirement outlook.
Investing in the market allows your savings to experience the power of compound growth.
As mentioned earlier, compound interest is the interest, or returns, calculated on the initial principal as well as the accumulated interest over time. In other words, it is interest you earn on top of interest, or money that makes you more money.
Still confused? Let’s look at an example:
Suppose you receive a bonus of $5,000. Congratulations! However, instead of blowing it all right away, you decide you want to save the money. So, what’s the best way to save it? Putting the money in a savings account at your bank, you could earn 0.06% in interest year over year. After 10 years, assuming you don’t touch the money, you would have accumulated an additional $30, bringing your total to $5,030. That’s not a lot of growth in ten years, especially considering the inflation rate is between 2% and 3% most years.
If, however, you invested that $5,000 in the market, you would see drastically different results. After diversifying your investments, you could realize a realistic annual return of 7.27%, the average 10-year return of some investment portfolios. After 10 years, your account would have accumulated an additional $5,086, more than doubling your money!
When you are investing for retirement, you should also consider the effect of making annual contributions to your retirement accounts. Let’s look at the effect of saving $5,000 per year. Even if you start with $0, if you save consistently, your results may surprise you.