best way to save for retirement

Here’s the Best Way to Save for Retirement

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Simply put, Americans are not saving enough money for retirement.

The Federal Reserve (our nation’s central bank) published a report (“Report on the Economic Well-Being of U.S. Households in 2016”) highlighting that American's don't know the Best Way to Save for Retirement:

  • Over 1 in 8 of Americans struggle to pay their bills each month
  • Half of Americans spent more money than they made
  • Nearly 1 in 4 Americans cannot pay their current monthly bills completely
  • Almost half  of Americans would not be able to cover an emergency costing $400
  • Most Americans with 401Ks, IRAs, or other retirement savings are not comfortable with how to make the right decision with their investments
  • Almost 1 in 3 of Americans have no retirement savings!

The need to save is no secret, but as the statistics above show, saving is not easy. It’s actually really hard! How can one expect to save for retirement, if you need 25x my annual expenses to retire?

Saving Money Is Hard

One reason saving is hard is that it’s not prioritized or sometimes pushed into the future; “I’ll start saving when I get that raise” or “it will be so easy to save when I get that promotion at work.”

Finding the best way to save for retirement quickly becomes an afterthought. Especially when your friends and family may even try to dissuade you from saving by saying things like “you have to enjoy life” or “you can’t take all that money to heaven.” But let’s be honest, there is some truth to that. Life should be enjoyed, but one thing we’ve learned is that while money can’t buy you sustained happiness, not having enough and being in debt can lead to sure misery.

Watch out for lifestyle creep!

The issue we have with the first few statements above is that when people begin to earn more money, they often allocate that money to new expenses before they save or invest in their own retirement. As soon as the raise or bonus comes, people start thinking about the new car or the kitchen remodeling they’ve been waiting for. This is called ‘lifestyle creep’ because your expenses slowly creep up with your wages so that you barely realize it and you wonder where all your money is going.

Just like spending more than you earn is on one end of the spectrum, so is saving everything and not spending any money. We think you can achieve a balance where not only can you adequately save for retirement, but you will not feel like you are missing out on the fun things in life. In fact, we think living purposely will make happier than ever before!

Although it is true that you can’t take your money with you once you die, the whole point of saving for retirement is not to die surrounded by piles of cash. The purpose of saving for retirement is to USE the money so you can sustain the SAME (or better) quality of life once you are no longer working. Or so that you don’t have to work until you die.

But if I am going to earn a much higher salary later in my career doesn’t it make sense to wait and save more later?

For most people, absolutely NOT. While this seems like a logical idea, this fails to take the power of compound interest into account. 

What is compound interest or compound growth?

Compounding just means earning money on money already earned. If you save and invest for retirement, the money you save will not only grow as you save more, but will also grow as you earn profit on your investment. The longer you have your money invested, the faster it will grow. The profits will begin to earn profits.

For example, if you save $100 and earn a return of 10% annually, in year 1 you will earn $10. This is because $100 x 10% = $10. However, in year 2 you will earn a profit of $11. That extra $1 earned is due to compounding since you earned 10% on $110. In year 3 that profit jumps to $12. In this example, it is clear that without making any changes putting more money into the investment, you earn more every year just due to compounding.

This is what gave birth to the investment saying “Time in the market always beats market timing”.

Why should I care about compounding?

  1. The sooner you start saving and investing, the more money you’ll have.
  2. To end up with the same amount saved at retirement, if you start earlier you can save less and still end up ahead

So, what's the best way to save for retirement?

By far, the best way to save for retirement is to start saving early and saving regularly! Once you start saving, you'll want to focus on commonly used retirement accounts like 401(k)s and IRAs because of the tax advantages that they have. Once you're ready to start picking your investments, the best choice is to find the lowest fee index funds you can find. Some of our favorites are listed here.

If you are ready to see the power of time and compounding in action here is an example for you. Take a look at the table below, which demonstrates how much identical twins, Jordan and Madison, saved for retirement. This example was done with a 8% annual rate of return.

Best Way to Save for Retirement

Breaking Down Their Retirement Savings

Jordan and Madison were born on the same day, have the same job, and plan to retire the day they turn 65. But clearly one of them found the best way to save for retirement! Jordan starts saving money right away in her retirement account for a total of 10 years, while Madison decides to start saving once she is a bit more established and can comfortably save without having to make any sacrifices.

While Jordan contributed $50,000 ($5,000 for 10 years), Madison put in  a whopping $150,000 ($5,000 for 30 years)! Despite saving only 1/3 of what Madison did, Jordan’s retirement savings are 50% more than Madison’s. If Jordan would have kept saving the same $5,000 for her entire working career, this single account would have ballooned to over 1.6 million dollars! That is the power of compound interest. As you can see, starting to save early is super important!

best way to save for retirementIf you want to be like Jordan, it’s time to get started. Whether you are early in your career or in your prime working years, the best time to start saving is now. Do not worry if you didn't start saving when you were 23, because there's nothing you can do to change the past. Just set your sights on the future and start your financial plan!

If you want to learn more about commonly used retirement accounts, read our posts on 401(k)s and IRAs.

Comment below if you have any questions or comments about the best way to save for retirement! Let us know what sacrifices you’re willing to make to start saving sooner!

Source(s):

https://www.federalreserve.gov/publications/report-economic-well-being-us-households.htm

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