Alongside saving up for a house or a car, investing for retirement is many Americans’ most daunting financial goal. Experts recommend that you have at least 10 times your annual salary saved by the time you’re 67. If you make $50,000 a year, that means you’d need to have at least half a million stockpiled somewhere if you ever want to stop working. For many, the thought of accumulating half a million dollars seems unlikely, if not impossible.
As a result, many Americans give up before they ever begin. In fact, the Economic Policy Institute reported in 2016 that the average retirement savings for all working families in the U.S. was a measly $95,776. That’s a far cry from the recommendation of 10 times your annual salary.
How much money you need to retire will vary based on your unique circumstances, such as where you live and how much you make. With just a few simple steps, you can begin to grow your retirement nest egg and ensure you have enough money to retire comfortably. The key is to start now.
Step 1: Start Early
While it’s important to save for retirement no matter how old you are, the younger you begin, the easier it will be to accomplish your savings goals. This is due to the value of compound interest.
If you’re not familiar with the concept of compound interest, the idea is simple. Basically, when interest compounds on the money you put into a tax-efficient retirement account — such as your 401(k) or Individual Retirement Account (IRA) — your money makes money on itself.
The best part: You don’t have to lift a finger.
However, for compound interest to really work in your favor, it needs time, hence the very strong suggestion to start investing as early as possible. To understand why, let’s take a look at how two different approaches to investing for retirement impact how much you could have in the bank at the age of 65.
Erin is a recent graduate who was lucky to get a job in her chosen field of marketing. She decides to start investing $5,000 a year in her company’s 401(k) plan at the age of 25, and continues her investment for 10 years. At the age of 34, she has invested $50,000 in her future. If she were to put no more money aside for the rest of her working life — assuming an average annual compound interest rate of 7% each year — that $50,000 will have transformed into $602,000 by the time she retires at 65.
Larry, a mid-level professional working in the consulting field, decides to wait until the age of 35 to start saving for retirement. Larry invests $5,000 in his retirement accounts every year from the age of 35 until he retires. In total, he will have invested $150,000. While to many this would seem to put him ahead of Erin in the retirement savings game — she only invested $50,000 over the course of her career — Larry will actually have less in the bank when he retires. Again assuming a 7% rate of return each year, Larry will only have $541,000 when he retires. That’s over $50,000 less in retirement, despite contributing an extra $100,000.
As you can see, compound interest is a very powerful ally on your path to retirement. While its powers are increased the earlier you start saving, compound interest will serve you well at any age.
Step 2: Automate
Whether you began saving for retirement during your first year as a working professional or haven’t managed to put away any money at all, there is one key piece of advice we have to offer: Start saving now.
But putting money away may seem impossible. Maybe you find yourself living paycheck to paycheck, with nothing left over at the end of the month. However, take a moment to consider: Is there anything you could go without?
For many of us, small purchases add up to big expenses over time. In the short-term, treating yourself to a $5 coffee on the way to work every morning might not seem like a big deal. But when you consider that a single coffee adds up to $25 a week, $100 a month, or $1,200 a year — it’s definitely significant.
If you instead put that $1,200 into your retirement account every year for 30 years, compound interest could have turned it into $130,000.
While there are plenty of creative ways to save money, perhaps the easiest and most effective way is to automate your savings plan. If your company offers an employer-sponsored retirement savings plan — usually called a 401(k), 403(b), or 457(b) — chances are you can ask your payroll department to divert a percentage of your paycheck toward in your retirement account.
But how much should you save? It’s good rule of thumb is to invest 10% to 15% of your salary each year, but depending on your personal financial situation, that number may be more or less. At the very least, we recommend automating your contributions each year to capture any employer match, as it’s essentially free money.
With an employer-sponsored plan, you may also be able to automatically increase your retirement contributions each year — usually by as little as 1%. While that increase might not seem like much, over the course of your career, it could be the deciding factor in whether you’ll be able to retire comfortably or not.
In fact, according to retirement researchers at Aon Hewitt, more than 70% of employees who elected to automatically increase their contributions each year are on track for retirement — or almost there. Given that only 20% of all workers are prepared for retirement, electing for increased automatic contributions is an incredibly easy way to ensure you’re ready to relax when your working days are done.
But what if you don’t have an employer-sponsored retirement account? Or you want to save even more?
Individual Retirement Accounts, or IRAs, are an excellent option. Whether you choose a pre-tax traditional IRA or a post-tax Roth IRA, these accounts also let you set up automated monthly contributions directly from your checking or savings account. All you have to do is log in to your account once, create the recurring transaction, and you’re on your way to a relaxation-filled retirement.
No matter what type of retirement plan you have, automating the contribution process is perhaps the easiest and most powerful step you can take toward securing yourself a healthy financial future.
Step 3: Make Sure You’re on Track
You’ve started saving — hopefully at a young age — and have automated your retirement contributions. Even if you did nothing else, you’d be in a better financial position than the majority of Americans.
But to really ensure smooth sailing in retirement, you should occasionally make sure you’re on track. Even if you only dedicate one hour every year to reviewing your retirement accounts, that small time investment can pay literal dividends in the years to come.
The primary thing you’ll want to check is whether your current savings rate will allow you to reach your retirement savings goal. There are plenty of articles that can give you a good rule of thumb for how much you should have saved at every age to make sure you’re on track.
Step 4: Maximize Your Return on Investment
If you find that you’re coming up short after checking in on your progress toward retirement, don’t despair. While saving more is always important, there are also several ways you can maximize the return on funds you’ve already invested.
To maximize your return on investment, there are two main factors you can control:
- The diversity of the types of funds you own.
- The management fees charged on your retirement accounts.
If you invest in a 401(k) or similar employer-sponsored plan, you might want to consider a target date fund that will automatically balance your asset allocation on the date you plan to retire. This means that the investment company in charge of your portfolio will adjust the level of risk based on your planned retirement date — for instance, they might place a higher percentage of your funds in lower-risk investments the closer you get to retirement.
About two-thirds of 401(k)s offer this type of investment vehicle to help you ensure you’re on track for retirement. However, keep in mind that these funds can carry high management fees, which eat away at your growth over time. Therefore, you should look for broad based index mutual funds with low fees. We recommend staying away from any investment with a fee higher than 0.66%.
This is why we recommend putting enough into your 401(k) to meet any company match, and then investing the rest into an IRA, which typically has lower fees and more options. Search for low-cost index funds such as those offered by the Vanguard Group, which have one of the industry’s lowest expense ratios for its target date funds that is closer to 0.16%.
While we recommend that you max out any tax-advantaged retirement investments available to you, you may find yourself ready to invest in the stock market on your own.
If that’s the case, we recommend building a portfolio of low-cost exchange traded funds (ETFs), and staying away from actively managed mutual funds, which usually charge fees ranging from 0.50% to 1.5% or higher. If you’re not confident you can make the best decisions on your own, low-cost robo-advisors are an excellent resource to help you build your wealth at much lower costs closer to 0.25% to 0.50%.
Not only are management fees higher, but according to S&P Global, the parent company of the S&P Dow Jones Indices, almost 70% of managed domestic equity funds had lower returns than the S&P Composite 1500 in 2018, and almost 90% underperformed their benchmarks over a 15-year average. In other words, you’re much better off investing in low-cost ETFs.
Step 5: Enjoy Your Retirement
Retirement planning may feel overwhelming at first, but by following a few simple steps, you could be well on your way to enjoying a healthy retirement income when you finally decide to stop working.
As with any personal finance decisions, how much you save each month — and how much you will ultimately need to retire — will depend on your particular situation. But no matter where you are on your retirement investing journey, know that with a few simple steps you can ensure a secure financial future.