This guide provides you with a simple, step-by-step process for how to automate retirement saving.
Saving for retirement can incredibly complicated. I'd like to share a very simple system that's worked for me, and I hope it helps you too. The goal is to be able to put together a plan for saving for retirement that allows you to save enough money, that's simple, and that's completely stress-free. The main keys to this system are:
- Start as Soon as Possible
- Choose a Low-cost, Target Date Retirement Fund
- Set Up Automatic, Monthly Contributions
- Start Small and Ramp Up
- Relax and Let Your Money Work for You
So when should you start saving for retirement? The short answer is that you can't start saving too early. In fact, the longer you want, the more you'll have to save each month to have a comparable retirement income. You're not only catching up with the money that you could've put aside, but you're also having to catch up with how much that money has grown from investing.
One misconception that many people have is that when you save for retirement, you're just putting it away for a while. They have a vague notion that the money will grow but don't actually understand or appreciate the truly awesome power of compound interest.
Want to see how much money you might be able to have? I made a simple tool to calculate it here:
Let me give you an example to illustrate how much the time factor plays into retirement.
Suppose you're 40 years old and invest $1,000 into an account that earns 7%. At age 60 that $1,000 would be worth $3,869.68 - not too shabby, you've made almost a 4x return on your money over that time.
However, let's say you invested that $1,000 when you were 30. At age 60, that $1,000 is now worth $7,612.26! Whoa - almost double.
Taking it a step further, what if you were 20 years old? You've now got $14,974.46 for your initial $1,000 investment - nearly a 15x gain on your money!
Here's a comparison showing you what that $1,000 is worth depending on the age at which you start.
The other reason to start as soon as possible is that inflation will erode your money over time if it's not invested. Inflation is the increased cost of goods and services over time. To put it another way, things get more and more expensive over time. $1 today is not worth $1 a year from now. So, if your money isn't invested in something where it's growing, you're actually losing money!
The average inflation rate from 2006 - 2015 was just under 2%. So, let's take 2% as an example here and look at what that $1,000 is worth when you're 20 to when you're 60 if you figuratively stuck in under a mattress and didn't invest it anywhere:
Ouch - it's lost more than half of its value ending up at about $446. By investing your money, you're not only growing it to use later in retirement, but you're protecting it from being eaten away at the same time.
Okay, so we've established how important it is to save for retirement, what are we actually going to invest the money in? They key here is to keep it simple. We're not going to try to set up a super fancy strategy with many moving parts and investment products we don't understand. We're not going to speculate and try to buy individual stocks or "time the market."
Instead, we're going to choose a low-cost, target date retirement fund and start feeding it over time. Ya, I know, it's slow and boring, but you know what? It works! And that's what's important.
So what is a target date retirement fund anyway?
A target date retirement fund is an account you can open that uses the money you put into it to purchase a mix of stocks and bonds (it's a little more complicated than that, but I'll keep it simple here - that is, after all, the goal). The way it works is that you select the year that you will hit retirement age, and that particular fund will automatically adjust the mix of stocks and bonds over time. This way, in the earlier years, you'll take more risks, but make more money, and as you get closer to retirement age, you'll take fewer risks, but get more consistent returns. It also has very low costs because it's mostly automated. It really is a "set it and forget it" type of product.
So what's a stock?
Generally speaking, when you purchase a stock, you're buying a percentage of a company. By holding that stock, you're entitled to a portion of the profits that it distributes to owners (a dividend) and the increase in the value of the company over time. Stocks are generally high risk but have a high return.
Ok, what is a bond then?
A bond is essentially a loan. You're lending money for a certain percentage return. As long as the organization that borrowed the money doesn't default, you'll continue to earn interest on the bond. Bonds are generally low risk but have a low return.
How do I set one up?
Many institutions offer target date retirement funds. A few of the larger ones are:
You can also go with a "robo investor" like Betterment, which is essentially the same concept but is a bit more sophisticated.
The key to making this work is to set up automatic, monthly contributions into your retirement account. You don't want to have to worry about it, and you want automation and consistency. This does a couple things for you.
First, it balances out all of the highs and lows of the market and gets rid of the "timing" element (a fancy term for this is called dollar cost averaging). The idea is that it's always a good time to be in the market. When stock prices are up - you're good, the value of your portfolio is doing well. When stock prices are down - you're good, everything is on sale this month. Consistently being in the market makes sure that you don't miss out on the growth of the market.
Second, it makes sure that you're "paying yourself first." If the money is automatically withdrawn from the account, it's as if it wasn't there in the first place. Once you get this plan in action, and if you start small, you won't notice the money going into the retirement fund at all. It's a concept called forced scarcity and is also an excellent way to help budget.
Okay, so we've established how important it is to save for retirement, and how to do it, but how much do I need to save for retirement? It may seem like an incredibly daunting task, but as the ancient Chinese philosopher Lao Tzu said, "A journey of a thousand miles begins with a single step."
So, the simple answer is: do what you can. If money is tight, start out with $20 a month, if you can afford more, to begin with, do it. Everyone can afford to save something - even if it's a small amount. As you get older and progress in your career (hopefully), you should be making more money. Make sure to increase the amount you put away as what you take home increases. Never decrease your contribution unless it's an absolute emergency - you want it always to go up or at the worst, stay the same.
Want to see how much you'll have in retirement based on your age and how much you save per month? I built a retirement calculator you might find useful.
Once you've got this system in place, it's important to relax and step away - that's the real power. The market will go up and down. You may see news of big gains or big losses, but none of that really matters. You truly have the freedom to just "set it and forget it."
Be content knowing that while you're out living your life, even while you're sleeping, your money is out there working for you.
Thanks for Reading!
I hope this has been super helpful and informative for you. Please do me a favor and share this on your favorite social media site or link to this article from your website or blog if you have one.