By Robb Engen, Boomer & Echo
Special to the Financial Independence Hub
One of the core tenets of financial planning is to pay yourself first. Automating your savings is a painless way to save for retirement and, in all likelihood, you’ll barely notice that you’re living on less.
Most experts suggest putting away 10 per cent of your income for retirement, but that number might seem out of reach for many people today. The key to developing good savings habits, however, is that you need to start somewhere.
That’s why I suggest setting aside what you can afford, be it three or five per cent of your income, and try to increase that amount every year.
Small changes lead to big improvements
Before we had kids I used to go to the gym at least three or four times a week to lift weights. After our first child was born, I stopped going to the gym and never got back into the groove.
Now that I have a bit more free time, I started working out at home. My strength was nowhere near what it was five years ago, but I knew I had to start somewhere. I could barely do 10 push-ups, but I kept at it every day, eventually working up to three sets of 30.
Take the same approach with your retirement savings. If the thought of saving 10 per cent of your income seems like such a daunting task that it’s preventing you from getting started, tone it down and start with a smaller amount, increasing it over time.
Most retirement calculators assume that you save a fixed amount every year and that number doesn’t grow with inflation.
According to Talbot Stevens, author of The Smart Debt Coach, inflating a monthly savings plan by two or three per cent a year might not sound like much, but it’s a truly painless way to make a meaningful increase in the size of your retirement fund.
John is 25 and earns $50,000 per year. He decides he can afford to save $250 per month ($3,000 per year) toward retirement – that’s six per cent of his income.
The conventional “pay-yourself-first” approach doesn’t assume any increase in that amount over time, and so after 40 years of saving $3,000 per year John will have $480,000 saved for retirement. Not bad.
How much would John have if he simply increased his savings rate with inflation? An annual increase of just two per cent would mean an additional $145,000 at retirement – or $625,000.
“As this example shows, big improvements come from small changes applied consistently over time,” said Stevens.
Will John miss the additional $60 or so that gets funnelled into his retirement savings every year? Not likely.
In his book, Stevens explains that one of the big challenges to saving for retirement is that if the task seems too difficult in any way – too much of a sacrifice, too complicated, or too much effort – many people throw up their hands and don’t even try.
I know that if my goal was to do 100 push-ups a day, I would have given up after the first day. I had to start small and build my strength back up over time.
That’s why, while it’s important to start the habit of savings, it’s much easier to start small and increase slowly.
Do you try and increase your savings rate every year, matching it with your salary increase or otherwise?