Back in the 1970s at about the time the pocket calculator and VCR were released and Star Wars first hit movie theaters, Americans saved over 10% of what they earned. So, one in ten dollars they earned was not spent, but went towards saving, likely for retirement. That made sense. You work for roughly 45 years, and then you retire for approximately 20. Since retirement is approximately half of your working life, it appears sensible to put together a nest egg to prepare for it, with growth in the money you save helping grow those savings over time.
However, since then the savings rate has more than halved and it’s now below 5%, so now less than 1 dollar in twenty goes toward saving. A lot of factors play into this, but with such a big change, it’s clear Americans are less well prepared for retirement. In part, that’s why we see Americans working longer, often not by choice but by financial necessity. The outlook for America is not good if retirement savings do not improve. This may be why the MyRA initiative was recently announced in the 2014 State of the Union to help Americans start saving for retirement.
There are several things you can do to better prepare for retirement. The first is to start saving, assuming you’re not substantially in debt, if you are in debt, paying it down is likely the best option before starting to save. Like many things in life, the earlier you start saving the easier it is. One tip for saving is to save most of any pay rises you receive via automatic deduction from your paycheck. You’ve been able to live on the paycheck before, so rather than spend the pay rise, save it. If you do this over time, you will gradually increase your savings rate without feeling the effects in terms of having to cut what you spend. Saving unexpected money like tax refunds can also be a helpful way to save. It also helps to look for ways to save that have preferential tax status such as IRAs or 401(k)s using these options can help lower your tax bill and increase your savings as long as you’re sure you can invest the money for the long term. 401(k) matching can also be a very helpful way to save if your employer offers it.
In terms of how to save, a number of online sites, such as FutureAdvisor, can help you work out a sensible portfolio online for free. The core of long term saving is to consider investing in a broad selection of stocks across companies, industries and countries. Going back over 100 years in the US, stock markets have proven a good place to invest, with an annual return of approximately 6% a year. 6% may not sound like much, but that doubles your money every 12 years. However, this strong long term return from the stock market also comes with risk, in bad years the stock market can fall as much as 40%. That’s why it’s also helpful to diversify into other investments such as bonds, real estate and inflation protected securities. It’s also important to pay close attention to any fees you pay, recent research has shown that the difference between high and low fees can cost you up to 20% of the amount you invest for retirement.
American isn’t saving enough, but you can do better than that, by looking at ways to divert money from your paycheck as it grows to put it toward retirement, and thinking about a diversified and tax efficient way to invest that money for the long term.