Saving Money: How 40% of the Nation Is Doing It Wrong

Source: Flickr user Justin.

The fact that the United States is an economic superpower is beyond dispute.

There are a number of things Americans simply do really, really well compared to the rest of the world. The U.S. is leading the world in high-technology products, it's the leading stomping ground for corporate investors, it's home to the world's most followed stock exchanges, and it lays claim to 17 of the world's top 20 universities, according to a survey by Jaotong University.

Where the U.S. falls far short
But, for all of the United States' glory, we really, really stink when it comes to saving money.

According to data from the U.S. Department of Commerce found at the St. Louis Federal Reserve, the July personal savings rate was just 5.7%, up 0.3% from the 5.4% savings rate reported in May. Admittedly, this is considerably higher than the sub-2% savings rate of nine years ago, implying that consumers are being a bit more prudent with their paychecks lately.

U.S. personal savings rate. Source: St. Louis Federal Reserve. 

Yet U.S. savings rates are abysmal on a historical basis. Between 1999 and 2008 the Eurozone countries averaged an 8.93% household savings rate. Over that same time span, American households managed to sock away just 2.83%!

This lack of savings is a potentially huge problem because it could 1) put families at a severe disadvantage if the economy dips into recession and they have no emergency savings to fall back on, and 2) hamper people's ability to retire on their own terms. Generally speaking, the earlier you start investing, the more you can use the power of compounding gains to your advantage. Individuals and families who aren't saving are potentially leaving huge long-term investment gains on the table.

Saving money: 40% of the nation is doing it wrong
This leads us to Bankrate's recently released monthly personal-finances report, the Financial Security Index. For the month of August, Bankrate surveyed 1,003 people and asked them at what age they began saving for their retirement. As you can see below the results were all over the place.

Graph by author. Data Source: Bankrate August Financial Security Index.

Although Bankrate highlighted the fact that college graduates were more than twice as likely to begin saving for retirement in their 20s as people without a college degree, I think the much bigger "highlight" is the cumulative 41% of respondents who haven't started saving, never plan to retire, or started saving in their 50s or 60s.

Using Bankrate's return-on-investment calculator, I created the following hypothetical but reasonable scenario to show the power of saving as early as possible:

• All persons start with an initial investment of $0.
• All persons contribute $1,200 annually to their investment portfolio ($100/month).
• The annual rate of return on their portfolio is 7%, which is fairly conservative relative to the stock market's long-term gains.
• All persons pay a tax rate of 15%.
• All persons retire at age 66, currently considered the full retirement age by the Social Security Administration.

Under this scenario I ran return-on-investment calculations for people who began investing at the ages of 20, 30, 40, 50, and 60. Here are the results: 

Source: Bankrate return-on-investment calculator, author's hypothetical figures.

As you can see, putting away just $1,200 a year beginning at age 20 and netting a 7% return can land an investor close to $284,000 upon retirement at age 66. More impressively, more than half of the final investment total is comprised of compound interest. By waiting just 10 years longer to begin saving and investing for the future, this investor would be leaving nearly $134,000 on the table -- and, the last time I checked, $134,000 wasn't chump change!

The lesson here is that time is on your side, and the earlier you can begin saving and investing for your future, the better your chances of retiring comfortably and on your own terms.

Source: TaxCredits.net via Flickr.

Easy ways to boost your retirement portfolio
Because time is of the essence, there are a number of things that working Americans can do now that will likely boost their future returns.

To begin with, if you have access to a 401(k) plan at your place of employment and your employer matches your contribution up to a certain point, you're doing yourself a disservice if you're not contributing enough to get the maximum employer match.

Just as we saw in the hypothetical savings example, the value of compounding gains from employer-based contributions can result in huge dollar differences when you retire. As of 2011, according to research from the Investment Company Institute, 51 million American workers were active 401(k) participators, so the chances are decent you, too, could benefit from employer-matching contributions. 

Secondly, consider how you're investing. While the urge to hold on to your hard-earned money by purchasing safe-haven investments like bonds and CDs can be strong, CDs and bonds may not always outperform inflation. In other words, even though you're making money on a nominal basis, you could be down in real-money terms once inflation is factored in.

Although there's nothing wrong with allocating some of your retirement funds to CDs and bonds, you should seriously consider remaining invested in the stock market over the long haul. Sure, the market will have its natural hiccups every so often, but overall, the stock market has been a stellar investment vehicle, returning anywhere from 8% to 10% on average per year historically. At this sort of growth rate, an investor could double their nest egg in less than 10 years, which could come in handy, considering that people are living longer than ever and could need their nest eggs to extend well beyond age 66.

Finally, investors -- especially younger adults -- should consider taking advantage of the benefits afforded by a Roth IRA. Though Roth IRAs do have income contribution limits (and you'll want to check to see whether you qualify to make a contribution), a vast majority of working Americans could likely benefit by opening a retirement account and maxing it out annually. Roth IRAs are particularly attractive because all money contributed (a maximum of $5,500 per year for those under age 50 or $6,500 for those aged 50 or older) is allowed to grow completely tax-free so long as you don't make any non-qualifying early withdrawals.

Consider for a moment the difference of having to pay tax on your stock gains at retirement versus having your nest egg locked up in a Roth IRA. Based on our previous hypothetical example of a 20-year-old who started with nothing and contributed $1,200 per year to an investment portfolio, his or her take-home at age 66 would be $283,709 after taxes. If no taxes were paid, as would be the case in a Roth IRA, that same investment would be worth $393,869 by age 66 -- an increase of more than $110,000!

The tools for a better retirement are at your disposal. You just have to act by saving now and investing for your future.