Source: Wikimedia Commons user Moritz Wickendorf.
It is often the most boring and obvious lesson that is the most valuable -- and the hardest to apply to real life. This is why we roll our eyes when we read things like "Set aside some of your income for savings" or "Stop eating processed food." Surely there's a better, sexier, more exciting answer somewhere!
Unfortunately, those boring and difficult-to-execute solutions tend to be the most effective. Cutting back on expenses and saving more, much like cutting back on calories and exercising more, may not be fun. A recent report demonstrates the value of such a boring approach. It's not about ingenious portfolio allocation, incredible financial acumen, or even a high income.
It's simple: consistency
The Employee Benefits Research Institute, a behemoth of retirement research, looked at millions of 401(k) participants who saved consistently from 2007 to 2012. The people who qualified to be in the "consistent savers" sample accounted for just 34% of the 2007 database. Yes, this was during the recession, when a lot of people lost their jobs or experienced some other form of financial distress, but the number of people interrupting their savings is nonetheless far too high.
For the minority of savers who kept at it, the benefits were substantial. By the end of the five-year period, the average consistent saver's account balance was 67% higher than the overall average 2012 account balance.
The average account growth rate for consistent savers was almost 7% per year, including appreciation and new contributions. Younger savers, or those in their 20, saw average account growth of over 40% per year (partly because contributions to a small account make a much bigger difference than contributions to a large one).
Put it in numbers. Say you save $5,000 in your retirement account every single year for 10 years, earning an average annual return of 8%. At the end of the decade, you'll have $78,230. Now pretend you only contribute the $5,000 every other year -- after all, you have other things to spend money on. Your ending balance? A paltry $37,600. Even if you only skip every third year, your ending balance would still be only $54,000. I don't know about you, but I'd say the promise of $78,000 makes skipping a year seem like an incredibly bad idea.
It's typical salt-of-the-earth advice: totally obvious as a hypothetical but incredibly wise once you actually follow it.
This isn't exactly news
The importance of saving consistently might be painfully obvious, but sometimes it's the obvious things that are the hardest to do. Between 401(k) loans or distributions, job transitions, and sheer procrastination, it's easy to become wildly inconsistent in our savings habits.
And if we want the benefits of a consistent savings habit -- that is, tens or hundreds of thousands of dollars more in retirement -- we have to change.
How to be consistent
As a wildly inconsistent person performing this research, I have discovered three key conclusions.
First, automation is your friend -- your best friend. It has never taken me more than five minutes to automate a financial transaction, and that includes the time I needed to change my 401(k) deferral with HR. Once something is automated, you pretty much never have to think about it again. The money just goes where it's supposed to, and you never know the difference. It's beautiful. It works. Whether you're sending money to a savings account, your 401(k), or an IRA, just automate it.
Unfortunately, the second lesson is that even automated things have to be recalibrated once in a while. This is painful, because I, for one, hate revisiting things I've already addressed. Too bad. Pick a day and make it the day to increase your deferral, reroute some money to an IRA because you've maxed out your 401(k) contribution, or rebalance your portfolio because some of your investments are simply tearing it up. (Best advice I've seen: if you get a raise, increase the deferral by that amount. You'll never miss it.) Put that date on the calendar and don't miss it.
Note: If your 401(k) doesn't have auto-escalation, schedule your day for December or January -- i.e., before you fritter away your bonus and/or your New Year raise.
The third conclusion: You must ruthlessly keep investment fees to a minimum and be positively smug about avoiding lifestyle inflation with every raise. Be the self-controlled type who makes everyone say, "Whoa. You are totally going to be a millionaire." (By the way, this kind of person is also considered highly attractive in romantic scenarios.)
Start soon enough and save enough every year -- consistently -- and someday you could even achieve millionaire status. And who doesn't want to have the last laugh because they can afford a throwback purple Cadillac while others are stressing over the bills?
