This Is Your Biggest Enemy When Saving for Retirement

When it comes to retirement, saving money is generally not enough; you will likely need to invest it to ensure you have enough to live comfortably in your later years. With banks offering historically low rates, here is your biggest enemy when it comes to saving for retirement.

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The interest rates are not ideal

While a savings account serves a valuable purpose in your financial planning -- mainly as a place for your emergency savings (three to six months' worth of expenses) -- it shouldn't be the primary place to put your retirement savings. If you're wondering why, look no further than the interest rates offered on savings accounts.

As of December 2021, the average interest rate on U.S. savings accounts was 0.06%. That means if you held $10,000 in the account for a full year, you'd only have $10,006 at the end. While any gains are better than none, making $6 a year on $10,000 is far from ideal.

You need to keep up with inflation

2021 was one of the worst years for inflation that we've seen recently, with a 7% increase, the highest since 1982. For consumers, this means $1 at the beginning of the year was roughly worth only $0.93 at the end. While the impact might seem small when examining it on a dollar level, the table below shows the change in the purchasing power of retirement savings from January 2021 to December 2021.

Data Source: Calculations by author 

Although a 7% annual inflation rate is far from normal, you can expect inflation to rise between 1% to 3% a year, generally speaking. That means if your retirement savings are not at least earning that much annually, they're losing their purchasing power. And that will make it harder for you to retire as comfortably as you'd like, especially with the low rates on traditional savings accounts.

You may be tempted to dip into your retirement savings

Unfortunately for most people, it's way too easy to access the funds they have in their savings account, especially if their checking account is with the same bank. With most banks having a mobile app, it can be tempting to simply move money from your savings to your checking account whenever you want to make a purchase you couldn't otherwise afford.

Retirement accounts, such as a 401(k) or IRA, have limitations and penalties in place to deter you from withdrawing from your account before retirement. For example, an early withdrawal from a 401(k) will result in income taxes being owed, as well as a 10% early withdrawal fee. Depending on your tax bracket, that could result in receiving only around half of the intended amount.

Investing for retirement doesn't have to be complicated

You don't have to be a professional investor or money manager to efficiently invest your money for retirement. For most investors, investing in an index fund like the S&P 500, which has historically returned 10% annually, should suffice and make saving for retirement much more lucrative.

If you save $500 monthly for retirement for 30 years, the difference between a savings account with 0.06% interest versus an index fund that returns 10% is over $800,000.

Data Source: Calculations by author 

While any amount of saving for retirement is a good thing, there are ways to go about it that ensure you maximize your savings and put yourself into a position to accomplish your financial goals and thrive in retirement.