If you're like most Americans, then you aren't saving enough for retirement, which could be a major problem for you later in life. There are plenty of ways to increase the size of your eventual nest egg, but one strategy is simpler and more effective than the rest.
Some studies indicate that the average American in their 60s has around $200,000 saved for retirement. Others have found results that are even lower, but even $200,000 is not good enough.
A commonly used guideline in retirement planning is the 4% Rule, which simply advises that during each year of your retirement, you should plan to withdraw from your portfolio 4% of its starting value, adjusted for inflation.
So someone with $200,000 saved up can safely take about $8,000 each year from their retirement accounts. Withdraw much more than that, and you run a serious risk of outliving your money. Even worse, given current economic conditions, many financial planners are challenging the 4% Rule, advising their clients to plan on withdrawing no more than 3% per year.
The average monthly Social Security check right now is around $1,600, which adds up to about $19,200 a year. Most people will need a lot more than $27,200 a year to sustain the lifestyle they want in retirement, so they'll need a nest egg that's more than $200,000.
The savings rate is the heart of the problem
To drastically increase the size of your portfolio by the time you reach retirement age, the best thing you can do is boost the rate at which you contribute to it.
Many people focus most on the rates of return that they're achieving on their investments, but that's not a reliable strategy in most cases. The S&P 500 has averaged an annualized rate of return of between 7% and 10% over various long-term periods. A long-term stock portfolio with a decent level of diversification should deliver a similar level of performance, and most people are able to achieve this in their retirement accounts. Talented and dedicated investors may be able to improve upon that, but it's not realistic to expect that you will be able to sustain, for example, a 15% annualized growth rate over the long term.
Conversely, the average personal savings rate in the U.S. is just above 5%. It's much easier to drastically increase your savings rate than it is to achieve a higher rate of return. You have much more control over your own financial decisions than you do over the stock market. That's why it's so important to focus on saving a much larger chunk of your income during working years.
Set a savings goal and measure your progress
It shouldn't surprise anyone that saving more will improve their retirement prospects, but there's a reason that most households are falling short. And one simple overarching strategy will go a long way toward countering that issue.
The best tool for improving your outcome is to set a measurable goal and track your progress toward that goal. This strategy can be transformative because it creates organization and clear guidelines. It can enhance all of the small habit changes that increase the amounts you're saving.
Americans will generally need to save 15% of their annual household income to retire comfortably -- and that's nearly three times what the average household manages. In part, this is because many people don't save in a planned way. Savings are just the money that's left over after bills and consumption, if there is any. That's never going to be the most effective approach.
If you want to switch from saving haphazardly to having a plan, your first step should be to take financial inventory. Review your monthly cash flows and map out where all your money goes after you get paid. There are numerous apps and banking tools that can help with this task. There's a good chance that a lot of your cash outflows each month are going to purchases that aren't really making your life better. The sooner you quantify your expenses, the sooner you can decide which can be trimmed.
This is basically just budget creation. Figure out how much of your income you can comfortably save after covering your basic needs and paying bills, then purposefully set that amount aside to invest every month. Open a separate bank account for wealth creation, and put money into it before you can spend it. At the end of each month, review your accounts to see if you are meeting your own goals.
It's important to set attainable goals for yourself. Many households can't manage a 15% savings rate for numerous reasons. If yours is one of them, start with a smaller goal, then work on some longer-term plans to increase your retirement contributions over time. Maybe you can reduce your cash outflows by refinancing or paying off debt. You might be able to save more in a 401(k). In extreme cases, it might be necessary to reconsider your career path.
There's no one-size-fits-all solution, but numbers don't lie. To have a comfortable, sustainable retirement income, you'll require a portfolio of a certain size, and you can measure your progress toward it each month. Hiding from those numbers can lead to disaster. Instead, use them to empower yourself.
Organizing and tracking your finances might seem like a pain, and it can be time-consuming at first. Eventually, though, you'll get accustomed to the process. And removing some of the guesswork in retirement planning is actually a great way to reduce your financial stress.