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Boost Your Nest Egg in 3 Easy Steps

By Todd Campbell - Feb 20, 2016 at 7:20AM

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Here are three simple decisions that can lead to greater financial security in retirement.

Source: Flickr user taxcredits.net.

More than half of Americans between the ages of 55 and 64 have no retirement savings. As a result, the Employee Benefit Research Institute reports that less than one in four workers are very confident they'll have enough money to live a comfortable retirement. Will you be one of them? Read on for tips that you can use to help increase the value of your retirement savings.

No. 1. Give yourself a raise
The average American worker received a 2.8% raise last year. According to a recent survey by Mercer, the average pay raise this year will be 2.9%. That's not a lot of extra money, but if you plan wisely, you could turn it into a big pile of retirement cash.

How? By leveraging the law of compounding interest, or the ability to earn interest on interest year after year. Here's how it works.

Imagine you invest one dollar, and that one dollar earns a hypothetical 10% return in year one. At the end of year one, you would now have $1.10. Earn another 10% return in year two and three, and your initial $1 would grow to $1.33. Because your interest earned interest in the following years, your $1 investment would be 33% bigger, without adding additional money out of your own pocket.

Now, imagine how big of an impact compounding interest could have on your savings if you increased the amount you invest every year by the same amount of your pay raise. The benefit could be substantial.

For example, investing $3,000 every year in something earning a hypothetical 6% annual return produces a nest egg of roughly $245,000 in 20 years. Not bad, right? However, increasing that annual contribution by 2% per year results in a portfolio worth $304,000, or almost $60,000 more!

2. Embrace IRAs
Just because you participate in a retirement plan at work doesn't mean that you can't also contribute to a retirement plan on your own. Traditional and Roth IRAs allow people whose incomes are below certain limits to enjoy significant tax benefits that can lead to bigger retirement nest eggs, too.

If you're married, filing jointly, and participating in a retirement plan at work, you and your spouse can earn up to $98,000, and still make a tax-deductible contribution of $5,500 ($6,500 if over 50 years old) to a traditional IRA. Investment earnings in a traditional IRA grow tax deferred, and are taxed when they're withdrawn in retirement.

If that same couple doesn't qualify for a traditional IRA, or prefers to contribute after-tax money instead of pre-tax money in order to receive tax-free income in retirement, they can consider investing in a Roth IRA instead. In 2016, married couples filing jointly can contribute $5,500 ($6,500 if over 50 years old) to a Roth IRA as long as their modified adjusted gross income is below $184,000..

Let's assume Jim and Kathy are 37 years old, earn $100,000 per year, and contribute 6% of their annual earnings to a workplace retirement plan, or $6,000 per year. If Jim and Kathy's investment earns 6% annually, they would retire with an account valued at about $490,000 in 30 years.

That's a solid nest egg, but if they also contribute $5,500 to a Roth IRA every year, they'd have an additional $448,828 in savings! Because Roth IRAs don't require withdrawals (traditional IRAs require that withdrawals begin at age 70.5), Jim and Kathy can live off their workplace retirement savings and let their Roth IRA keep growing, or they can tap the Roth IRA for retirement expenses, too.

3. Dollar-cost averaging
Lenders recognize that they're more likely to get their payments on time if borrowers enroll in automatic monthly payment plans. By the same token, it's more likely you'll stick with your savings plans if you automatically invest at regular intervals (such as monthly), too.

Automating your investments reduces the risk that you'll deviate from your investment plan during bear markets. Therefore, they help protect you from making emotional decisions that could derail your financial security in retirement.

Automatic investments at specific intervals also provides investors with additional benefits associated with dollar-cost averaging. Because predicting market tops and bottoms is a fool's errand, contributing at specific intervals spreads your investments across both good and bad times. Thus, it can help keep your average cost below the market price.

Consider this point: The average month-end price for the S&P 500 ETF (SPY 1.06%) over the past 10 years was $131.41. Despite that period including the Great Recession, that price is still far south of the ETF's current value.

Still not convinced? Consider the following chart. It shows how investors may have done if they attempted to time the market, rather than invest at specific intervals, and ended up missing some of the market's best-performing days. If an investor missed just 10 of the best days between 1993 and 2013, he or she would have roughly half of the savings of someone who remained fully invested. 

 

DATA SOURCE: SEAN WILLIAMS AND JPMORGAN ASSET MANAGEMENT USING DATA FROM LIPPER.

Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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