Photo: Flickr via proimos
Many Americans don’t know where to begin when it comes to preparing for retirement.Recent research shows that 82% of people are capable of saving more toward retirement, but only 28% of people know what to do.
This gap between the ability to save and taking action can leave people shorthanded when it comes time to retire.
The impact of the action gap is sizable, too. The Schwartz centre for Economic Policy Analysis at the New School in New York City found that 75% of people aged 50 to 64 had an average of $26,395 in their retirement accounts, and many people had nothing at all.
$26,395 is not enough to sustain someone through their retirement as most people need 20 times their annual income in savings to maintain their current lifestyle.
As daunting as 20 times income seems, it’s not impossible to reach. Below we look at 3 actions investors can take now to ensure they have a secure retirement—increase their contributions to a retirement plan, maintain an appropriate asset allocation, and placing their investments in lower-cost funds.
To demonstrate the impact of these actions, we created an example using an investor who is 35 years old, makes $90,000 per year, and who has $20,000 saved in a retirement account. We assumed an average annual return of 5.9%, which is based on the 6.9% annual return of the S&P 500 during March 1997 to May 2011 less 1% to account for the estimated loss incurred by choosing high-cost funds over less expensive offerings. The first action we looked at is if this person did nothing more for the next 30 years. The result is their portfolio value would be $111,663—$91,663 more than where they started.
But what if this investor took action today? Here we outline the impact each action can have on the investor’s bottom line at retirement.
Action 1: Saving 15% of Salary
Increasing contributions to a retirement plan has the largest effect on the money available at retirement. These additional contributions will compound at the 5.9% rate and generate a larger retirement value. Contributing 15% of the investor’s salary generates an additional $1.5 million in retirement funds. That contribution works out to $13,500 in the first year and increases by 3% thereafter as the investor receives raises.
Action 2: Maintaining an Appropriate Asset Allocation
A way to increase returns without costing you anything but minimal time is by maintaining an appropriate asset allocation. Even investors who start out with a risk-appropriate mix of stocks and bonds, domestic and international investments sometimes allow it to fall out of whack over time. Rebalancing—selling investments that have become over-weighted to buy investments that have become under-weighted—can add incremental return over the long run to a retirement account. To demonstrate the benefit of maintaining an appropriate asset allocation, we looked at the time period between March 1997 to May 2011—the same period when the S&P 500 return was 6.9%—and we found that the performance of a portfolio with an allocation of moderate risk would have been 8%. That’s an improvement of 1.1% per year, and that adds $357,218 to the account value at retirement.
Action 3: Reducing Fund Costs
Fees and expenses on mutual funds reduce returns and have a real impact on your net worth. However, investors are often not aware of the costs of the funds they own. Another no-cost way to improve returns is to know what you are being charged and to select funds that are not overcharging. Investors can often reduce costs by 1-2% or more. Our example shows a 1% increase in return, or $403,058 over the investor’s 30-year career.
Closing the action gap is possible. Often it just takes one small step to get started on the path to financial well-being. If investors take all 3 of these actions, the additional money available at retirement can be the difference of living the life you’ve wanted versus finding yourself with not enough to live a self-sufficient lifestyle.Jemstep.com is a free online financial advisor that helps individual investors make better investment decisions and achieve their financial goals faster. A privately owned company with headquarters in the heart of Silicon Valley, Jemstep is a registered investment advisor under the rules and regulations of the U.S. Securities and Exchange Commission. To learn more, please visit www.jemstep.com. For a free, easy way and objective way to find the best investments for you, visit Jemstep.com.
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