Spooked By Market Turmoil? Focus on Saving Instead
Given how the media celebrates every time the stock market rises and portends doom every stocks drop, you could easily think that savvy investing is the surest route to a secure retirement. It’s not.
Don’t get me wrong. Investing is important and you want to earn a solid return on your investments. But when it comes to building a nest egg for retirement, your primary focus should be finding ways to save as much as you can.
Here’s an example. Let’s assume you’re 30 years old, earn $45,000 a year, get 2% annual raises and save 8% of your salary every year in a 401(k) or similar plan until you retire in 35 years. If you earn a 7% annual return on your investments, you would have just under $645,000 for retirement at age 65.
Now, if you wanted to increase the size of your nest egg—and who wouldn’t?—you could try steering your money toward investments that deliver a higher return. And, indeed, if you found investments that paid, say, 8% a year instead of 7%, you would end up with roughly $795,000 at 65, an increase of $150,000.
But is that realistic? Squeezing an extra percentage point or two of return out of your savings may not seem very difficult. And it wouldn’t be if you were starting from a portfolio of low-yielding money-market funds, CDs and bonds.
But if you’ve already got your savings in a mix of stocks and bonds that’s appropriate for your age and risk tolerance your chances of boosting your return without also taking on significantly more risk are low. You can’t just order up higher returns. To get higher gains, you’ve also got to take on more risk, which increases the setbacks your portfolio will encounter from market turbulence throughout your career. As a result of that higher risk, you could end earn only slightly more than you expected. And if your riskier investments flame out, you could get even less.
But there’s a better, safer strategy: save more money.
Remember that $795,000 you’d have by saving 8% and earning 8%? Well, if you continue to earn just 7% but boost your savings rate to 10%, you’d end up with just over $805,000 by retirement. And if you ratchet up your savings rate to 12% (perhaps by taking full advantage of an employer match in your 401(k)) and earned 7%, you’d end up with just under $1 million.
And while nothing is certain, you would be more likely to achieve those higher balances by boosting the amount you save than by counting on a higher rate of return that would involve taking on more risk and may not even materialize.
I’m not saying that smart investing isn’t important. You do want your retirement savings to grow. But once you’ve got a reasonably diversified retirement portfolio, it’s very tough to earn more return without subjecting yourself to a potentially devastating downside.
Saving more, by contrast, is a much surer way to boost the eventual size of your nest egg. After all, while you don’t have total control over how much you save, you certainly have a lot more say over the lifestyle you choose to live and how much you decide to save than you do over the returns the financial markets deliver, which is no say at all.
And boosting the amount you save has one more benefit: the more you sock away, the more conservatively you can invest to build the same size nest egg. Which means you won’t have to worry as much each time the market takes a dive.
Bottom line: Don’t let your retirement security hinge on taking big risks to rack up outsize gains that may never materialize. If you really want to improve your chances for achieving a comfortable retirement, look for ways to increase how much you save. (7/18/14)
Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at firstname.lastname@example.org.