Saving for retirement is tough – so tough, in fact, that many Americans haven’t even begun to put away money for their golden years. Still more Americans have some money, but not enough. Not feeling like you can save for retirement is incredibly frustrating, and advice all over the internet differs in how much it recommends you save. How late is too late to save for retirement? How much do you really need to retire?
It’s a pretty stressful thing, retirement, and too many of us get caught up in the complex rules or panic when we don’t meet goals. But here’s the good news and the simplest truth about retirement savings: a little bit saved now means a lot of money later.
Everything you save helps
Even if you don’t have much money, you probably have it in a lot of places: in your bank or credit union accounts, both checking and savings; in stocks and in bonds; and tied up in your assets, like your home or your car. The key to retirement saving is to make sure that at least a little gets from one of these places into your retirement account, such as a tax-free IRA or 401k.
There’s plenty of (and perhaps too much) advice out there about just how much to save, but here’s the reality: the most important thing to do is to start as soon as you can and to at least contribute something. That’s because early savings mean more growth.
The reason tiny contributions matter is because of one of the oldest and most important principles in banking: compounding interest.
Here’s how compounding interest works. Imagine that you put $100 into a mutual fund. Now imagine that you get 10% interest on that money every year (that would be nice! We’re using that large figure because it’s a nice, round number). How much do you earn each year?
Your first thought may be $10, and that’s true – to a point. If you take your interest out and pocket it and leave in your principal – the $100 – you’ll make $10 every year. But that’s not how your retirement fund will work, because you’re not going to take out anything you earn (right?). Instead, you’ll make $10 the first year and leave it in. So the following year, you won’t earn 10% on $100 – you’ll earn 10% on $110. That would be $11, of course, so you’ve made $1 more than last time (a 10% increase in earnings, as it happens). The year after that, you’d earn 10% of $121, so you’d net $12.10. The next year, you’d make $13.31, and so on.
In this way, money left on its own in a sound investment will keep on building on itself, eventually generating a pretty tidy nest egg even if you haven’t been putting in huge amounts of money. The key is to simply put in some money, as often as you can, and to let the money sit for as long as possible without spending it.
Compounding interest is the single most important concept in retirement savings, and the simple advice we started with – put at least something away as often as you can – is the most important place to start when saving for retirement. But, of course, some situations can grow complicated. If you’re behind on your retirement savings, putting in any amount of money will help, but may not save the day.
For advanced retirement problems like this, it is worth investing in help. Turn to a financial planning professional to learn more about the specifics of retirement planning, including just how to invest your money, how to catch up on a retirement fund you started late, and how to budget once you’re actually retired.