The 10-Step Staircase to a Comfortable Retirement

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The secret to saving enough for retirement is simple. Start early and increase the amount you save over time. For many people the hardest step on the journey is that first one. Think of saving for retirement as climbing a staircase. Step One is to save enough money each year to receive the full employer match available to you under your company 401k plan. Often, this is around six percent of salary. (See also: How to Make the Most of Your 401k.)

Why is this step so important? One, it gets you in the game. Two, the employer match is free money. Depending on the generosity of your company plan, the employer match could equal anywhere from a 25 percent return on investment to a 100 percent return. Nowhere else in the investment universe do you find returns like this so easy to attain.

In order to get started, you may need to construct a budget and cut some expenses. Two of the usual suspect categories are a) “walking around money,” the kind you withdraw from an ATM or put on your debit card, and b) take-out food. Master these two categories and you will save enough to get started.

One Step a Year

Once you are saving something, plan to increase the amount you save by one percent a year. Make a pact with yourself that you will do this like clockwork every year for ten years, until you are saving 16 percent of your salary. Think of it as climbing a staircase one step at a time, one step per year. If you start saving six percent a year at the age of 30, you will reach your goal by the age of 40. By that time, in comparison with the average saver, you will be at the top of the class.

This regimen may not make you rich in retirement, but it should easily put you easily in the top 10 percent of American savers. According to the 2008 Employee Benefit Research Institute survey, Americans in their 40s with a job tenure of between 10 and 20 years have an average of $65,512 in their 401k plans.

If You Start Early, Time is on your Side

Remember: the earlier you start, the easier it gets. Dollars put away while you are in your twenties have up to 10 times the earning power of dollars saved later.

If you started saving six percent of your salary per year at the age of 25, based on a salary of $30,000, an employer match of 50% and an annual return of 8%, and you just left that arrangement on autopilot. Even without a raise throughout your life, you would amass $750,000. This is far more than the average 401k contains today. But our method combined with your growing salary may net you, believe it or not, something in the range of $2 million dollars. But if you wait until you are 40 to start saving, even if you save a much higher percentage of your income, odds are great you will never crack a million.

If you want to run a few numbers yourself, Bloomberg and CNNMoney offer online retirement calculators. Neither of these, unfortunately, allows you to model the stair-step method featured here.

Adjust Your Allocations as You Age

Consider sensible, yet aggressive, market allocations for the long haul. You do not need to restrict yourself to “investing your age” in stocks. This is an old rule that says whatever your age is, subtract it from 100, and that should be the percentage you have in stocks. That is too conservative if you are only 30 or 40 years old. According to US News, retirement savers in their 30s, invest roughly two-thirds of their portfolio in stocks. That’s too conservative. Many experts say you can put as much as 80 or 85% of your money in stocks at the age of 30. Find your comfort zone and then, as you get older, consider transferring some percentage of your holdings to your bond fund every year that stocks rise.

On the other hand, 100% in stocks is never appropriate. Studies show that a 90-10 stock-bond allocation is appreciably safer than keeping it all in stocks, while the investment return is just a fraction of a point less than an all-stock portfolio. And an 80-20 split doesn’t earn a lot less than a 90-10 split. Moreover, of course, it is less risky still.

Use Index Funds

John Bogle, the pioneering founder of Vanguard Investments, observed years ago that most people give up a good bit of their potential investment returns by chasing returns of previous winners and spending too much on investment costs.

Instead of trying to pick winners (which no one can do reliably over time), Bogle suggested the investor buy the entire market through an index fund and trade only to rebalance allocations for annual investment earnings and long-term risk adjustment. Thus, the birth of the couch potato portfolio—the amazing breakthrough designed to prevent the investors from becoming their own worst enemies.

Unfortunately, many companies do not offer index funds in their 401k plans. If this is the case, ask your company to introduce one or more. Mention Vanguard as an example. Their premier index fund is called the Vanguard Total Stock Market Index Fund. Other companies offer similar products. You will need a bond index fund, too.

Wise investors invest in international markets as well as U.S. stock funds. Often, you will see 20 to 25% of the amount invested in stocks allocated to offshore funds. There are other wrinkles as well, but you can get started with just three funds: a domestic stock index fund, an international fund, and a long-term bond index fund.

One important tip is to rebalance your portfolio at least once a year. If stocks have a good year and increase by 10 percent, your 75-25 stock-bond allocation will be knocked out of whack. It may look like a 77-23 portfolio by the end of the year. Transfer some of those earnings back to your bond fund to regain the 75-25 target allocation. This forces you to do what only the most brilliant investors do: buy low and sell high. (Other than rebalancing, resist the urge to tweak your allocations.)

Discipline helps in tough times. Even if your employer suspends the match, as many have done during the economic meltdown, maintain your Step One investment. Oh, and never borrow from your plan. Repeat: do not touch this money during your working years. You are better off taking a temporary or second job rather that raiding your nest egg. If you do, chances are very great you will never make it up. So make imminent starvation the bar for raiding the piggy bank.

Defined contribution retirement plans, or 401ks, are pretty much the only game in town when it comes to saving for retirement these days. Learning to invest wisely and sufficiently in a 401k will put you in the top echelon of individual savers. It will make you feel better about your money life. Saving for retirement is one of the Big Three economic commitments in life: retirement, house, education. So give it your best shot — one step at a time, one percentage point a year.

This is a guest post by Steve Klingaman, a nonprofit development consultant and nonfiction writer living in Minneapolis. Read more by Steve:

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Guest's picture

I'm really growing weary with articles which deal solely with or partly with saving early. Most people in their 20s are just getting going in life, having kids or buying a home. Saving is not their top priority.

So, I would like to see articles pertaining to saving when you reach your 30s. All the "save in 20s" articles is heap guilt on people when you don't or can't do it.

Tell me how much my savings are going to grow when I reach my 30s.

Guest's picture

As a 24 year old, I can appreciate where the author is coming from. Many twenty somethings are fresh out of college and making more money than they ever have in life. While some are more family oriented, some (myself included)are postponing home buying and starting families while they pursue careers or other interests; a consequence of this higher disposable income.

I don't know how many of my friends spend frivolously on nights out, clothing, cars, and exorbitant rents just because they don't have big financial obligations like kids or houses and many may not have these until their 30s. They're too busy living in the moment and spending beyond their means to plan for the future. If they'd just put aside a portion of that into a retirement fund, they'd be making an investment in a richer life in the future.

This article definitely inspired me to make wiser decisions with my money and I'll definitely share it with all my friends...of any age. It's never too early or too late to start saving. As they say, 30 is the new 20 and at 30 you still have a lot of time and money to contribute to a retirement fund.

Guest's picture

I agree with your thought would be nice for a reality-check article on when people DO start to save, and keying in on how to guide the 30-somethings in there financial and savings choices!

Guest's picture

On what planet are most employers still matching 6% for a 401K? This information sounds obsolete. Most match 2, if anything. And I agree- I too, am tired of articles on retirement that are aimed at 20 year-olds. Sure, 25 years ago I should have saved. I'll bet 90% of the people who clicked on this are 40 or over. 20-20 hindsight gets us nowhere. Address the readers actually worried about this.

Guest's picture

I'm 26, and I read this article. It's valuable to have a reminder to save for retirement. Terribly sorry that not everything can be tailored to people exactly your same age.

Linsey Knerl's picture

I'm 31, and just now starting to get serious with my retirement. On top of that, there is no 401K employer match available to me (I'm self employed.) That doesn't mean that I can't many of the principles in this article, however. They're still solid.. I'll just get a late start.

Linsey Knerl

Guest's picture

I have a feeling thanks to the current conditions, a good number of us youngsters will be reading this.

I just learned everything the article mentions several months ago and I already feel guilty for missing just one year (spent trying to live it up). So I missed being able to add $15k to retirements accounts with 4% match and I won't get that chance again.

Klingaman's points (sans indexing) are correct; time is a finite resource and has the greatest impact. It does suck for those with less time, but they still have time. Comment 2 definitely sums it up.

Guest's picture

Starting as early as possible saving money is always step number one. No matter how old you are, the time to start is today. On my personal debt eliminating blog, I talk about my path to becoming debt free and all the "secrets" to succeed. Building that nest egg can not wait until you have "extra money". START TODAY!

Dollars Not Debt

Guest's picture

As a 31 year old, I know I've missed my best savings window but that shouldn't deter anyone to begin saving RIGHT NOW.

If you are older, you are going to have to kick it up a notch. It really is true that time is your best asset but it's never too late to start.

For most of us, time is all we have going for us. Time is the way we working stiffs can get ahead in the world. Saving over a 40 year career with good interest rates will allow you to live comfortable into retirement. It's just a fact that the more time you have the better returns you will get on your money.

I'll admit it's a little bit of a guilt trip to hear it all the time when you have missed out saving in your 20's but the advice should get you motivated to start NOW, however old you are.

Guest's picture

It's like they say. It's all about starting as early as you can. If you haven't started, adopt the habit to day no matter how absolutely small.

Guest's picture

It's like they say. It's all about starting as early as you can. If you haven't started, adopt the habit to day no matter how absolutely small.

Guest's picture

Age 25, been saving since 16. Maybe we should stop focusing on ages, but I think it's important for young people to realize that "earlier is better." The site already posts its fair share of "later is better than never" stories, so why not something for the younger crowd?

I'll be forwarding this story to all of my 20-something friends!

If you feel like you can't save anything, this article probably wasn't meant for you. Attitude plays a HUGE role in personal finance. It doesn't matter what you earn - save 6-10%. Cut back on cable, trim your cell phone features, or eat out one less night per week. It's doable with the right mindset.

Guest's picture

I just learned everything the article mentions several months ago and I already feel guilty for missing just one year.

Guest's picture

I'm 22 and for the past year I've been saving 16% of my income in retirement accounts, up from 6% the last two years. I plan on raising that to 20% this year. Part of the problem is, I only make 20k a year, my employer doesn't match, and I'm trying to pay my way through school. Gas alone costs at the very least 10% of my income. I would like to save more so I could put a down-payment on a small house (in my area that would be cheaper than renting). Already I feel horribly frustrated that without a higher salary, there's not much I can do to save more money, but since I have to work full time it's taking significantly longer to finish school in order to get that better salary. Meanwhile, I have friends who are making much more than I am, but haven't put a penny of it aside. So it's somewhat amusing that though I am already frustrated about my finances 40 years down the road, I'm still better off than pretty much everyone I know around my age.