Make saving a lifelong habit
If retirement planning is a race, a smart approach to help you get to the finish line is generally not sprinting—but rather starting at a smart, steady pace and not slowing down.
"There's a huge benefit to investing early and sticking with it," emphasizes Michelle Fuller, an employee benefits advisor at Steward Sneed Hewes, a division of BancorpSouth Insurance Services. "You can really see the snowball effect of investing over time."
There are two primary reasons behind the snowball effect: the power of compounding and an investing principle known as dollar-cost averaging. Here's how they work.
The power of compounding
- You have the potential to earn returns on your returns. Compounding is the ability for investment returns to earn potential returns of their own. So over time you can make money, not only on your original investment but also on your accumulated gains from earlier years. Generally, the longer you hold your money in the account, the greater the potential your assets have to grow.
- The effect can be dramatic. Over time you let the power of potential compound earnings work for you. The more you contribute, the more these savings may perform for you. A few dollars a week now may make tens of thousands of dollars of difference in retirement.
An example: This chart shows the potential impact a small increase in contributions to the plan could have on retirement savings for a worker with a $35,000 salary.
|Additional contribution||Reduction in take-home pay per week||Projected savings at retirement|
This example is for illustrative purposes only. The assumed rate of return in this chart is hypothetical and does not guarantee any future returns nor represent the return of any particular investment option. This chart assumes a 25% tax bracket, which includes local, state and federal taxes. Assume $35,000 in annual income, 30 years to retirement, and an annual 8% rate of return. Reduced take-home pay is accurate for the initial year and would change based on participant’s annual pay. Chart assumes a 4% annual pay increase.
- Compounding may be even faster in a tax-advantaged account. Earnings in a traditional employer-sponsored retirement plan or Individual Retirement Account (IRA) may accumulate without being taxed until they're withdrawn. That means there could be more retirement funds in the account to accelerate the power of compounding. Moreover, earnings in a Roth 401(k) or Roth IRA can potentially grow tax-deferred, and if certain conditions are met, distribution can be tax-free.
- You'll be glad you started early. One-third of employees surveyed in The Principal Well-Being IndexSM for the second quarter of 2010 said not starting retirement saving early enough was an impediment to their financial goals. Many have taken the lesson to heart: One in five has boosted retirement saving since the recession began in 2008.
- Slow and steady investing may help offset volatility of the market. If you repeatedly invest the same dollar amount, the idea is that you'll buy fewer shares when prices are high and more when prices are low—and your average cost will land somewhere in the middle.
- It's easy. By participating in your employer's retirement plan or setting up regular contributions to an Individual Retirement Account, you are taking advantage of dollar-cost averaging automatically. Systematic contributions are being made to the retirement plan without you having to remember.
- You'll develop the habit of saving. Even if you start small, setting aside something with every paycheck will build a lifelong saving routine.
Take the next step
If you’re already taking advantage of compounding and dollar-cost averaging in your employer’s retirement plan, you can help make it even more powerful by increasing your contribution percentage.
Michelle Fuller and Steward Sneed Hewes, a division of BancorpSouth Insurance Services are not affiliated with any member company of the Principal Financial Group.
Dollar-cost averaging involves continuous investing. Investors need to consider their ability and willingness to continue investing through periods of low price levels. This does not assure a profit nor protect against loss in declining markets.