The most important factor in retirement savings

“Wanna see something neat?” Kris asked the other night. She was holding the year-end statement from her work-based retirement plan.

“Sure,” I said. “Show me the money.”

She handed the statement to me. “Look at my account balance,” she said. “Look how it's grown. It went down a little bit in 2008, but because I kept contributing, the balance has gone crazy during the last two years.”

The balance in Kris's retirement account
Kris's retirement account took a hit in 2008, but rebounded in 2009 and 2010.

“How do you earn such great returns?” I asked. “I'll bet readers at Get Rich Slowly would love to hear.”

“Well, it's not just investment returns,” Kris said. “A lot of that growth is because I save so much. I max out the allowable contribution in this account. I started by contributing 8% of my gross [pre-tax] pay. When I got my raise the next year, I bumped that to something like 10%. Then 12% with the next raise. And so on.”

“What percentage do you contribute now?” I asked.

“I'm not sure,” she said. “Last year, I did the max, which is $16,500 a year. I'd contribute more, if they'd let me, but they don't, so I just invest it elsewhere. Like my Roth IRA and my mutual funds.” (All of Kris's investments are in mutual funds, but she calls one particular account her “mutual funds”.)

Kris smiled. “Pretty cool, huh?” she said. Yes. Yes, it is. Pretty cool, my savvy wife.

There are a number of great lessons here — including the wisdom of sticking with an investment plan even during a down market — but one in particular stands out. Kris' experience highlights the most important piece of the retirement savings puzzle: The number-one factor in determining how much you'll have at retirement is the amount you save. Please re-read that sentence, because it's not really as obvious as it may sound.

The economy, your choice of funds, your tax bracket — all of these play a role in your final retirement balance, but none of them is as important as how much you've actually set aside. All of the compounding in the world won't help you if you never save any money. But if you consistently save as much as you can, you'll be better able to weather market downturns — and take advantage of bull markets like the one we've enjoyed the past two years. The more you save now, the more you'll have when you need it.

The National Economy vs. Your Personal Economy

Last January, Get Rich Slowly and MoneyRates asked readers of both sites for their opinion about the current state of the economy. Over 1200 people responded. This January, we asked the same question and received nearly 2100 answers. The results are certainly un-scientific, but they're interesting:

Where do you think the economy sits right now?

  • Strong growth. Full steam ahead! 2010: 2%, 2011: 3%
  • On solid ground and growing some, thank goodness. 2010: 15%, 2011: 26%
  • Stagnant. Not growing, but at least not getting worse. 2010: 43%, 2011: 39%
  • Not horrible, but looks like it's going downhill. 2010: 20%, 2011: 17%
  • Free falling. I'm bracing for the worst. 2010: 21%, 2011: 15%

Regardless of the state of the national economy, it's important to remember that ultimately, you are responsible for your personal economy. When times are flush, you need to set something aside for the future – be it through a retirement savings plan, savings account, or other method. Then, when things turn dark and dismal, you'll be better shielded from the slings and arrows life hurls your direction. My wife, for example, has done a fine job of ignoring the world at large while trying to improve her own situation.

It's been a while since I stressed this point, so let me repeat what I've said before. A strong personal economy is built on personal-finance fundamentals such as these:

  • Clear financial goals
  • An adequate emergency fund
  • Limited use of debt
  • The practice of thrift
  • Smart investing for the future

The national economic situation will affect our personal financial decisions to some degree. When unemployment soars, it's important to maintain an adequate emergency fund and to limit your use of debt. When the stock market is down, you need to understand your investment objectives, and how these relate to your risk tolerance and your investment timeline. (And when the stock market is up — as it is now — you need to ask the same questions.)

Ultimately, all you can control are your personal finances. Take matters into your own hands: Save for retirement today.

More about...Retirement, Investing

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Derek
Derek
9 years ago

I love that graph of Kris’s mutual fund account. It only makes sense though. Since the market value went down in 2008, she was able to purchase more shares with the same amount of money. Now that the market has rebounded, she has many more shares, and therefore, a higher return. It definitely helped that she upped her contributions as well! That’s awesome!

brokeprofessionals.com
brokeprofessionals.com
9 years ago

The other great thing about what your wife did, is that she avoided making a bad decision (i.e. selling everything) during the downturn. She knew these things were cyclical, stayed the course, and now she is reaping the benefits–of both continuing to invest, and the appreciation inherent in the market rebound. It is a great reminder to just take the “free” money that is the 401(k) match/tax savings, and to save and hope for the best. There really isn’t anything else you can do anyway, because very few people will be able to save enough money for retirement without investing… Read more »

JRR
JRR
9 years ago

I did the same, as I got raises over the years, I increased the 401K withholding. One little caveat; if your company matches a percentage of the 401K withholding, and you’re hitting the $16,500 max before the last paycheck, you’re throwing away money. For instance, if my company matches 1/2 of my contribution up to 4%, and I don’t make at least an 8% contribution on the last paycheck due to the $16,500 limit, I just threw away a 4% contribution for that paycheck. This is something that I have ignored in the past, but it’s starting to become significant.… Read more »

Nicole
Nicole
9 years ago

Does Kris have 401(K)/403(b) investment options besides Ing? They have the Highest fees of any of the 7 companies my university contracts with. We’re talking a factor of 10 highest. On top of their already high individual fund fees, they throw in an additional 0.7% in fees. I was paying an additional $300 per year in FEES alone before I switched to Fidelity (that’s the difference in fees between Ing and Fidelity on the same index funds). Kris has more in her account than I did when I switched, so if she has other options she may want to look… Read more »

sjw
sjw
9 years ago

JRR @3 – I’m not sure why you need to look at that more closely, you aren’t leaving money on the table, you’ve already gotten the full amount you’ll get in matching. I guess you could contribute less each pay, and regularly allocate the other money elsewhere, but it sounds like that is what you ended up doing anyway.

Rick Marquis
Rick Marquis
9 years ago

I’m a little confused by this. If she is putting in $16,500 a year then for the 5 years listed here she should have contributed $82,500. And yet it shows a total value of $82,209. A loss of $291. Even if we just look at the last year, the difference in value is $10,394. Surely this fund is not gaining, but losing.

J.D.’s note: Hey, Rick. She hasn’t been contributing $16,500 for five years. She contributed $16,500 in 2010 (and possibly in 2009). As mentioned in the article, she’s been working her way up to that level.
Crystal@BFS
9 years ago

LOL, my husband was pretty surprised with what was in my 401(k) account and our Roth IRA account too. Like Kris, I kept contributing during 2008-2009, so we are doing pretty well (about $45,000 and I’m 28). Both accounts are up about 17% overall since starting them in 2005 and 2007 respectively. Even the long-term dividend stocks in our Scottrade account have done very well. Woot for retirement savings!

Everyday Tips
Everyday Tips
9 years ago

I loved opening our retirement statements this year! We contributed every year, regardless of how the stock market was performing. (Who can time the market anyway?)

I was doing some ‘net worth’ calculations the other day and I was just so happy with how well we have done this year, and a lot of it was actual market appreciation. Haven’t seen that in awhile…

Keep on saving!

Brian S.
Brian S.
9 years ago

Actually, the number one factor in determing how much money you’ll have at retirement is time. If you start saving and investing early, you allow for more time for your money to compound and grow. The different between starting when you’re 20 and starting when you’re 40 is huge. Even if you save far more when you’re 40, it can be hard to make up that difference.

Mom of five
Mom of five
9 years ago

Quite frankly, I’m finding this whole thread a little depressing. We’ve been maxing out our retirement for a few years and we’ve only recently surpassed what we had in there prior to the crash.

Panda
Panda
9 years ago

I took the same approach to my 401. Started it at the level I could afford (I think it was 10%) and then banked each raise until I was maxed out. Now as I get raises I decrease my 401 % a little, increase my % in taxable accounts, and keep a little for myself.

JRR
JRR
9 years ago

@sjw #5 – no, I am leaving money on the table. I’m hitting the maximum personal contribution of $16,500 in November, which means I spend 3 paychecks not getting the 4% copay that I would normally get from the employer. My employer matches up to 4% of my gross pay in contributions to my 401K, as long as I made at least the same amount of contributions on that paycheck. Therefore to get maximum copay contributions, I must contribute at least 4% of my pay to my 401K on EVERY PAYCHECK. I make 15% contributions, and get a 4% copay,… Read more »

Vanessa
Vanessa
9 years ago

I haven’t stopped contributing completely, but I’ve been tempted to. In 2009, my company had two weeks of furloughs and froze raises. This was preceded by a mass layoff at the end of 2008. We had another week of furloughs last year and currently have one in this quarter and there are rumors of more layoffs in the spring/summer. I have cut my Roth contributions in half to $100/mo and I contribute only enough to get the company match for my 401K. I know that time is everything when it comes to saving for retirement, but my focus for the… Read more »

retirebyforty
retirebyforty
9 years ago

I agree with this to some degree – The number-one factor in determining how much you’ll have at retirement is the amount you save. The amount saved is extremely important early on. We max out 401k contribution every year and our portfolio has recovered nicely as well.
There will a point when performance gain will eclipse contribution. When we get to that point, performance will be more important than contribution. The amount saved is extremely important early on though and you still need to put away a lot to get to that point.

Will @ HackingTheBank.com
Will @ HackingTheBank.com
9 years ago

Seeing this makes me yearn for the opportunity to invest in my 401k. I’ve chosen to invest in my Roth and pay down debt for this year because my employer’s matching is pretty paltry. However, once I’m debt-free and maxing out the Roth, you can bet I’ll be adding to the 401k in significant amounts. Can’t wait.

HollyP
HollyP
9 years ago

Hurrah for Kris!

I too was pleasantly surprised by my 401k account balance this year. I’m now back to having at least 100% of every dollar contributed to the account… Now I’m looking for increase in value.

Dominic
Dominic
9 years ago

Hey JD,

Here’s a great NYT article about the importance of savings and not relying on ROI.

From The New York Times:

YOUR MONEY: With Retirement Savings, It’s a Sprint to the Finish

You can save all your life, but those last years before you retire will determine the result.

http://nyti.ms/gqzMwv

Brett Yonally
Brett Yonally
9 years ago

Nicole @ #3: I completely agree I just read “The Smartest Investment Book You’ll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals” and have almost finished “The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns ” and am currently on a low fee fund kick. Both of those books greatly tout low-cost index funds. The fact that ING adds on 0.7% is crazy, a lot of vanguard funds don’t even have that high of fee for the whole fund. But that is all besides the real point,… Read more »

Steve-Personal Success Factors
Steve-Personal Success Factors
9 years ago

What’s interesting for me to read is how really basic all of this is. We complicate it with our many myth-understandings about money and laziness in facing our finances. (I speak to myself here as well). Once we do get to work with a budget (and daily tracking is key, I believe), we can then work on our financial goals, including saving and giving to our maximum abilities.

KAD
KAD
9 years ago

Funny, I was just thinking about that yesterday, thanks to this article in the NYT showing how heavily dependent the standard retirement planning scenario is on the compounding rate of return in the final ten years of investment:

http://www.nytimes.com/2011/01/22/your-money/401ks-and-similar-plans/22money.html?src=me&ref=general

Brett Yonally
Brett Yonally
9 years ago

Is the max of $16,500 just for for employee contributions or is that total? My employer puts a lot into my 403(b) and up to now I have just been putting my own contributions into a separate Roth IRA due to fears of maxing out the 403(b).

Simon
Simon
9 years ago

A couple of points to the comments: 1. Determine if your 401(k) matches every check or annually. There are different types of plans – the annual match makes the timing of contributions less important. 2. The “cheat” to get more than $16,500 into your 401k if you have a regular 401(k) is to use the Roth Option. If you’re in the 25% marginal tax bracket you can squeeze the equivalent of 22,000 (22,000*(1-.25)=16,500) of pretax money in your 401k and have no tax liability in retirement. Any match will be taxable in retirement, but it’s a great method of contributing… Read more »

JRR
JRR
9 years ago

@Brett: The $16,500 limit is on your contributions, excluding employer contributions. At age 50, you become qualified for “catch-up” contributions and can start contributing $22,000 annually.

Tyler Karaszewski
Tyler Karaszewski
9 years ago

A couple of things: 1) “The number-one factor in determining how much you’ll have at retirement is the amount you save. Please re-read that sentence, because it’s not really as obvious as it may sound.” I think it’s entirely obvious, but that’s been undermined by finance writer after finance writer trying to illustrate compound interest by telling us that the money we spend on an iPhone would work out to $60,000 by retirement age. People see a $200 price tag on an iPhone, and the graph above, and figure that saving $82,000 will be *easy* if they just wait a… Read more »

Pat S
Pat S
9 years ago

Awesome! Thanks for this post. A great lesson on the day to day impact of dollar cost averaging into our diversified portfolios.
Pat
http://compoundingreturns.blogspot.com

Ely
Ely
9 years ago

I had the same experience. My accounts dipped in 08 but I ignored them and kept contributing. They sure look pretty now. I am nowhere near the max though, so there’s room for improvement. 🙂

Pat
Pat
9 years ago

J.D. – First of all, congratulations to you and Kris. You guys did the right thing by staying the course during tough times and calmly riding the wave while everyone else was panicking and buying gold. I think you got a major point wrong in this article though and should seriously consider some additional clarity- The #1 most important factor in retirement savings is TIME. The “cost of waiting” between 20 and 30 is enormous. Contributing the max from 30-60 won’t catch you back up to where you would be if you had started 10 years earlier. The power of… Read more »

Charles
Charles
9 years ago

Thanks for posting what many of us wish we can say to friends who bail out of their mutual funds during down times. I’ll make sure to send them this link the next time they ask if they should stop contributing to their 401k.

Dollar cost averaging!

J.D. Roth
J.D. Roth
9 years ago

I hear you all on the “time” thing, and I weighed it heavily. But you know what? I still think contributions trump time. You have to have the contributions. Without them, the time doesn’t matter. And the more you contribute, the more time works in your favor.

I’ll admit that I could be wrong — I often am! — but for now, I maintain that what you save is more important than how long you save it for. (Though the two are tied together!)

Rob M
Rob M
9 years ago

Other than this past quarter, the mutual funds appear to have performed rather poorly. I you add up all Kris’ contributions since she started, what is the total compared to 82k? It looks to me like she would have been better off putting the money in CDs. J.D.’s note: Really? You think they’ve done poorly? They’re up $26,000 or so in each of the past two years, which means they’ve had growth of nearly $10,000 in each of those years (beyond Kris’ contributions). Of course, the stock market has risen by nearly 75% in the past two years, so you’d… Read more »

Chett
Chett
9 years ago

To illustrate JD’s last point, would you rather have a 20% annual return on $10,000 or $100,000?

There is a quote about luck that says something like “Luck is when preparedness encounters opportunity.” When the upswing in the market comes, and you have a larger balance in your account (because you’ve saved more) you have a greater opportunity for a larger financial return.

Shawn
Shawn
9 years ago

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

This Warren Buffett quote says it all. Kris kept her cool and not only stood her ground, but got even more aggressive when the markets were falling. An Investors biggest enemy is himself. Despite knowing that we should be buying Low & Selling High, most people instinctively do the opposite. I wish I had been even more aggressive during the downturn, it was the sale of a lifetime.

PawPrint
PawPrint
9 years ago

#12 JRR, one of the things we do yearly is call up the company that manages the 401(k) and get them to figure out the percentage monthly contribution to make sure we get the equitable employer match. We, too, were leaving money on the table until I started doing this. I decided to let them earn their management fees.

Tracy
Tracy
9 years ago

Hey –

I’m curious what amount one should have in one’s 401k at key years (let’s say 25, 35, 45, 55, and 65) to retire with 1 million dollars say. Does anyone know?

Thanks, Tracy

Pat
Pat
9 years ago

Chett-

Of course I’d rather have an X% return on $100,000 vs $10,000. That’s obvious. No disrespect intended, but you’re asking the wrong question.

The RIGHT question is:

Person A invests $10,000 per year starting at age 25 and earns an average annual rate of return of 8% over 45 years.Person B invests $15,000 per year starting at age 35 and earns an average annual rate of return of 8% over 35 years.

Who has more money at retirement?

Answer:
Person A: $4.4M
Person B: $2.65M

Time matters more than contributions in 99% of cases.

Shawn
Shawn
9 years ago

#34 Tracy – You can use a savings goal calculator to determine how much you should be contributing to hit $1 million. It depends a lot on your level of risk, current balance, contributions, and years until retirement.

http://www.bankrate.com/calculators/savings/saving-goals-calculator.aspx

bethh
bethh
9 years ago

Kris is doing awesome! I’ve been saving diligently since I was first eligible for a 401(k) at age 27. Right now I’m contributing 16%, and my employer puts an additional 4%, so I’ve been doing 20% of my salary for several years now. But now you’ve got me thinking I should be doing even more, as I’m not nearly maxing out the 16,500. Really I ought to be Roth-ing it but it seems so much easier to put the money in pre-tax. But if I DO save more for retirement it’ll be at the cost of saving for a house… Read more »

Tyler Karaszewski
Tyler Karaszewski
9 years ago

Pat’s assumption of a guaranteed 8% return is as wrong as anything else mentioned in this discussion. Sure, you’d rather get higher returns. You’d also rather save more per year, and you’d rather have more to save. These are obvious. But the number of years you spend saving, and the amount you save each year are controllable by you. The annual rate of return (for investments like stocks) is entirely outside of your control. Time matters more than contributions for 99% of cases that take place between 1930 and 2010, which includes 100% of the examples that can be cited,… Read more »

Pat
Pat
9 years ago

Tyler – Don’t get stuck on the average annual rate of return of 8%. If you go down to a very conservative 4% using my example, you’ll see the same result. The extra time produces a compound benefit that extra contributions just cannot overcome. “Will the average rate of return on American stocks between 2010 and 2055 be similar to the rate it was for the last 75 years?” No argument from me that the overall total change will be different for us, but if you’re betting that the market is going to LOSE over the long term, you’re making… Read more »

J.D. Roth
J.D. Roth
9 years ago

Kris has had a chance to run the numbers. She’s contributed roughly $67,000 to this plan since she started in 2004. Its balance is now $82,000. So, her money has seen $15,000 in growth. (To figure out internal rate of return, we’d have to have all of the data about when she contributed and how much. I don’t know if she has that data.) And to emphasize Pat’s point, the longer she leaves the money in this account, the more it should grow. If she can go 25 years without touching it, compounding (and time) will likely become a more… Read more »

BrentABQ
BrentABQ
9 years ago

Bottom line is that you have no way of controlling the market, but you do your contributions. Do what you can to give yourself the best chances later in life.

Nicole
Nicole
9 years ago

I was mentally putting contributions and time together. Save early, save often, just like working on the computer! 🙂

Adam
Adam
9 years ago

I’m 34 now, currently contributing 6% but get 4% from my company and another 3% matching for 13%, plus 7.5% every year as part of profit sharing right into my DC plan for 20.5%. So I hope that’s enough, I have only been contributing since I was late 20s though and right now have about $50k in there but will double that in the next 2 years thanks to a massive promotion. All the calculators I use have me on track for a decent retirement, but I question them in light of that article posted above! I definitely hope to… Read more »

Chett
Chett
9 years ago

Pat,

I’m aware of the time value of money concept. Invest $10 and let it compound over 60 years, I’ll invest $10,000 and let it compound over 60 years. The amount does matter. That was my point.

Jackie
Jackie
9 years ago

I think the moral of the story should be save now and save often, with a dash of “don’t panic” thrown in for good measure. It takes guts to keep investing (and to go further by increasing) contributions when everyone around you is proclaiming that the sky is falling. Good job to Kris 🙂

Cam
Cam
9 years ago

#34 Tracy, kiplinger had an article about that back in 2007 so some of their investment allocation advice might be a little off, but it still gives you an idea of how much starting early changes things.

http://content.kiplinger.com/features/archives/2007/01/savings.html

chacha1
chacha1
9 years ago

Just for the sake of stirring the pot, I’d like to point out that making some deliberate choices re: employers can also have an enormous impact on the success or failure of your retirement plan. Between 1989 and today I’ve accumulated over $110K in a 401(k) plan. It’s not the first plan I ever had. I signed up as soon as I was eligible with my first law-firm employer. I eventually rolled over the 401(k) to the plan of a new employer – also a law firm with profit-sharing. For eight years, that plan grew by $10K a year –… Read more »

Tara C
Tara C
9 years ago

Like Kris, I stayed the course and maxed out my contributions, and I’m very pleased with my 401K balance right now! I have been saving for a long time and things finally seem to be hitting critical mass now after 25 years of working and 20 more left to go… I hope it continues!

Cath
Cath
9 years ago

I think it is just as important to stress “contributions” as it is “time”, as we’re not all in our 20’s. If you’re reading GRS at age 40 and not quite on track for a safe retirement, it is far easier to find ways to contribute more money than it is to find ways to go back in time and start earlier!

Lulu
Lulu
9 years ago

Thanks to everyone for taking the time to comment. As someone in her 20’s who has a good chunk of money in my retirement, I am just thankful to have had great advice and discussion like that at GRS. My mother is constantly congratulating me on all of the “great choices” I make that she didn’t, but I can’t help wondering if she would have made the same choices had she come of age during this period of endless information and discussion. I think what we all know is that you can’t go wrong if you save something and start… Read more »

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