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The Importance of Saving for Retirement

| December 10, 2019
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The thought of retirement can be exciting but planning and saving for retirement should begin well in advance. This article will examine three main reasons why you should begin saving as early as you can, and saving as much as you can - leading up to retirement.  

Today, people are living longer and healthier lives. People are living into their 80’s, 90’s, and some are even living to see over 100 years. The ability to be financially independent and for work to be a choice comes with having the correct amount of money to supplement/replace your current income with retirement income. As a rule of thumb, when people ask how much money should be saved for retirement, you should be able to replace 75%-85% of your current income with retirement income, which can come from a variety of sources.

 Why is it important to save?

Inflation

Inflation is a quantitative measure of the rate at which the costs of goods and services in an economy increases over time. With an increase in the cost of goods in services, the value of the dollar will decrease. In other words, a unit of currency will now buy less than it was able to buy in a previous period. As an example, say the cost of lunch today is $12.75. We can expect that in 20 years, with an inflation rate of 3%, that the cost of lunch will be $27.94. The important thing to realize regarding inflation is that you want to be able to afford the costs of these goods and services 20,25,30 years down the road. One way to do that is by investing your money in a place where it can grow and outpace inflation (ex. stock market).

Compound Interest

Compound interest (interest growing on interest), is an extremely powerful principle, especially when it comes to investing and saving. This principle is particularly focused on the idea of beginning to save as early in your life as possible, allowing compound interest to take place for a longer period of time. The earlier you begin saving, the longer the amount of time that money has to grow. For example, if you save $2,000 per year from age 25 to age 65, you will have a total of $328,095, which comes from contributions and earnings (assumes 6% interest rate). Had you decided to begin saving at age 30, and put away $2,000 per year until age 65, you would have an approximate total of $236,242. So, by waiting 5 years to start investing (rather than starting at 25), not only are you missing out on the $10,000 in contributions, but you are also missing out on $81,853 in lost earnings. You can make up that difference of $92,853, but in order to do so, you would either need to save five years longer (up to age 70) or increase your annual contributions from $2,000 to $2,778.

Social Security

Social Security is a program run by the Federal Government, and provides four main types of benefits: retirement, disability, supplemental security income (SSI), and benefits for spouses or other survivors of a family member who has passed. Many people rely heavily on social security in retirement. Social Security was never intended to cover all of your retirement income needs, and therefore it is important that you have other types of retirement income available to you to make up the gap between your Social Security income and needed expenses (employer sponsored plans/401(k)s, IRAs, real estate, etc.).

No one has ever said that they have saved too much for retirement!Hopefully this article helps you understand a few reasons why it is important to begin saving as much and as early as you can. Make savings a habit, so that you can live a life of financial independence, make work a choice, and be able to retire comfortably.

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