Would You Save More If You Knew How Much It Would Be Worth?
Two recent studies, one at the National Bureau of Economic Research (NBER) and the other at The Center for Retirement Research at Boston College, found that when people are better informed about what their savings will be worth in the future, they save more. Although both studies focused on younger savers, the results suggest that companies trying to encourage their employees (not to mention financial planners trying to encourage their clients) to save more for retirement would increase their success rate through a more detailed explanation of the results.
Why is this important?
Most significantly, the number of companies providing defined benefit pension plans for their employees is shrinking dramatically. A higher and higher percentage of Americans’ retirement assets reside in defined contribution plans, in which each individual is forced to make his or her own investment decisions. The consequences of making suboptimal choices are potentially large. At the same time, lifespans are increasing, putting more stress on the funds people are able to scrape together and invest for their retirement. And as if things weren’t challenging enough, Stephen Marche in Esquire magazine asserted recently that only 58 percent of Baby Boomers have more than $25,000 put away for retirement.
Therefore I would like to elucidate briefly on the value of saving for retirement. Let’s first assume that you can earn a relatively conservative 7.5 percent on your investments. Now, how much more will you have saved at retirement if, starting today, you save an extra $100 per month and you retire in the year:
• 2022: an extra $17,793. Not a lot, but it could buy you some pretty nice meals.
• 2032: an extra $55,373. Could mean quite a number of years of travel, entertainment, and fun.
• 2042: an extra $134,745. Now we’re getting into some serious money.
Here’s another way to look at it. Suppose you expect to be able to retire on $50,000 per year (in current dollars), and Social Security will pay you $20,000 per year. How many additional years of retirement living will the above savings provide you, assuming the inflation rate remains at a historical 3% per year?
• $17,793: Less than one year.
• $55,373: Two years.
• $134,745: Five years.
In other words, for people in the above situation, saving an extra $100 per month starting in their mid-30s should add a good five years to their retirement plan. Are you ready to start saving more now?