The Power of Saving Just 1% More

When it comes to saving for retirement, the sooner you start, the better off you will be, thanks to the power of compounding. The idea is that the more time you give your investments to work, the more you will be able to increase the gains from that original investment. It turns out that saving a little extra each year in a 401(k) or other retirement plan can also go a long way toward having enough money to fund your retirement. (For more, see The Effect of Compounding.)

It’s particularly important because retirees can easily spend more than 20 years out of the workforce. Without enough retirement savings people will have to overhaul how they live out their later years, which could mean downsizing their living arrangements, foregoing hobbies and even cutting back on daily necessities.

1% More Can Go a Long Way

Aiming to illustrate how boosting your savings rate can have a big impact, Fidelity Investments examined the benefit of increasing a 401(k) or 403(b) savings account by 1% for people age 25 to 55. Each group saw an increase in estimated monthly retirement income. Needless to say, the 25-year-old saw the largest gains because there was more time for the money to work.

When Fidelity looked at a 25-year-old earning $40,000 who increased the money going into a 401(k) account by 1%, retirement savings increased by $190 a month. Taking that same example, Fidelity looked at the impact of increasing the savings rate by 1% every five years – a total of 5% over 25 years. The result was a $690 increase in monthly retirement income. If that same 25-year-old increased the savings rate by 1% annually for a total of 12 increases, he or she could get $1,930 extra in retirement savings each month. The examination highlighted the need not only to save but also to increase the amount socked away each year. (For more, see Retirement Planning: How Much Will I Need?)

Had that same 25-year-old delayed starting to save for retirement because of debts and expenses, it would have meant a lot less money when it came to retire. Not to mention that if a company offers a 401(k) contribution match, an employee is leaving free money on the table by not taking advantage of it early on. It’s the reason most experts say people should contribute enough in their 401(k) to at least take advantage of the full match. (For more, seeHow 401(k) Matching Works.)While starting sooner reaps the biggest gains, older people who put away more money for retirement each year will also see increases in how much they amass. Fidelity chose to use the millennial example to highlight how important a role compounding can play. It also illustrates the need to put away money for retirement even when you are just starting out and struggling with student-loan debt and other bills.

“We know life is expensive and people have competing financial pressures,” said John Sweeney, executive vice president at Fidelity, when announcing the findings. “This research clearly demonstrates the impact making small savings improvements can have on a young person’s retirement funding. The more regularly you can set aside money from your paycheck at an early age, the more grateful you may be when you retire.”

The Bottom Line

Retirement is one of the biggest expenses people face, and in order to maintain your lifestyle it is going to require a lot of planning and saving. (Have You Done Your Retirement Arithmetic? will help you accomplish this.)

The sooner you start to save, the better – thanks to compounding – but it’s also important to put away more money each year. Of course life can get in the way, but as Fidelity Investments illustrated, even saving just 1% more each year can go a long way toward having enough money when it's time to kick back and stop going to work.

By Donna Fuscaldo

Source: http://www.investopedia.com/articles/personal-finance/022416/power-saving-just-1-more.asp