Saving money for your future may not be sexy; buying a new car, the latest cell phone, or a new wardrobe might be more exciting. New stuff might impress your friends and make you happy at that time, but this won’t help you later in life; buying all these goods may allow you to keep up with the Jones, but it could land you in the poor house when you reach retirement age.
There’s been an uptick in Americans’ savings rates of late. As you can see from the chart below, courtesy of the Federal Reserve Bank of St. Louis, Americans are saving more today than they were a few years ago during the Great Recession of 2008-2009.
US. Bureau of Economic Analysis, Personal Saving Rate [PSAVERT], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/PSAVERT/, August 16, 2015
Savings rates for Americans may be on the rise, which is great to see, but this positive looking chart may be a bit deceptive; this savings rate is likely not enough cash to help most Americans retire comfortably. The Personal Savings Rate is the amount of money, expressed as a percentage, which someone deducts from his/her disposable personal income to set aside for retirement; just a fancy way of saying how much money someone saves from their free cash — the money they have left over after paying their essential expenses (i.e. rent or mortgage, utilities), or even simpler: current income minus spending.
As many Americans spend nearly as much as they make, there isn’t necessarily much money left over for savings. Consequently, even if your Personal Savings Rate is 10%, but the money left over leaves just a thousand dollars or so, a 10% savings rate doesn’t amount to all that much money being put away for the future.
Instead of looking at the Personal Saving Rate, I would rather concentrate on the percent of cash being set aside for investments from your gross wages instead of from your available cash.
Vanguard, one of the largest mutual fund companies, presented a report recently on savings rates. Based upon data accumulated from those people with have investing accounts with Vanguard, the average savings rate is 7%; that’s 7% of gross wages, so if you earn $50,000, that means that you would be socking away $3,500 every year for your future. That’s a much better figure than the 5% Personal Savings Rate the the St. Louis Fed depicted.
The main difference is that no everyone is investing their money. Vanguard indicates that the amount of money that people set aside to invest increases (a) as they get older (b) the more money they earn (c) the longer they are employed with one company. The savings rate does vary much based upon gender.
It is unfortunate to see the the percentage that people contribute increases as they age; while it’s great to see that people are setting aside more money for their future, ideally they would start saving and investing as early as possible to take advantage of the compounding effects that time affords you. The more time that you have money invested, the more it will work for you.
One of my favorite examples of this compares two people: one starts investing at 25 and invests $10,000 a year until she turns 35, then stops investing and allows time and compounding to work for her. Conversely, her friend doesn’t start investing until he turns 35, then he invests $10,000 a year, every single year, for the next 30 years until he too reaches his 65th birthday.
When the two people reach their 65th birthday, who do you think has more money? She started early and invested a total of $100,000 by her 35th birthday and didn’t invest anything afterwards or he, who started 10 years later and invested a total of $300,000? She would; not only would she have amassed more money, but she would have over $300,000 more!
The good news is both parties would be millionaires by the time they retired; she would have $1.7 million and he would have over $1.3 million. This hypothetical example assumes that all of the money was invested in an S&P 500 index fund (not necessarily at Vanguard, but they are a great choice), and that the fund returned 8% a year, which is roughly its historic average.
(Caveat: past performance is no guarantee of future results, consult your investment advisor before investing any money; the information presented here is theoretical and should not be construed as personal investing advice.)
source: American Advisors Group via Flickr
She ended up with more money because time worked in her favor; the more time that you have to allow your money to compound, they more impressive your nest egg might look.
Start saving for retirement as early as possible. Put aside as much money as you can. You will be happy when you retire.