How to save money for retirement

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One of the joys of working at a brokerage firm is that people are always asking me for investment advice or telling me about how they don’t trust their broker.

Probably the most frequently asked question is, “how do i save money for retirement?”

First, I tell them to follow these 4 steps to retirement savings, and then I tell them not to worry about your rate of return when you are starting out. Yes, it is better to get 12% on your money than 8%, but when you are just starting your retirement savings it should be the least of your concerns.

Let me preface this by saying, this advice is for beginners who are intimidated by saving for retirement to the point of DOING NOTHING. This is what I suggest to keep them from worrying about which mutual fund to buy when they are starting out.

The biggest hurdle for most people is saving money. As Dave Ramsey would say, it is a behavioral problem, not a money problem. Getting in the habit of consistently saving is far more crucial to your success than getting a better rate of return (at the beginning). Let me show you why:

Let’s say you start saving $100 a month towards retirement. When you first start investing, the $100 a month contribution is going to have a larger impact on the size of the total amount saved than your rate of return.

For example, if you have $1000 saved up and add $100, you now have $1100 – which is a 10% increase. But if you have $10,000 saved and you add $100, it is only a 1% increase. Once you have $100,000 saved up that $100 monthly contribution becomes even more insignificant; it is only a 0.1% increase.

So, if you are only increasing your account value by .01% each time you contribute, then it would not be nearly as effective as having a 12% rate of return.

As you can see the importance of consistent contributions is CRUCIAL in the beginning stages, but becomes less significant as your nest egg grows in size. Conversely, your rate of return on your investments starts out with little importance, but becomes CRUCIAL as your nest egg gets larger.

So, if you are a beginner, get started saving and you can take your time learning about which mutual funds are going to give you the best returns.

{ 2 comments… read them below or add one }

rose August 23, 2007 at 7:55 am: i completely agree with dave ramsey! i’ve had to teach myself how to not spend all the money i have in one afternoon. but the rewards of learning that lesson are far greater than the joy of one afternoon of spending pleasure–even though you don’t feel it at the time.
bob August 23, 2007 at 9:16 pm: @Rose

Yea, some of these lessons come with a price – but, as you mentioned the rewards really are worth it!!