Retirement Plan Contributions Trump Market Performance

Retirement Plan Contributions Trump Market Performance

Quick quiz: Who will have a bigger retirement account balance after saving for 25 years?

Two employees, age 40, earn $100,000 per year and receive an employer matching contribution equal to 100% of the first 4% of contributions.

Batman:
Saves 10% of compensation each year and earns an annualized rate of return of 5%.

Robin:
Saves 4% of compensation each year and earns an annualized rate of return of 8%.

What is the answer?

Batman will have approximately $83,000 MORE than Robin at the end of a 25-year period.

But Robin had such great investment performance. Why does Batman have more money in his account?

Even though Batman’s investments had a lower rate of return, he had a higher balance in his account (because he contributed more) which allowed compound earnings to help him accumulate more over the 25 year time period.

Many investors make investment performance their primary focus when savings for retirement. While having a diversified mix of investments is important for long-term growth, your contributions will have a greater impact on your expected level of retirement income.

As we meet with retirement plan participants, we find that most are not contributing more than the amount required to maximize their employer matching contributions. Many employees struggle to allocate their financial resources to meet current expenses and save for the future. The solution for most is to hope that their investment performance will make up the difference. This type of behavior is common; however, most people do not realize that it will have a significant impact on their future account balance.

Show me the money!

How can you find the extra cash to increase your retirement plan contributions?

  • Contribute a percentage of your pay instead of a flat dollar amount
    • Most people set a contribution amount and never update it. By changing your contribution to a percentage of pay, your contributions automatically increase as you receive pay raises. This will help increase the total dollars being added to your account without requiring you to take action.
  • Figure out what the net effect of raising contributions will be on your take-home pay
    • Many people don’t realize that increasing pre-tax contributions to a retirement plan may not have as big of an impact on their net paycheck due to the associated tax savings. Many online calculators like those available at bankrate.com help you evaluate how increasing your contributions will affect your take-home pay.
  • Evaluate your current budget – can you live without some of those expenses?
    • Can you set your coffee pot at home to have coffee ready when you are leaving the house and save money on your daily coffee purchase?
    • Saving $5 a day adds up to an additional $35/week that you can contribute to your plan.
      • $35/week times 52 weeks = $1,860 per year you can add to the plan
  • Save for retirement before contributing to your child’s college education
    • Many parents don’t want to burden their children with large amounts of debt before they begin their careers. Unfortunately those parents are only hurting themselves. The last time we checked, we didn’t see any banks offering retirement loans but there are lots of places that offer financial assistance for students. Think of saving for retirement like the oxygen masks on an airplane. Secure your own mask first before helping others.

The hardest part about saving for retirement is finding the money to save. By keeping the focus on what you can control (your behavior) and focusing less on short-term investment performance you can position yourself to have a comfortable level of retirement income. Investments are an important factor in the overall plan; however it should be a secondary focus after you ensure you are contributing enough to your account.

Want to talk to a professional about how you can make the most of your retirement savings? Contact McLean today.

 

 

McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

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