Building a nest egg can be daunting. Even with a modest goal like $500,000 in savings, it can be difficult to imagine saving up a sum like that, especially for many Americans making less than one-tenth of that figure per year.
However, the good news is that — with smart saving and compounding interest — you could be closer than you realize. In fact, something simple like putting away as much of your salary as you can each pay period and maxing out your 401(k) plan is the first critical step toward saving nearly $500,000 or more for retirement, according to Leon LaBrecque, CEO of LJPR, a fee-only financial advisor and wealth management firm based in Troy, Michigan.
The Best Way To Save For Retirement
LaBrecque has helped some clients save well over $500,000 for their futures and believes he has found a solid formula for wealth accumulation: Simply save a larger percentage of income.
LaBrecque recalled how one client approached him in the early 1980s and said, “Just give me something simple to do.” LaBrecque responded, “Save 18.7 percent of your money in the Vanguard Windsor Fund.” In 20 years, the client had amassed a whopping $2.5 million.
The client, who had all of his Vanguard statements stacked up unopened, was happily surprised. “I’ve been on the 18.7 percent solution ever since,” said LaBrecque, who noted that the figure includes employer contributions. “So, if your employer matches 5 percent, your job is to save just 13.7 percent.”
Let Compound Interest Do the Heavy Lifting
The previous story illustrates something essential: Much of the work of building your retirement fund isn’t actually done by you. If you’re hoping to hit close to $500,000, you’ll need to count on the steady returns produced by investing in a diversified mix of stocks and bonds.
An individual making $67,521 a year — the most recent national median household income — and investing 18.7% of their salary with an 8% rate of return compounding annually would reach the goal of $500,000 in just under 19 years. Hold on until year 26 before retiring, and that figure will have ballooned to $1.2 million.
So, although the key first step is entirely on you, the good news is that the majority of the work afterward is mostly hands-off.
Why You Probably Need Nearly $500,000 for Retirement
You might ask yourself, “Do I really need almost $500,000 in retirement savings?” The answer depends on your lifestyle and whether you want to maintain it in retirement. If you’re planning to continue living high on the hog through your golden years, even $750,000 or $1 million more in retirement savings might not be enough.
Getting to your retirement goal is doable if you start early, know how much to put away and understand how to withdraw funds in a disciplined fashion, usually at a rate you’ve worked out with your financial advisors.
Cost of Living Matters
Of course, no one can answer the question of “How much do I need to retire?” until they’ve carefully considered their anticipated expenses. This can mean that — if you want to live somewhere with a high cost of living — you will need to save even more.
For instance, a GOBankingRates study found that a $500,000 nest egg would last fewer than six years in high-cost Hawaii but over 12 years in Mississippi.
“If you are living in a metropolitan center [and] are middle-class making at least $75,000 per spouse, you probably need $1 million or more,” said Todd Rustman, a certified financial planner and managing partner of Clarity Capital Partners in Newport Beach, California.
Living outside of pricey cities could mean you need less, but getting to at least $500,000 can mean more flexibility in deciding how to spend your retirement.
The good news is, even if you’ve decided you need considerably more than $500,000, the methods for getting there are pretty similar. Here are five simple steps to help you get to your retirement goal.
1. Check Out Your 401(k) Match
Go to your benefits director and find out how much your employer will match in your 401(k) or other retirement savings plan, Rustman said. Then, put as much money into the 401(k) plan as you can to earn the maximum match.
LaBrecque agreed that it is foolish to pass up the match. “Free money is free money,” he said. “And the match is free money.”
2. Save Half of Any Raise You Get
If you get a 2% raise, increase your 401(k) contributions by 1%, LaBrecque said. Keep doing this with every raise you get. “Don’t just increase the sum you put into the plan, but increase your percentage contribution as well,” he said.
3. Don’t Freak Out When Markets Tumble
Sometimes, the stock market experiences a downturn, causing some investors to panic and immediately sell their stocks. However, dumping your stocks is often a huge mistake.
“Don’t quit. Don’t stop,” LaBrecque said. “I’ve seen people stop their 401k in down markets. Awful idea. Down markets are sales. We buy steak on sale and clothes on sale. Make investments on sale.”
In other words, a down market can be a chance to buy at a discount. Also, remember that saving for retirement is a long-term process. Eventually, the stock market will recover — and so will your investments.
4. Invest Your Tax Refund
Next year, don’t use your tax refund to splurge on a flat-screen TV, a new pair of shoes or a last-minute vacation. Instead, invest your tax refund to help you reach your retirement fund goal.
“I see folks who claim they can’t save for retirement, yet get a $2,600 refund,” LaBrecque said.
Direct deposit is not only the “best and fastest way” to get your tax refund, according to the IRS website, but it can also help you resist the urge to spend your tax refund on nonessentials. You even have the option to split your refund into two or three additional financial accounts — including an IRA.
5. Invest In Yourself
Taking classes, earning an MBA or doing whatever you can do to increase your value as a professional can all pay dividends in the long run, according to Rustman. You’ll earn more, which should mean you’ll be able to invest more. You might not even have to pay for the classes out of your own pocket as many employers will foot the bill for the classes.
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Joel Anderson contributed to the reporting for this article.